What Bitcoin Did

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Nik Bhatia on Why Bitcoin is a Response to Central Banks

Peter McCormack
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Nik Bhatia on Bitcoin is a Response to Central Banks - WBD161 Peter McCormack

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Location: Los Angeles
Date: Friday, 18th October
Project: OpenNode & Tantra Labs
Role: Research Strategist

State adoption of Bitcoin is unclear but countries such as Iran, North Korea and Venezuela are believed to be holding and using Bitcoin. While these countries are in the minority, some believe it is just a matter of time before Bitcoin becomes a generally accepted state-level monetary tool.

State-level censorship resistance is useful for nations subject to tight sanctions. The unique properties of Bitcoin could make governmental ownership of Bitcoin a necessity in the future and increased accumulation by governments around the world may lead to the U.S Dollar being replaced by Bitcoin as the global reserve currency.

Further, the global economy is becoming increasingly uncertain, with negative interest rates and the Fed's growing intervention in the repo market standing as warning signs of an imminent global recession. 

Could all these factors speed up the shift towards Bitcoin adoption?

In this interview, I talk to Nik Bhatia, Research Strategist at OpenNode and Tantra Labs. We discuss how banking works, the global economic outlook and why Bitcoin is a response to centralised and monopolistic money creation by central banks.

TIMESTAMPS

00:04:39: Introductions
00:04:54: Background into why Nik is involved in Bitcoin
00:06:11: Delving into what the overarching goal is for Bitcoin  
00:11:23: Touching on Nik’s views on the divergent nature of Bitcoin and Lightning
00:12:49: Discussing what Nik is currently working on and his thoughts on Bitcoin in the future
00:16:49: Exploring Bitcoin’s volatility and how it is connected to bringing new users into Bitcoin
00:20:04: Touching on Nik’s conviction for widescale Bitcoin adoption
00:22:23: Discussing hurdles to mass adoption of Bitcoin and the lack of apparent institutional interest
00:26:24: Delving into the current global economic outlook and reflecting on the 2007 financial crisis
00:36:33: Discussing repo markets and the current concern around those markets 
00:41:26: Touching on how banks function, including leverage and fractional reserves
00:43:46: Exploring the possibility of future fractional reserves on Bitcoin 
00:46:57: Continuing to discuss the inner workings of banking and how they are able to print money
00:50:36: Discussing what facets of Bitcoin will improve the current financial system
00:54:04: Delving into how Bitcoin and time preference can impact other aspects of life
00:57:01: Nik’s thoughts on the differences between Bitcoin in the West and in rest of the world
01:02:23: Touching on non-custodial wallets in Lightning
01:04:06: Final comments and how to stay in touch

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TRANSCRIPTION

Peter McCormack: Hi Nik, how are you?

Nik Bhatia: I'm doing great Peter!

Peter McCormack: We finally get to do this! We talked about it a while ago, couldn't make it work, but here we are.

Nik Bhatia: Great to have you in LA.

Peter McCormack: Yeah man, I absolutely love it out here. I went to see Elton John last night, which was very cool. The sun is shining, everyone treats me nicely.

Nik Bhatia: Excellent!

Peter McCormack: So I think we're in very weird fucking times right now, very weird times, politically in terms of how people are thinking about money, about how the world is... Everything's really fucking weird right now and money is so central to this. Where are you at with everything?

Nik Bhatia: Yeah, this is the reason that I'm involved in Bitcoin. I come from a global macroeconomics background and I think Bitcoin is the future of where global macroeconomics and geopolitics meet and that's really why I'm involved. So I think that yeah, a big part of the problem that we see in the world today is in part due to this centralized and monopolistic, money creation power that comes from the central banks and banking system and Bitcoin is the direct response to that.

Satoshi in the Genesis block put "the Chancellor on the brink of second bailout", and so the beginning of Bitcoin, is basically an attempt to respond to the failing bail out, the implicit bailout financial system that we live in. So that transition is why I'm here and why I want to be a part of Bitcoin.

Peter McCormack: So there's definitely a couple of distinct use cases that people talk about. I just did an interview with an interesting chap earlier, this guy Cedric and we were talking about dark markets. He was actually saying dark markets are really the killer app for Bitcoin, because Bitcoin is censorship resistant, he's like, "that's the key fundamental property of Bitcoin that we should love and adore".

