Nik Bhatia (00:04:11):
The interesting thing is that at the time, the Florentine Mint creating the gold florin coin meant nothing because hundreds and thousands of governments and empires and kings had created coins before that point. Gold points came to be about 700 years before Christ. So 1900 years had passed before the Florentine Mint created the gold florin. What was remarkable about the florin was that it went unchanged in purity and weight spanning for centuries, for over 300 years.

Preston Pysh (00:04:52):
Which is mind-blowing. I mean, the thing that wasn’t the base for centuries to me is nuts. So when you were reading about this, what caused that to last for so long because nowhere throughout history we’ve seen something that wasn’t the base for three centuries?

Nik Bhatia (00:05:09):
I think it came to the form of government. So it was in a post-feudal society. And these city republics across Northern Italy, Florence, Venice, Genoa, Pisa, they all had mints and they all had coins that lasted quite a while. So it wasn’t even specific to Florence. Florence was just the one that got the network effect as in our modern terms. It’s the one that got the network effect across Europe. But I do believe that from what I read and the history of Renaissance Florence is that it was this post-feudal society that allowed this Republican form of government to lead to this type of stability.

Preston Pysh (00:06:05):
So let’s talk about the second layer on top of the Florentine Mint’s gold coin. Talk to us about how some of this arrived. I know in the book you talk about physical transfer risk and how some of this started to develop into the reasons why the second layer of money or currency was built on top of this.

Nik Bhatia (00:06:27):
At this time, you really had the idea of a global economy forming where cities across Europe were prosperous, Northern Africa into the Middle East and all connected by the Mediterranean. And they started trading with each other year-round. And this type of year-round trade led to a need for deferred settlement where you didn’t have to exchange coins every time to the last cent every fair. By fair, I mean the trading events that happen across the continent seasonally.

So if you didn’t need to, or want to settle in coins every time a transaction took place and remember, we’re in the 13th century here, deferred settlement was a way to escape that risk of transferring coins or carrying a lot of points. And deferred settlement basically means I’ll pay you back next time and write it on a piece of paper and sign your name on it and sign each other’s name. And it’s a financial agreement. And so that type of situation was what I call the second layer of money because it’s a promise to pay the first layer of money, which are gold and silver coins.

Preston Pysh (00:07:48):
So during this period of time you also talk about how businesses… And maybe not individuals when they transact, but businesses when they would transact, started to use these gold coins in particular because they were so valuable, they were basically a week’s worth of wage or whatever back then. Because they were so valuable, they started to be the unit of account for businesses and how they were managing their books. So talk to us a little bit about this idea and what this meant for this period of time in particular.

Nik Bhatia (00:08:18):
Right. So the advancement in denominating everything in florin was that before the florin stability when you had a world of coins change impurities all the time, nobody had a common language in terms of how to account. They would account in gold and silver, but they didn’t have an exact measurement that they all agreed on. The florin gave them that. And when I say them, I’m talking about the European continent as a whole, because who cares from a global’s economic perspective if everybody in a town is using the same accounting language, right? But if you want to do it on a global scale and thinking dollars today how everybody thinks in dollars around the world, it’s the benchmark, it’s the measuring stick for the world.

Nik Bhatia (00:09:15):
And I think Bitcoin is going to become that and it’s already on its way. But back then, the florin being the coin or the measurement, that unit of account, the denomination that everybody rallied around, it was the first time that it ever happened in our modern history. And that was a revolution in itself. And I think spurred a lot of economic activity because everybody was speaking the same language for the first time.

Preston Pysh (00:09:48):
So to extract a little bit more of some of your writing here, you wrote, and you get into double-entry accounting, there’s a quote from your book you say, within the double-entry accounting system were the secrets of how bankers could create money, not by minting a coin, but from their balance sheet, what are you getting at here?

Nik Bhatia (00:10:05):
This is the idea that when bankers issue a loan, they’re actually creating money into the system that didn’t exist before. They do that because when they create that loan, there’s not necessarily a precious metal that is backing that money coming into existence. And so in order for a government to create money back then, they had to mint coins, but bankers could issue debt to each other, credit money and not reserve it with any metal whatsoever. And so that’s what I mean by it comes from their balance sheet, they just write it into existence. And Milton Friedman also called it the bookkeeper’s pen, which we talk about in the book as well. But all liabilities of a bank or dollars are just forms of liabilities from the bank and it comes from the bookkeeper’s pen.

Preston Pysh (00:11:04):
One of the ideas that you talk about right after this idea is counterparty risk. Instead of talking about counterparty risk in the historical sense, I’d be more curious to hear some of your thoughts on what we saw back in March, April timeframe of 2020, just call it nine to 10 months ago and how counterparty risk played such an enormous part in that liquidity squeeze that we saw get into all the nuances of this for people.

Nik Bhatia (00:11:34):
The problem with our current financial system is the interbank counterparty risk, where banks don’t trust each other when things get tough, because they all are expecting the Fed and the central banks to come in and save the situation. So when things get difficult, they all pull back from each other. And that is actually now the natural state of our financial system. And I do believe that that’s due to this moral hazard that the Fed has created by responding to every situation with unlimited bailouts. And it’s not to fault them explicitly because they have no other choice, the system is broken and the banks don’t trust each other. And that is the core problem with the financial system. And so when things got crazy in March, April of last year, when the pandemic started, the banks, what they do is that they don’t lend to each other in the wholesale money market anymore.

Nik Bhatia (00:12:42):
They don’t engage in repo’s lending to each other, meaning that even US treasury collateral doesn’t warrant a loan from your banking neighbor. And that is a problem. That’s why the Fed had to step in and basically create a repo facility in which they basically said all treasury collateral across the world included foreign institutions later in this. Everybody with a treasury can get cash from us if you need it. I mean, that’s a bandaid on the system that you can never rip off. That is why I refer to the Fed as the lender of only resort. They’re the only game in town because there is no liquidity otherwise.

Preston Pysh (00:13:31):
So as you were describing that, I flipped to page 72 in your book. And something that I love that you did here is you showed the layers of money throughout time and how they’ve evolved and how they’ve changed and how they’re being used today. So when you were talking about the treasury repo, I’m looking at this chart on page 72, where you’re talking about the US dollar system today and I can see right where that fits into the layer of “currency” or money that we’re using. So when we look at this counterparty risk and we look at what it played out back 10 months ago, you saw gold and I should probably say paper gold, sell off not dramatically, but it’s sold off just like everything else sold off. But I think what everyone’s not seeing is they’re not seeing the dollar and every other Fiat currency get bid relative to everything else that got sold off. No one talks about that, but that’s effectively what’s playing out because of all this counterpart. Everything is a counterparty risk to these monetary baseline Fiat units that we’re talking about, correct?

Nik Bhatia (00:14:37):
Yes. And that’s why United States treasuries, the interest rates are so low on them because the demand is theoretically the entire supply of money that exists at any time. There’s something that I didn’t really get into in the book because trying to talk about the direction of interest rates and why interest rates were so low doesn’t really fit into the story of Bitcoin. But it’s actually crucial to understand this. It comes down to two worlds, you have the safe world and everything else. And we know from the international statistics that the approximate size of dollar-denominated debt across the world is well over 200 trillion. And so let’s call it 300 for a simple man. And let’s round the treasury supply to 30 trillion, where it will be any minute now. So you’re 30 trillion safe and 300 trillion in everything else. If you understand at the margin demand for treasuries, because if you think of the 30 trillion supply, let’s say 25 of it are locked up in very strong hands. So the marginal availability of these treasuries is not that big relative to the size of money in the world.

Preston Pysh (00:16:09):
And this is what everybody needs in order to settle their counterparty risk.

Nik Bhatia (00:16:13):
It’s not what everybody needs. It’s the only thing you can physically own to assure yourself of dollars tomorrow. And that is the nature of our credit money system, where most forms of money are forms of credit. If it’s not the credit of the United States Treasury, it can’t be fully trusted. And that dynamic means that when anything goes sour, rates absolutely plummet in the United States, meaning that treasury prices skyrocket because the demand, it overwhelms the available supply. And that is despite the fiscal profligacy, or however you want to call it, of the United States government dependent of the fact that they spent so much money.

Preston Pysh (00:17:03):
Would you say that it’s safe to characterize what’s happening as counterparty risk globally is going up but maybe even accelerating at this point?

Nik Bhatia (00:17:14):
Yes, that’s a fair characterization. It is accelerating because the Fed is incrementally backstopping everything. So now that you don’t have a natural treasury market for repo anymore, the Fed is the implicit backstop there, you’re removing the risk that anything fails. And so why trust a counterparty when the going gets tough because you have the Fed there and that’s the dynamic that is accelerating I would argue too.

Preston Pysh (00:17:54):
So there’s a term you used in your book that I just really liked. And I liked the way that you went about this and the term is disciplinary constraint. And when we think about this, what you really get into with this term is fractional reserve banking, can you give us a background on fractional reserve banking? Because this is what got us to this point. And I think when I talk to a lot of people, they look at what’s happening around the world right now and they immediately want to blame the politician that’s currently in office or the one that was in office the term before. And I think it’s just so narrow sighted as to what’s really driving what we’re seeing today. And I suspect that it happened decades ago that got us into this place. I think you agree with me because we chatted a little bit before we started here. So can you talk to us about this term disciplinary constraint and then particularly talk about how it played out from the 1940s into the 1970s and 80s here in the whole world, not just in the US but globally.

Nik Bhatia (00:18:58):
So disciplinary constraints is another term that comes from the inherent hierarchy of money paper. And what Professor Mehrling talks about is that disciplinary constraint is how much you have reserved against how much you’re issuing in terms of money. So if a bank has a million dollars worth of gold in the fall and issues $10 million worth of deposit money, that’s a 10 to one or a 10% fractional reserve situation.

Preston Pysh (00:19:33):
The people can understand this in Tether terms, because it’s such a hot topic right now. If Tether had 10 US dollars in their treasury, but they’ve issued $100 worth of Tether tokens, that would be the exact same scenario that you just described, correct?

Nik Bhatia (00:19:50):
That’s right. So we see that when the fractional reserve banking evolved, that gold, it exercised discipline on how much money a bank could create, because in the end, if there’s a bank run, they have to be able to satisfy enough people’s deposits or demand for redemption that enough confidence could exist for that entity. Now, I do believe that fractional reserve banking is a natural evolution because people want credit and people treat credit as money. That’s the way that I saw when I was researching that that’s kind of how it unfolded.

Preston Pysh (00:20:39):
Well, and you also laid it out in your book, Nik, that once the governments inserted themselves into that second and first layer, that this was a natural progression because it’s a form of taxation. And if they can just print more in order to supply whatever that base “money” is, it’s so much easier for them to do these types of things, but whenever it was all localized and you provide this in your book as well, when gold coins were privately minted and distributed, and we’re going way back in history, you didn’t necessarily see these activities because it was all about trial. You saw it in some regards, but then in others in deed they lasted for decades where particular mints were trusted because they had 100% backing on whatever paper they were issuing on its behalf.