But also, a lot of people talk about central banks being a problem, so really there is a goal there to increase adoption to separate money and state. I see them as two separate things, where do you sit and have your priorities with this?

Nik Bhatia: I think that's a great point and Bitcoin is definitely a savings technology and definitely a transactional technology. They both are important, they are both essential, they strengthen each other and one can't exist without the other. I approached Bitcoin more from the savings technology standpoint, because I have an interest in global markets, how they work, I did a lot of research into gold when I was understanding what was happening during the financial crisis as well.

But Bitcoin as freedom of speech money, as a transactional platform and technology that allows global participation, is as important or if not more important, I think it's hard to say which one is more important, they both exist and they are both part of Bitcoin's heart and soul.

Peter McCormack: Well Nic Carter said he did a whole bunch of unpopular opinions and one of the things he said is that, mass adoption is not the goal. The goal is separation of money and state and it’s to take away the power from governments, from abusing the monetary system and also to reduce tax dollars and the ability to print money at will, to create weapons of war and all the bullshit that comes with governments.

I'd never really thought of it that way. I was always like, "oh Bitcoin is a chance for everyone just to have their own censorship resistant money, but actually you can kind of start to see the path of the demonetization of state. You can see how that could happen with a circular Bitcoin economy.

Nik Bhatia: Yes, I really like Nic Carter's work and his peaceful revolution piece was phenomenal. I do think that it isn't necessarily mass adoption that we're after, but adoption one by one, is how we get there.

So if you start to see a government actually come out and formally announce that they're going to start allocating their reserves in part to Bitcoin, and that unleashes a chain of events, in which global central banks and governments are all participating in this grab for scarce Bitcoin, that can help bring about this peaceful revolution and try to progress us on a path towards separating money and state.

But it does take this adoption one person at a time and convincing, whether it's within the government or central banking system, one person at a time, that can get us there.

Peter McCormack: It's potentially really, really strange fucking times man. I've no doubt that there are already governments using Bitcoin. So we know that North Korea is using Bitcoin, we know that Venezuala is probably using Bitcoin and has said that they plan to use Bitcoin, we know they've mined it and stolen the miners. We've also heard about other countries like Syria and Iran. So in some ways, this is like the state level dark markets, right? The states who have sanctions, this is a way to circumvent sanctions.

Nik Bhatia: There's no doubt about it and gold is the previous version of this, where Iran sells oil for gold because they can't access the traditional oil markets set up in London and New York. So Bitcoin is just the modern version of that. That's why gold and Bitcoin have so many similarities, is that they are this counterparty free, bearer asset that is censorship resistant. Gold can be more censored I think and now that a couple thousand years have gone by in terms of gold, Bitcoin still has that censorship resistance.

Peter McCormack: So why do you think for a bunch of people, that they still can't accept that Bitcoin is digital gold?

Nik Bhatia: I think Bitcoin as digital gold is very hard for people to wrap their head around, when gold has a body, it's physical in nature and Bitcoin doesn't. When people start to understand that Bitcoin is just a number and that number can be considered something physical as well, there's a tangibility there and as Trace Mayer likes to say, "Bitcoin is tangible, but not corporeal." It doesn't have a body, but it definitely is tangible because it's a number. So it's just a leap of faith that I think more and more people are understanding, but it'll take time.

Peter McCormack: All right, so before we get into the detail, the other thing I just want to preliminary get past with you is, there's two sides to Bitcoin, there's the base chain and there's Lightning and there's definitely some divisions here, in that there's people who are just focused on working on Lightning and some of the base chain. Do you think this is healthy? Do you think it's good that they have this kind of separate kind of entities? They've now got a separate conference or do you think that's not actually helping Bitcoin? How do you feel about it?

Nik Bhatia: I think it's definitely helpful and I don't think that the Lightning network development and companies are in a silo by themselves. We all understand that Bitcoin is the base layer and Bitcoin security allows us to do everything that we do in Lightning network. So I think it's actually more of an acknowledgement that we are starting to really see Bitcoin security lock in. I don't want to speculate on protocol changes, because I'm not a developer, but the core tenants to Bitcoin security are there for life.

We all know this now and it's why we're all building on Bitcoin. The Lightning network community is basically saying that, "we are ready to speed up the velocity of Bitcoin. We're happy with where the base chain is and we're ready to make the progress on another layer. Let's leave the base layer alone and let's try to experiment and innovate on higher levels of the Blockchain."

Peter McCormack: Cool, all right, so let's get into this. You've obviously been doing a bunch of writing at the moment, where's your headspace right now? Where are you focusing your time?

Nik Bhatia: Sure, so right now I'm with two Bitcoin companies, OpenNode and Tantra Labs. They're very different from each other, OpenNode is a payment processor, we're trying to be the next PayPal, we're trying to be the next Stripe, but based on Bitcoin. We're trying to allow developers to have tools to use Bitcoin and very easy to use API tools.

That's something that Stripe did, is they enabled the developers to just build with very easy to use tools and we're really trying to do the same thing at OpenNode. So my goal at OpenNode is to write content for businesses for enterprise, the executives and people at companies that are not familiar yet with Bitcoin in terms of its use cases for merchants and bringing them really into the Bitcoin era and the future of money.

At Tantra Labs, it's a hedge fund also based here in Los Angeles and we have an algorithmic trading strategy. My goal there at Tantra is to write Bitcoin financial theory, much like some of the stuff that I started writing last year like, "the time value of Bitcoin", "Lightning network reference rates", "how can we think about Bitcoin on its path to world reserve currency" and some of those things, really trying to explore the future of money.

Peter McCormack: Your belief is that Bitcoin is the future world reserve currency?

Nik Bhatia: I do believe that Bitcoin is the future reserve currency, the reserve asset as well. I think it'll take a long time to get there, but that's where I see Bitcoin going.

Peter McCormack: Multi-decade?

Nik Bhatia: Multi-decade yes. But I think that sometime in the next 1 to 2 decades, Bitcoin, gold and US treasuries will be in the same conversation as a triumvirate of liquidity, a triumvirate of risk-free assets so to speak, that dominate the reserve base of the world.

Peter McCormack: Triumvirate, that's a new word to me.

Nik Bhatia: Triumvirate, so it comes from the Roman Empire where Julius Caesar was ruling, but he was ruling in a trio. So it's just another way to say that this is a three headed monster of risk-free assets. We all think about Bitcoin in terms of either digital gold or replacing dollars, but I think that the dollar analogy is a little misplaced and mischaracterized. I think we're better to refer to US treasury bonds, which are considered the risk free asset in our capital market system and our dollar base capital market system.

That doesn't mean to say that the US treasury will never default, however the US treasury has the highest credit worthiness perceived by the market and the system, so we base our system referring to the US treasury rates as our reference rates in the market. So those treasury bonds, that is the asset that underpins the financial system, it's not dollars. Dollars out in the system are just banking liabilities, they're not actual money, they're debt.

The money is either the physical paper, Federal Reserve notes, of which there are only a couple trillion of in existence. I say only a couple of trillion, because the market of gold is actually almost 10 trillion and the market for US treasuries is over 20 trillion. So yeah, I think that the dollar is the wrong analogy for Bitcoin or at least the wrong target. We should be targeting gold and we should be targeting US treasuries to join this club of world risk-free assets.

Peter McCormack: Where do you consider the Bitcoin volatility in this? Because when you talk about risk-free assets, there is still a lot of risk associated with Bitcoin on certain timescales due to the volatility.

Nik Bhatia: Exactly and that's a great point. That's why Bitcoin is not ready to join that club, from a reserve asset standpoint right now, but it's on its path. The reason why it's on its path, is because the liquidity is what makes Bitcoin similar to gold. It's the fact that you can sell it for dollars or other currencies anywhere on the planet. There is not a defined market or exchange that you have to enter, to participate in buying or selling Bitcoin.

Gold is the same thing. You can go to any Cornerstore really in any country around the world, pawn shop or gold exchange and be able to liquidate that gold into whatever currency. So we see Bitcoin serving this function, now getting to a valuation of $10 to $20 trillion in market capitalization, versus where Bitcoin is right now, which is only over $100 billion, so only 1/10th of $1 trillion.

Getting from 1/10th of $1 trillion to 10 trillion, is going to see some incredibly volatile jumps up and crashes down. I do believe that we'll continue to see extreme volatility from Bitcoin for the next 20 years as it starts to approach a multi-trillion dollar market capitalization as an asset class. It can't just reach multi-trillions without having huge gyrations along the way.

Peter McCormack: I heard Murad talked about the same with Pomp, like you can't go from zero to multi-trillion dollars without volatility over such a short space of time.

Nik Bhatia: No, you can't.