Nik Bhatia (00:21:30):
Yeah. And in the book, I talk about this idea of privileged lending. When the government inserted themselves between the first and second layer of money, they lent money to themselves in a privileged manner and benefited from that money they lend to themselves being on par with all the other gold backed money that was out there circulating. And that’s the taxation that you’re talking about, because what you’re doing is you’re altering the denomination by inserting your own privilege into it. And that was a precedent that was set with the Bank of Amsterdam and the Dutch East India Trading Company, and the city of Amsterdam itself.

The city and the company inserted themselves into this privileged situation where the money that they issued to themselves was on par with gold-backed money of the people of the Netherlands at the time. And that precedent led to the Bank of England doing the same thing when they wanted to finance a war at the end of the 1600s and that is how, when the Fed owned US treasuries, that’s what’s happening as well. It’s a form of privilege lending that originated from the Bank of Amsterdam.

Preston Pysh (00:22:51):
So take us to Bretton Woods, and then describe what played out from the 1940s up until 1971, based on this idea of fractional reserve banking.

Nik Bhatia (00:23:02):
In 1944, the Bretton Woods agreement dictated that the US dollar was now the currency of global settlement, and only the dollar would have convertibility to gold. And all other currencies around the world would have a base price in dollars. And that would be the relationship between currencies, the dollar and gold. And the dollar supply was not in check in any way. So the amount of dollars that were issued after 1944, the supply kept growing and growing and growing. But the price of gold in terms of dollars was unchanged because the redemption pressure on the United States didn’t really exist, but it was bubbling up because we had basically a liberalization of how many dollars existed that were lent by banks into existence. So that’s why we need to understand the layers of money all the way out to three layers, to really understand this model. On the third layer of money, our commercial banking deposits.

Nik Bhatia (00:24:25):
This is the money that you and I use, right? Our money that we keep is a form of deposit money. It’s not Central Bank issued money that people keep, right? And so if the supply of this third layer of money grew and grew and grew, but never challenged up to the first layer during, let’s say the ’50s and the beginning of the ’60s, but then during the 1960s, it started to catch up and the redemption started coming for the gold because the dollars were so plentiful that people challenged that price. And they said, “I’d rather have the gold. I’m calling your bluff.” But the government of the United States didn’t have the ability to control that supply growth. They weren’t the ones that were doing it, it was the banks because the banks issue money to the world. And so when that rush up the pyramid of money, the layers, happened in the late 1960s and governments around the world demanded the gold instead of the commercial banking dollars that they had issued from wherever they were issued from, that’s what broke the gold peg.

Nik Bhatia (00:25:48):
And that’s what broke the disciplinary constraint forever on money and discipline transferred from a precious metal to a consortium of central banks around the world. And now discipline only exists in their minds. There is no physical discipline in the form of gold where this whole framework of money originated from. And so the period between 1944, Bretton Woods and 1971, I like to think of it as 68, 71 and 73, because 68, the gold pool broke. 71 was closing the gold window and 73 was when the official Bretton Woods agreement ended and currencies free-floated against each other. And the relationship between gold and the dollar and currencies was ended forever. So that period from 68 to 73 was set up by basically this third layer of money growing at no explicit fault of the issuer of the dollar itself.

Preston Pysh (00:27:05):
When you look back in history and you go into 1964, right before you’re coming off this gold standard, the president back then was Lyndon B. Johnson. And he was giving a speech of the great American society and how perfect everything was in America at this point in time. And when you look at what was actually taking place that preceded this from the Bretton Woods agreement in 1944, 20 years later when Johnson’s making this speech about the great society, and you look at this fractional reserve banking kept adjusting this money multiplier. So you were talking about $10 actually being in the bank versus the 100 that’s lent out. Well, three or four years later now it’s only $5 that needs to be in the bank for every 100 that’s lent out. And then it went to three and then it went to two and then it went to… When you keep adjusting that money multiplier, you’re debasing against that gold backing that’s there.

Preston Pysh (00:28:05):
And for me, when you read a history book and you read about this period of time, there’s no mention of the monetary history in the things that were taking place in order to create this perception of this being just miraculously achieved without there being some type of monetary manipulation that was actually taking place in the background slowly, not quickly. It didn’t happen over a one-year period of time, it happened over decades. And when it happens over decades, it’s really hard to see it. I really appreciate you kind of going into some of those details and providing that. And when I look at the historical stuff that goes along with what you’re saying, it’s just fascinating to me.

Nik Bhatia (00:28:47):
It’s a credit money system and the expansion and everything was done on a fractional. And as you mentioned a more fractional meaning a less reserved type of way. And we are still in the echoes of that expansion. I don’t think that has ended yet, or that it ended back then, or that 1971 or 73 were necessarily any break in that. It just kind of accelerated and that’s the system that we are in today.

Preston Pysh (00:29:20):
So talk about that period. So we all know that interest rates started going up from the time you come off the gold standard into the early ’80s, interest rates peaked in 81, and then they’ve been progressively going down for 40 years since.

Nik Bhatia (00:29:35):
Yes, because at that point, the realization that treasuries were the best way to store the dollars because gold was gone from the financial system and gold was gone from backing the dollar itself, and treasuries became the asset adjure and that is why rates have trended lower for 40 years because it’s a progressive realization that it’s the only way to store dollar safely. And it was the new gold.