Peter McCormack: And Dan Held also actually talks about the volatility, as actually a marketing hype cycle, because what happens is, the price moves so quickly, it creates lots of media awareness, it brings lots of people in and then obviously there has to be a recalibration, but those are actual marketing cycles.

Nik Bhatia: Absolutely! I wrote an article about this for OpenNode, I call them "adoption waves" and you basically have people coming into Bitcoin because of the hype and then staying throughout one cycle and building along the way, but the price behaves in an extreme manner independent from the way that people are adopting it. People are adopting it kind of slowly and steadily, but the speculation creates these massive price swings.

I think it is a feature and it'll prevent Bitcoin from getting adopted too fast. We want a nice steady adoption from Bitcoin and these price bubbles every four years or so, do scare away I think the people that are really only in it for the greed and keeps the builders excited and happy.

Peter McCormack: Where does your conviction come from? Because whilst I'm a Bitcoiner and I believe in it, I still recognize there is psychologically something there with gold, that it is a physical asset, there is something about owning and holding gold. I don't actually subscribe to the Bitcoin versus gold arguments, I think both have a very important and relevant role in the world.

But you're one of these people who does have a conviction for Bitcoin long-term. It means we're going to have to survive this bear market, we're going to have to have more bull markets, we're going to have to have a higher rate of adoption. Where does your conviction come from that this will happen?

Nik Bhatia: Well I think two places. First of all, using Bitcoin for the first time was a very empowering experience for me. I think inside, deep down I knew that this is how money should work and it should be based on scarce numbers and we should be able to transmit those numbers over the internet. So I think kind of just inherently I knew that it worked.

Where does the conviction come from? It comes from seeing 2008, 2009 happen in the financial markets, seeing the multi-trillions in explicit and implicit bailouts that came from the banking system and trying to understand, how is this money being created? What is this money system and how is it fair that they can just print all that money? So I guess the first question I had to ask myself is, are they actually printing money and how are they doing it?

Then you have to study, how does a central bank work? How does the banking system work? How does money creation work? Understanding all of that, understanding fractional reserve banking in the modern era, it really drove me to gold, to understand what gold's role was in monetary history. Bitcoin came about and I said, "this is the better version of gold and this is the fix" and that's what I believe.

Peter McCormack: Okay, so you have your conviction, you have your belief, what are the hurdles therefore for adoption? What are you looking at? What are you considering? Because we've had this like elongated bear market and there's been a lot of talk of, "oh the institutions are coming", then Bakkt launches and nothing really happens. There's very little obvious institutional interest. We've kind of just settled into a nowhere land at the moment. What's next? What do we need to happen?

Nik Bhatia: So I actually really like the realized market cap metric. It starts to strip out a little bit of this volatility that we've talked about, because we're able to now track the actual price at which Bitcoin is transacted on a cumulative basis and see that the base price for Bitcoin is actually just rising steadily. We reached $20,000, it crashed back down to $3,000, almost up to $14,000 again and then cut in half once again, you lose sight of the actual slow and steady build in cost basis and transactions really in this realized market cap level.

So I would actually just beg to differ a little bit and say that this really is adoption from individuals and institutions. We didn't see a spike or anything off of the Bakkt thing, but Grayscale is noting massive inflows...

Peter McCormack: Record quarter, right? $400 million was it?

Nik Bhatia: I don't recall. But they're getting huge inflows into GBTC. We are hearing from guys like Raoul Pal on Real Vision, that every single hedge fund that he knows, that is a global macro hedge fund, is exposed to Bitcoin. They have some long position, because they realize they cannot afford to be without that convexity. Bitcoin offers a convex return profile where if only allocate 1% of your portfolio, in a few years, it can be 10% of the portfolio.

That type of outsized return doesn't exist in traditional asset classes, so they actually feel that if they're not long Bitcoin, they're short and they've talked about this. It's kind of a theoretical short cover in advance, where you just have to be long. So adoption is there, it's building and yeah, if we think of Bitcoin's price volatility cycles happening over a four year time horizon, at any one point during that four years, it can feel like it's taking forever to get back up there.

Peter McCormack: I think it's because it's my first one. It's the first time I've lived through a real Bitcoin bear market knowing I'm going to be there at the end of it. I experienced 2013, 2014 but I just left Bitcoin. I came in, I discovered it and I left, I didn't care .I didn't understand it and I was just using Bitcoin for Silk Road. Now I'm in for good and it's not about financial gain, I don't really care about that. I'm more interested in just seeing what can happen as the market grows. But this is my first time through one.