Preston Pysh (00:30:06):
So for much of that period of time, only in the last 10 years if they really moved away from just adjusting the Federal funds rate but talk to us a little bit about what was the Fed in particular doing during this period of time from the early 1980s, up until the 2008, 2009, how were they manipulating or adjusting? What lever were they pulling in this treasury market in order to keep the rates moving lower and lower? Because from my understanding, it was just the Federal funds rate. It was just at the far left of the duration curve that they were stepping into. And then the rest of the yield curve was following the lead of what they were doing with the Federal funds rate. Was there anything more to it than that, from your perspective?

Nik Bhatia (00:30:50):
To be honest, Preston, I don’t think that question has a great answer because it’s hard to know whether monetary policy drives the rates of treasuries down or that treasury rates fell because of other reasons and that Federal funds tracked it because of a natural demand for money around a certain given interest rate or price money throughout time. So it’s a tough one.

Preston Pysh (00:31:18):
It seems like whenever there would be a big credit event, like a business cycle, the business cycle is seven to eight years long and you have this big credit event and the central banks would step in and they immediately drop the Federal funds rate lower, but it was always lower than it was at the previous business cycle. And it seemed like it never was able to fully recover higher without there being yet another big credit event is how I saw it, or at least the way that I’m seeing the charts.

Nik Bhatia (00:31:52):
Yeah. And I would say that that’s fair because the Fed being the leverage tool in the money market or the actor in the money market, if they keep making money cheaper, they always kick the can down the road of this natural counterparty risk and this prospect of default in the system. So to make money cheaper is always the easiest route, is the easiest path. And that’s part of the reason that you see that trend.

Preston Pysh (00:32:25):
So you talk a lot in your book about the philosophy of money. First, talk to us about just what that is for a person who’s maybe not familiar with the term, and then talk about the trend that we’ve seen with the velocity of money here more recently.

Nik Bhatia (00:32:40):
Yeah. So money velocity, I introduce it in a very broad way where I say imagine yourself in the 13th, 14th century using coins every day, versus being able to defer settlement with a piece of paper. And if the piece of paper itself was treated as cash, then the ease of using paper versus coins meant that money can transfer from hand to hand more quickly than it could before. And so that’s what money velocity means more broadly. It’s how quickly does money change hands? How quickly do people transact with each other? Is it once a quarter or are they able to transact every day because money moves more quickly? And having thousands of different coins at one time, all in the same place is a disaster for money philosophy, but deferred settlement and trustworthy bankers that just issue notes that say, “I’ll pay you tomorrow,” or, “I promise to pay you tomorrow,” make things move a lot more quickly.

Nik Bhatia (00:33:56):
And so money velocity accelerated with the advent of paper money, of promissory notes during the 16th century and Antwerp. But today money velocity has a more economic and a more quantitative definition where it’s actually measured by central banks and there’s statistics to calculate it. And we see that money velocity is slowing and it still does refer to the turnover of money in the system. And we see that slowing because I do believe there’s broken interbank trust. And we don’t see the lending because money philosophy really comes down to how quickly are banks lending money. And the lending is slowing because, like you said, counterparty trust is eroding. Every day, it gets worse than the day before. And so that causes money velocity to slow. So I think that’s one of the reasons we see that in official statistics.

Preston Pysh (00:35:01):
So when we look at velocity of money and we look at this idea that Bitcoin could be potentially stepping in and playing a much larger role moving forward, how does that impact the velocity of money based on what you just said?

Nik Bhatia (00:35:16):
Bitcoin is a settlement layer. It’s a form of final settlement. And because of its decentralized nature, this form of final settlement can happen every 10 minutes, 24 hours a day, 365 days a year. And that is quick enough to build an entire financial system on it that moves a lot quicker down the layers. Because today, settlement on second and third layers takes a long time. It takes days to send money across borders and several transactions, but in a world with Bitcoin as the final form of settlement and we see this with the lightning network, you can actually have second layer transactions that are instant at any value. And so it’s really powerful and it starts with Bitcoin as a settlement tool is because the final settlement is so easy to do that we can have lower layers of money that just move at light speed.

Preston Pysh (00:36:27):
I’m curious what you think of this idea. So when I think of the philosophy of money in the terms that I think economists want people to think… They want it to be this metric for measuring if I pay you a dollar for whatever good or service, how quickly then are you able to go out and spend the dollar somewhere else? And when I think about what’s taking place today, where so much of the world’s equity is in the hands of the few, those people that hold all that equity, there’s only so many boats they can go out and buy and so many mansions they can go out and buy in order to allow that transaction in that currency to be put into somebody else’s hands in order for it to go somewhere else. Most of the currency today, it seems like it’s all just being capitalized into higher and higher asset prices, which is just sucking this velocity of money from taking place.

Preston Pysh (00:37:20):
So if there’s this huge movement to Bitcoin where it becomes this new form of money, and now you have people that have tremendous wealth in this new currency, they’re going to want to go out and buy equities and they’re going to want to go out and buy things that are generating some type of free cash flow, which then recapitalizes that entire equity in debt market completely. To me that seems like that reorganization and that shuffling would actually greatly accelerate the velocity of money as everything kind of gets reorganized and people are willing to depart with their Bitcoin in order to own equity and assets that are kicking off free cash flows. Would you agree with that or do you think that it’s an extreme thought? I’m kind of curious to hear some of your thoughts.

Nik Bhatia (00:38:05):
I do agree with that and I do believe that the acceleration of Bitcoin as a world reserve currency happens only if those investors demand their returns denominated in Bitcoin. And if they make the companies they’re investing in denominate their balance sheets in Bitcoin, it will ensure that the returns, the dividends will be paid back in Bitcoin. And so several years down the road, I hate to speculate on how long that’ll take, but that does seem to be a natural progression assuming a much larger market cap of Bitcoin in the future.

Preston Pysh (00:38:52):
So this is probably the most popular question I get asked on Twitter, what would make you change your mind about Bitcoin or what are some of the things that would be a red flag for you?

Nik Bhatia (00:39:03):
Yeah. So I mean, SHA-256 underpins Bitcoin, right? So that’s one of the basic things is if there’s some problem with the cryptography that is brought to our attention, because that’s the thing that keeps Bitcoin secure. And so the cryptography would be something that changes my mind if we learn collectively. And I have no computer science expertise whatsoever. So I have to use my own discretion. And I understand that SHA-256 is a secure hashing algorithm that keeps Bitcoin functioning in a way that nobody can tamper with it. And so that is my best understanding of how Bitcoin works. And if there’s a problem with that, then we’d have to take a look. So my favorite saying as a trader and I use it as an adjunct professor, is that price is truth. It’s my favorite quote in the world because the price tells you everything you need to know. Now, what is the problem with Bitcoin today?

Nik Bhatia (00:40:08):
The price says that nothing is the problem. The price says that Bitcoin is a growing asset that is an emerging technology that is seeing adoption around the world in an exponential sort of way. I mean, the price says that everything is good. If the price of Bitcoin went to below $1,000, that would be a cause for alarm, because that means something is really wrong with it. And I don’t know what would cause that, but the price will tell you, I promise you that if the price of Bitcoin goes below $1,000 in the next 12 months, there’s something seriously wrong with Bitcoin. The price will tell you that, but 80% price corrections are well within the historical context of Bitcoin. So maybe a crash down to $5,000 wouldn’t really alarm me necessarily because we’ve seen it before in Bitcoin several times. So maybe it’s a little bit of a cop-out, but there’s not anything right now that’s threatening Bitcoin’s rise dictated by what the price is telling us.

Preston Pysh (00:41:20):
How do you think about the regulatory front? Because that’s probably if what’s your biggest risk and then they always like to throw out, well, how’s the government going to regulate this? Aren’t you concerned about that? What are some of your thoughts on that?

Nik Bhatia (00:41:33):
Well, I think that the United States government, which is the most powerful influential regulatory government in the world still is wildly accepting of Bitcoin and full embrace the proof is in the pudding. They treat it like a property at the IRS. So it was like on par with gold to the IRS. It’s regulated as a virtual commodity by the commodities futures trading commission. It is now the latest office of the comptroller of the currency ruling on these independent node verification networks, there’s a long new acronym that they have. They basically said that banks can use Bitcoin now to transfer money to each other as long as they follow the law. So it’s a wild endorsement from the United States government left, right and center.

Nik Bhatia (00:42:30):
And anybody that thinks that the government is going to ban Bitcoin is not paying attention whatsoever to what’s going on in the regulatory landscape. I mean, it’s embrace, embrace, embrace at every step of the way because the government realizes that number one, Bitcoin is a form of speech because it’s a form of cryptography. And number two, that there is nobody you can send a letter to subpoena in Bitcoin and therefore it’s an independent concept and cannot be constrained. They realize this. So other governments will echo this type of thing and governments like China and other sort of more authoritarian governments, dictatorships, those types of things, they will ban Bitcoin and probably do so effectively because the people are scared that they’ll get murdered or jailed if they break the law. So to me, it’s almost a tired argument because you’re not actually reading what the government is saying at all.

Preston Pysh (00:43:37):
So let’s play out a scenario where I think the pressure for the government to intervene is going to get more dramatic. So let’s say the price runs the 200,000 and it does it in a pretty aggressive way and let’s say it does it by the end of this year that we’re in right now, 2021. Now you start to have people in the fixed income space, which I know you’re extremely well-versed on, they’re looking at this and saying, “Oh God, if this thing becomes the new money, and this thing is a reflection of where interest rates are going to be based, this thing that I’m holding in Fiat currency becomes totally impaired, worthless.” And they start selling off in the debt market or the debt market starts to sell off. Central banks have to step in and aggressively provide a backstop by yield curve control.

Preston Pysh (00:44:29):
They’re already doing it. They’re already talking about it, but they can see the amount of orders that are coming in in a drastically aggressive way and they’re providing a backstop and a buy for all of that. They can see the flows of all these cash that they’re basically inserting into the system and where it’s flowing it’s flowing into Bitcoin exchanges. At this point, if I’m a central banker and I’m seeing this, I’m saying the whole system’s about to collapse and it’s about to change. Do they come together as a collective entity and try to step in and regulate it at that point?

Preston Pysh (00:45:06):
Because everything that you said, Nik, I completely agree with 100% but all the laws and regulations that they’re putting forth tells you that they’re actually being accommodative with it. But when I think about where things start to get a little concerning and a little bit more on edge is pretty much the scenario that I just described. So how do you think through that? Is that something that they could even do? Do you think global or the main nation states could come together and implement something collectively? What are your thoughts around some of that?