Nik Bhatia: It's actually my first time through one as well. Part of my background is watching financial markets and studying price action and looking at price history. Studying the price history of Bitcoin, has led me to this conclusion that we are in some sort of four year cyclicality.

It does coincide with the halving cycle, it does coincide with adoption and media hype and I believe that we're just basing, the next cycle is starting and so maybe in 2021, we'll get the same type of mania that we saw in 2017 and 2013. Maybe not, but that is the way that I'm approaching this and so let's see, over the next couple of years!

Peter McCormack: All right, so you talked a lot about what happened in 2007, 2008, that was essentially a precursor to Bitcoin, although my assumption is, whoever Satoshi is, they were working on it for quite a while, probably many years and involved in many projects etc. But it looks like, again, the global macro conditions are getting pretty freaky. I've spoken to people, like I interviewed Dan Tapiero yesterday, I don't know if you know Dan, I've interviewed Raoul Pal, there's lots of weird stuff happening. What sense are you making of the markets at the moment?

Nik Bhatia: Yes, the global economy is expanding at its slowest pace since the financial crisis, so we do have that statistic out there. Global central banks are in ease mode, they are cutting across the world, so we have that there. So generally speaking, the economic outlook is not good. But if you layer that on top of the fact that the US dollar system itself is extremely fragile, as we're seeing right now with some of the disruptions in the repo market, the problem that we had in 2007/2008 never was fixed, it was just papered over.

So the next problem is that I think people don't believe that it's going to be fixed again, it's just going to be papered over in a much larger way than it was the last time and that means quantitative easing, ad infinitum from every corner of the world.

Peter McCormack: It's almost like a game of chicken between different markets, like who's going to give up first? Because for me, as somebody who's not an economist, I struggle to really understand in detail these things. I have to listen to people like yourself or Raoul Pal, but my gut feel is that China, the US, Europe and possibly Japan, they're playing a game of chicken now, who's going to give up first.

There just seems to be a relentless printing of money, every chart I've seen seems to show that government debt is increasing at an alarming rate. It feels like when this does crash, this is going to be a lot worse than 2007. Should people be worried?

Nik Bhatia: It's really hard to say, because what happened in 2008 should have ended the financial system, but the response was large enough that it delayed the problem by a decade.

Peter McCormack: Ended the financial system, in what way?

Nik Bhatia: Well what happened was that when Lehman Brothers collapsed, what happened to all the other investment banks that had exposure to the Lehman debt that was going to be basically marked from a 100 to 0, that draw down in asset prices across the entire financial system, meaning all the banks that hold the debt that's being marked from 100 to 0, if they have to mark it down to 0, their insurance premiums go through the roof, AIG couldn't insure, they couldn't underwrite the insurance anymore and the whole thing literally collapsed and every bank collapsed.

So when the bank bailout happened, they did several things all at once.They did quantitative easing to buy toxic assets from the banks themselves, they did quantitative easing to just boost reserves, they bailed out AIG because Goldman Sachs and other investment banks called their credit default swaps that AIG underwrote and AIG didn't have the money to pay all of them out, so we had to bail out AIG, to bail out the CDS contracts. So you understand, like the whole system would have collapsed had they not done a multifaceted bailout.

Peter McCormack: But have you reflected on and actually kind of envisaged what a collapse would have looked like? The government has to do something, right? They can't just allow for a collapse.

Nik Bhatia: So that's my point, they did step in and they prevented any collapse of society or any real societal collapse that could have happened with all the banks going under, in period of 24 hours.

Peter McCormack: But is that a good thing? Would it have been a good thing for the banks to collapse and rebuild our financial markets or would that have led to absolute utter chaos and anarchy?

Nik Bhatia: Probably utter chaos. But this is why Bitcoiners believe in Bitcoin for the future, is that we can build this parallel system. We don't want society to collapse!

Peter McCormack: Exactly! So the bank rescue's important. It should have happened, we want it to happen.

Nik Bhatia: Well we don't want society to collapse. We get upset by the mechanisms in which they bail out, because we're like, "that's not fair. Why are you bailing out the banks? You're not bailing out everybody and then you reward bad behavior because the banks are allowed to continue to operate."