Nik Bhatia (00:45:40):
I don’t think that nations will come together and hammer this thing down to the ground from a regulatory perspective, but you do bring up a very interesting scenario. And the game theory is fascinating what that type of situation will look like. And it probably will maybe here maybe in another country and it actually makes me excited to see what happens because I do feel that Bitcoin will find a way, it always does. And watching Bitcoin find a way when the governments get most aggressive is going to be breathtaking to watch just like how the decentralized network gets around the governments.

Preston Pysh (00:46:30):
Let me ask you this. If you’re a strategic advisor, let’s say, you’re working at the treasury and you’ve got the ear of Janet Yellen, what would you be advising her if this scenario that I just described was playing out and LeGuard and everybody else in the world was saying, “We need to come to the table, we need to have a meeting right now collectively.” What would you be advising from a strategic standpoint for the country that you represent? How would you be playing that? Because I know how I’d be playing it and I want to hear how you’d be playing it.

Nik Bhatia (00:47:02):
I think what you have to do is exactly what the OCC, the United States Treasury just did. They legalized the use of Bitcoin as the rails of the financial system for clearance. And I would double down and make United States the home of Bitcoin the most friendly and allow a world of dual denomination where banks can right away start running parallel balance sheets in dollars and Bitcoin so that they can get comfortable and ready for the transition to a world with a more neutral money like Bitcoin.

Preston Pysh (00:47:45):
So I think you and I would be doing the same thing, which is accumulating as much of this as I can, as quietly as I can, but going to the conversations to hear what everyone else is doing, but not being committal to anything. You’re not being committed to anything because you’re making an assessment on how everyone else is about to act and hear what they’re about to do. It’s kind of a situation where if you go to… And this is the ultimate prisoner’s dilemma, if you trust everyone at the table and you’ve got to trust everyone at the table that they’re going to ban it, or they’re going to act in a way that is collectively in all of their interests to ban it, right?

Preston Pysh (00:48:25):
Or if one person or two or three, and I said person but the nations, if a few of them don’t go along with this and they’re actually printing and buying Bitcoin and putting it on their treasury, the whole thing doesn’t work. Because over time, those few that are adopting this are going to have the hardest sound as money and it’s going to work out very well for them in the long run over a very long period of time. So do you buy that? Do you think that thinking is on board with how you would see it playing out or is it a coin toss between the first scenario where they all come to the table and they all agree to…

Nik Bhatia (00:49:03):
No, somebody and again by person, I mean nation, somebody is already going to be extremely long Bitcoin, either in the treasury or from a regulatory perspective or the taxpayer corporations within its borders are all killing it in the Bitcoin world, charging Bitcoin for their goods and services, denominating their balance sheets in Bitcoin. So somebody is going to be long at that point so long that they’ll say, “No, we’re not going to read Bitcoin from our country.”

Preston Pysh (00:49:40):
Or better yet drag your feet and act like you’re going to do something, but just be noncommittal and drag out another meeting all while you’re stacking it on your domestic balance sheet. There’s an incentive to drag your feet and act like you’re not doing anything, but in reality you are.

Nik Bhatia (00:49:58):
And I think that Bitcoin’s a natural, all years cyclicality where it has this boom and bust cycle that seems to keep repeating itself now where it looks like we’re in the third one and it’s no longer a coincidence. Each time the price crashes, it brings the heat off. And so I hope we get the crash before the heat gets too hot. And I think it will. And it keeps growing bigger and bigger each time. And I think it’s a foregone conclusion now that governments won’t come together and ban Bitcoin. I just think that will never happen.

Preston Pysh (00:50:38):
It’s interesting that you say that, because think about how much entrenchment has happened from 2017 to where we’re at now from a technology standpoint, like how much technology that’s happening with lightning, you’re looking at debit cards, credit cards that have Bitcoin rewards baked into every single transaction a person makes. I know personally, Bitcoin is involved in every single transaction I make today, right now, through this reward, through forward and any other type of debit credit card that offers these rewards. So when I hear you say what you just said, what you’re really saying is you hope that we go through another cycle because you think it’s going to only make the case for Bitcoin to be that much stronger as the winner in the long run, versus if it really starts going parabolic on this run, you think that that potentially poses more regulatory risk. Am I saying that, or am I taking words out of your mouth?

Nik Bhatia (00:51:41):
No, that is it. And I don’t even think that it’s possible for anything to go straight parabolic. And it wouldn’t be a good thing either, but the way that Bitcoin grows, it’s like a heartbeat. It pumps and then it pumps again. And each time it pumps, it leaves something in its wake. And that seems to be the natural evolution. Bitcoin is alive. It really is this organism. And there are people out there, writers like Robert Breedlove and others that they talk about Bitcoin in this really majestic way for the human species and how empowering it is. And I love all their writing and I can’t really echo what they say.

Nik Bhatia (00:52:33):
And I recommend reading and comparing Bitcoin to mushrooms and comparing Bitcoin to the number zero. And these powerful ideas of what Bitcoin is and just the way that it grows and the way that it beats like a heart and it goes like an organism just evolving. It has all these natural defense mechanisms. It has this immunity and maybe probably its boom and bust cycle is part of its immune system that lets it not get adopted too fast, not get the governments too angry. And it’s an amazing thing to watch some technology like this. I was very young when the internet started and so I didn’t get to see that unfold and understand the power, but I get to see it this time. And it’s really cool.

Preston Pysh (00:53:29):
So let’s fast forward. Let’s say that Bitcoin successful, what does a yield curve look like in the future?