Peter McCormack: I never buy that reward bad behavior, it's not rewarding bad behavior, it is protecting the markets and it's stopping the collapse of society. I get why it happens and we can look at it with like, "oh this is evil and the bankers have got away with it" blah blah blah. Certainly certain people probably should've gone to jail, but at the same time, I never saw it as rewarding bad behavior, I saw it as protecting people.

Nik Bhatia: That's fair. I mean that's really why they do the bailouts because they know that people will lose their jobs as a result if they don't. So we're not trying to condone the behavior or say that that's exactly what should have happened, it is what happened and we avoided whatever collapse could have happened without that. But I think the exciting thing about Bitcoin is that we can build something without having to come up with a solution to a problem that just seems so complicated and massive.

Like you said, you're seeing debt exploding from all over the globe, what is the end game? What is the solution? It's really impossible to know.

Peter McCormack: Well I see a massive debt right off, because I don't see it all being paid. When's this all going to be paid? It's just a situation that seems to be getting worse and worse! I quite like and prefer the idea of Bitcoin being built alongside a more healthy system. I don't think it is healthy, but a more healthy system because I think you have the opportunity therefore to... I never liked when something really bad happens for people, but it's good for Bitcoin.

It's like, "look at Venezuela, this is great for Bitcoin!" I would rather Venezuela was in a healthy position and Bitcoin was growing. I can't buy into Bitcoin benefiting from bullshit happening to people. I just can't buy into that.

Nik Bhatia: Yeah, there are a lot of geopolitical situations around the world that are cause for worry. Bitcoin does help people in a lot of those situations, but it doesn't mean you have to root for bad things to happen!

Peter McCormack: So I still don't think I've got a full answer, where do you think things are going globally right now? Do you see another crash coming?

Nik Bhatia: I think the global economy is heading into contraction. What that does to the financial system is anybody's guess, but global trade is slowing and has been for a year now or more. So the normal recession that happens in the business cycle, every 5 to 10 years, that's starting to happen now. What happens to the banking system as a result and if we're going to have a financial panic, like we had an 2008, is anybody's guess.

Right now, what's happening with the Fed having to do emergency measures, it doesn't feel great again and I'm definitely watching this repo situation and this liquidity situation with what the Federal Reserve is, very, very closely.

Peter McCormack: Okay, can you talk through and explain the repo situation, because I'd never heard of it until two weeks ago when I saw Caitlin Long tweeting about it. What is the repo market? Please explain it for people who don't understand.

Nik Bhatia: So it's actually considered the inner plumbing or the inner workings of how the financial system operates. So banks are leveraged, that basically means they don't have the cash that is required to pay for all the assets that they have on their balance sheet at any given point.

Peter McCormack: Does this go back to fractional reserve?

Nik Bhatia: This is fractional reserve. They have to borrow to fund the assets on their balance sheet. So primary dealers are the 20 odd banks that have an agreement with the Federal Reserve and the Treasury to traffic Treasury debt from the auctions and the primary market. When those Treasury securities get auctioned, banks, these primary dealers have to take down excess supply by law. You have countries, asset managers that bid for the bonds and whatever's left over, the banks have to absorb by law.

They have to take these bonds onto their balance sheet and guess what, they don't have the cash to pay for them. So they have to go out and finance them in the repo market. The repo market is basically a pawn shop for bonds. So the bond is the collateral and you get a loan for it. So banks typically fund their Treasury holdings, meaning they go to the pawn shop, and the pawn shop is in this case, basically the global cash base, everybody who has cash and they say, "lend us the money, we will post Treasuries to US collateral, so it's pristine collateral.

You don't have to worry about the Treasury defaulting. If I default, you can just take the Treasury bond and sell it and you're made whole on the loan." So it's like a collateralized loan. Banks should not have problem funding their treasury books, because the collateral itself is pristine. So what happened on September 15th, is that a bunch of treasuries settled into the system that the cash from the world just happened to disappear.

Now where did the cash go from the system? Was it just too many treasuries that hit the market all at once? It's a combination of both, but now we are coming up to the end of October and the Fed is still needing to provide that cash overnight, every night to these banks. So there are banks that are short liquidity, they don't want to sell the treasuries or can't because of reserve requirements, capital ratios or also safety.

Maybe they just don't want to part ways with the collateral because it's so pristine, because remember, when stock markets go down and companies default, the risk free asset are US treasuries. So what happened in the repo market? Long story short, an influx of treasuries and an outflow of cash, caused a bank or a few banks to be short of cash and the Fed has stepped in to provide that cash and they're doing so nightly right now and we don't know what's next.