Nik Bhatia (00:53:36):
I think it’ll mirror other upward sloping yield curves. The theory behind an upward sloping yield curve partly derives from this idea of a liquidity premium in which you demand a higher interest rate for locking your money up for a longer period of time. So liquidity premiums and positively sloping yield curves are what I feel and I think financial theory also says is the natural state where if I’m going to lend you Bitcoin for a day, I’ll charge you 10 basis points but if I’m going to lend it to you for five years, I’m going to charge you 15% or something like that. The shape of the yield curve, how steep it is I think it’s very, very premature to start speculating about that stuff. I’ve played around with yield curves and Bitcoin and it’s not a great exercise because there aren’t that many data points and there isn’t that much liquidity at each data point.

Nik Bhatia (00:54:44):
So making sense of the shape of today’s Bitcoin yield curve, it’s not a very useful exercise to me. Neither is speculating what it will look like in the future in terms of where the rates will be, but upward sloping, yes, maturities all the way from one minute to 100 years, probably. And watching those instruments develop will be very important for a transfer of denomination from Fiat currencies to the world of Bitcoin. And we don’t really see that happening today in any size where we have fixed income instruments denominated in Bitcoin and like a securitized yield curve, meaning a yield curve with instruments that are treated like securities with a high degree of transparency, liquidity, none of that stuff really exists in Bitcoin yet it’s more of maybe a next five years building out that true capital market.

Nik Bhatia (00:55:46):
But the more native small, natural money markets like lightning network or there’s a market for liquidity dedicated to this pool of capital that routes payments, that’s already starting and the size isn’t really there to attract what we think of as capital market size. But the ideas are there, they’re starting. And those types of native Bitcoin ideas will be foundational in how we think about Bitcoin denominated interest rates and risk.

Preston Pysh (00:56:21):
When you look at the derivatives market today for Bitcoin specifically, it seems like the spreads that a person could farm, the yields that a person could farm by going long and short at the same time and just kind of capturing that spread for an immediate return, it seems like it’s really wide and that you don’t have a lot of participants stepping in from traditional finance in order to just capture this spread that’s… I’m calling it risk-free, I’m sure there’s some minor small risks that’s being incurred through the short custodial period that’s taking place, but for all intensive purposes, it seems like a massive yield that could be captured that your traditional Wall Streeters aren’t taking advantage of, how are you seeing that?

Nik Bhatia (00:57:05):
So arbitrage exists for the people that are willing to make that bet. My favorite example of arbitrage are the buyout arbitragers where a company gets bought for $35, the stock rallies to $34.75. A hedge fund comes in, buys all the shares and makes a quarter when the buyout closes and that arbitrage opportunity is there. They take it. And there are people that are willing to make that arc and take that risk. Well, the same degree of ease of closing that arbitrage isn’t there for enough people to be comfortable with yet. And that’s why the spread is as wide as it is because the comfort in executing or let’s just say the confidence that you can close on the arbitrage opportunity isn’t well developed yet. And that will happen with time and with enough participants that trust each other and are willing to move money quickly.

Nik Bhatia (00:58:14):
And it also has to do, Preston, with jurisdictional arbitrage. So one of the things that own exchange traders will do is they’ll trade different currencies with different banks in order to make a spread because certain banks are in one country and the other and there’s just a way to capitalize on that. Bitcoin exchanges are very cloudy in their jurisdictions and that comfort of the arbitragers with the jurisdictional mysteries, it prevents closing that spread. So it’ll take time.

Preston Pysh (00:59:00):
Interesting. What are your thoughts on Central Bank digital currencies? What purpose are they going to serve moving forward? And then also your thoughts on Tether.

Nik Bhatia (00:59:10):
I think the CBDCs will be used for helicopter money. What do I mean by that? Today in the United States, if the government wants to stimulate the economy by giving money to people, they can write checks and send them to people as they did in 2020. If the Fed wants to stimulate the economy, they can not do so directly to people. They have to create monetary stimulus that goes into the banking system hoping that the banking system then issues money and loans money to the public and hope that their monetary stimulus ends up helping the employment situation and so forth.

Nik Bhatia (01:00:01):
The term helicopter money comes from again, Milton Friedman, who gave an example of the Fed getting crates of dollars up into a fleet of helicopters and dropping them over the populace in order to stimulate the economy because the Fed can’t give money to people unless they drop it from helicopters, but a CBDC allows them to do this, so it’s the digital helicopter. And they will happen for this reason. And so that’s the way I see them unfolding, but they won’t tell you that until right at the end or right after they’re like, “Oh, by the way, we’re going to use it to give you money.” Or, “Hey, check your wallet. You have 1000 Bitcoins.” So that’ll take some time to unfold but that is my prediction.

Preston Pysh (01:00:50):
How about the timeline on the Central Bank digital currencies? Because to me, it seems like we are years out from them having some type of technical solution in place. And then how does everyone get their wallet? How do you get a digital wallet in order for them to do something like this? It seems to me like the logistics around getting the whole thing set up and in place is just years away from that.

Nik Bhatia (01:01:12):
I think it’s a lot quicker than you think. So China will be live by next year.

Preston Pysh (01:01:19):
Okay.

Nik Bhatia (01:01:20):
The European Central Bank will, by the end of this year, have a plan for their life version. So ECB will have a live test going on next year, 2022, Reserve Bank of Australia, Bank of Canada and Bank of England will all be in that kind of live testing by next year as well. Reserve Bank of Australia is already in their testing phase. So they’re using technology and doing some testing. The Fed will be last of all these major countries. For sure, they’ll be last, they’ll get full mode into it, but they’ll be able to do it really quickly because they’ll copy what the ECB and the Bank of England does and they’ll adjust it for themselves.

Nik Bhatia (01:02:13):
Now, the wallet question is a super simple answer. Bank of America, JPMorgan will have a wallet product where you can store your Fed coins. And they’re already working on that stuff, it’ll be very easy for them to do on day one. You won’t even notice it. Your cash will be or your helicopter money will just be in your JPMorgan Chase.

Preston Pysh (01:02:37):
It’ll look and feel just like somebody just made a direct account.

Nik Bhatia (01:02:41):
It’ll feel like your checking account or it’ll feel like your Bitcoin wallet on your smartphone.

Preston Pysh (01:02:46):
Now, is there a way for that? I know Lyn Alden has suggested that that’s going to be their method for control. Like if you’re trying to spend that coin outside of the United States, maybe it won’t work. If you try to send it to a Bitcoin exchange, maybe it won’t transfer, what do you think about the program ability of the tokens that they’re going to be issuing?

Nik Bhatia (01:03:07):
It’ll be determined. My book recommends that the central banks treat their digital currencies with as much freedom attached to them as they are willing to cede. That is the recommendation. How close they will get to that, it will vary widely across countries let’s just say, first of all. And secondly, I do believe that some will emerge that let you use it pretty freely. And I can’t predict all of that stuff. All I can do is advocate that in the future err toward the side of freedom, we can be sure that certain countries will not do that. The DCEP, the DCF project from the People’s Bank of China, this digital renminbi is not going to be a freedom currency.

Nik Bhatia (01:04:03):
It’s not going to have any… It’s going to be monitored. Every transaction is going to be logged and monitored by the government. And I think it’s probably going to be naive to say that every government won’t do that. But whether or not you monitor it is not the issue, whether or not you restrict it and how much you restrict the use of it, I think will be interesting. And some central banks will allow people to use it.

Preston Pysh (01:04:32):
Tether.

Nik Bhatia (01:04:34):
Tether is probably three quarters reserved by dollars and trades at par and has been criticized for years as not being fully reserved, but still fades pretty close to par. And its importance has windled over the years. So it’s kind of a non-issue to me now.

Preston Pysh (01:04:53):
Are you getting your figure for three quarter reserved? And then is there another quarter that they have on reserve that isn’t dollars? Talk to us about that.

Nik Bhatia (01:05:02):
There was a report a few years ago and you’ll have to fact-check me on it, but there was a report where they came out. Some research had said, “We think that there’s about 72% reserve based on what we’ve discovered.” I think that number’s from a couple of years ago. So don’t quote me on it but my point being, I think Tether is probably mostly reserved and they might have a shortfall, but the price is par. So I mean, what’s the big deal? Like bank deposits traded par to other bank deposits regardless of how fractional reserve each one of them is. And there are other fully reserved stable coins out there that are developing an underway and have market liquidity. And the market has demanded them and they exist and so I think that Tether, it’s importance is really dwindled in the grand scheme of things.

Preston Pysh (01:06:02):
So your argument is even if there is funny business happening there, let’s just say it’s not three fourths it’s way lower, there are all these other stable coins that exchanges have, Coinbase or Crack-In, or you name it, they also have fully backed stable coins and they would just take up the market share of Tether, is that the argument?

Nik Bhatia (01:06:22):
Yeah, think about it like this, if Coinbase failed tomorrow, the price of Bitcoin would go down significantly and then it would recover.

Preston Pysh (01:06:30):
Same argument.

Nik Bhatia (01:06:32):
And then it would recover. And so if Tether went down tomorrow, the price of Bitcoin would probably go down and maybe 25%, but then it would recover because that’s all in a day’s work for Bitcoin.

Preston Pysh (01:06:50):
I love it.

Nik Bhatia (01:06:51):
Come on. Tether stuff, it’s like, there are so many ways to poke holes at Bitcoin, but one stable coin is just not the way anymore. And one government ban is not the way anymore either.

Preston Pysh (01:07:05):
Last question for you, Gary Gensler coming in as the SEC chairman, what are your thoughts on what that means?

Nik Bhatia (01:07:13):
No opinion, Preston, honestly.

Preston Pysh (01:07:14):
You’ve spoken like a smart gentlemen right there. Okay. The name of the book is Layered Money. This is by Nik. I’m telling you guys when I was done reading this, I thought this is the best book that I’ve read since I read Jeff Booth’s book about a year ago, and this is just laid out so well. Man, I cannot encourage you enough to go out there and check out this book. Nik, you did a fabulous job with this. Thank you for coming on the show, give people a handoff where they can learn more about you.

Nik Bhatia (01:07:47):
Thank you so much Preston for having me. You guys can find the book on Amazon, Layered Money, Amazon worldwide. Barnes & Noble, they’re retailers that are selling it as well. You can find me at layeredmoney.com. You can find the book there too, and you can find me on Twitter @timevalueofbtc.

Preston Pysh (01:08:06):
Thanks for coming on Nik.

Nik Bhatia (01:08:07):
Thanks, Preston.

Preston Pysh (01:08:09):
Hey, so thanks for everybody listening into the show. If you enjoyed the conversation, be sure to subscribe to the show on whatever podcast app you’re using. We really appreciate that. And if you have time, leave us a review. So thanks for joining us this week and we’ll catch you next Wednesday.

Outro (01:08:23):
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