Peter McCormack: Okay, that sounds kind of scary!

Nik Bhatia: It is scary because the repo market was at the center of the beginning of the last financial crisis.

Peter McCormack: But what is underpinning the risk this time? Because last time it was the mortgage backed securities, right? We don't have that as a problem anymore, so what are the risks?

Nik Bhatia: The subprime mortgages were one of the risky activities that the bank was doing, but keep in mind, if the bank is leveraged 30 to 1, 40 to 1, 50 to 1, it doesn't matter what asset goes bad. If something goes bad, they're insolvent. That's what leverage does to you, you don't have the ability to withstand losses. So we don't what... That's why I'm saying let's separate the incoming global recession from any banking panic, because bank assets being written down causes this banking panic.

Peter McCormack: Okay, I get it, because fractional reserve banking is essentially leveraging yourself.

Nik Bhatia: That's right yeah.

Peter McCormack: I'd never actually thought of it as leveraging yourself.

Nik Bhatia: It's leverage, that's what the fraction is! The fraction is the asset or the equity base to the assets that you're holding and if the number isn't the same, you have to borrow.

Peter McCormack: Okay, I get it. This is interesting because part of this, I've never fully understood. You know when it all starts to click for you? So are there laws about how much the banks are allowed to leverage themselves?

Nik Bhatia: That's a great question. This is something that I think is getting more popular to talk about in the global macroeconomic circles, and I'm excited that it's at the front and center of the conversation, which is that the US onshore Federal Reserve regulated banking system, has leverage ratios that are enforceable and are reasonable within the context. There are about 10 to 1 and the Federal Reserve has reserve requirements that they mandate continuously.

There is an offshore eurodollar system and by eurodollars I just mean dollars that aren't located here in the United States domestically. The offshore eurodollar system is a system of banking liabilities that gets created within the syndicate of banks, without any federal reserve or central banking oversight.

So we have an offshore system for the settlement and clearing of dollars, but that leverage ratio that's in the offshore US dollar system, is something that none of us can know, because only the entities that are creating those liabilities, which are the banks themselves, only they know what that ratio is.

That offshore eurodollar system is part of the problem with the dollar system. The Fed thinks that they can stoke monetary policy by creating bank reserves and increasing the size of their balance sheet, but if the Eurodollar system globally is in contraction, there's nothing that the Fed can do to actually stoke the global economy and many people believe that's what has been happening since 2007, is that this offshore dollar liability system is in contraction. So even though monetary policy is accommodative in the United States, it's not working.

Peter McCormack: So what's the difference between the banks and degenerate BitMex traders?

Nik Bhatia: That's a great question!

Peter McCormack: But is there any difference? Do you prescribe to wanting a world of no fractional reserve, fully reserved because some people believe that. Someone like Saifedean Ammous, he doesn't believe in fractional reserve at all.

Nik Bhatia: No, I think that fractional reserve is just a natural activity for people to do, where if they think that they can manage a loan book and leverage it up, then they'll be able to do that activity. I think it'll happen in Bitcoin where obviously you can't create Bitcoin, you can't lend Bitcoin, but you can lend Bitcoin-like instruments into the market. They will trade at a discount to regular Bitcoin, there will be an arbitrage there and I think that Bitcoin will end up in a fractionally reserve system.

Peter McCormack: That's going to piss a lot of people off!

Nik Bhatia: It will, but here's the great thing about Bitcoin. If you want to have custody of your Bitcoin, you can, you can audit the Blockchain and know that you have a percentage of 21 million coins forever. If you want a Bitcoin substitute to engage in economic activity, we might see that decades into the future. We're not looking at a fractionally reserved Bitcoin system tomorrow and we'll never be looking at a system where you're not able to verify your ownership of Bitcoin with your own full node thankfully. But we don't know how it's going to evolve!

Peter McCormack: So I'm pretty sure it was Wyoming. They have now, I'd have to double check this, but I'm pretty sure they've passed a law now that you have to have fully reserved banks or fully reserved operations. I know it's one of the reasons BlockFi aren't based out, you can't get a BlockFi loan or use their interest accounts in Wyoming. But I do need to double check this, so anyone listening, just let me double check that. But do you know about this?

Nik Bhatia: So I know that Trace Mayer's working on a lot of great legislation in Wyoming and one of the things that you have to think about, is the difference between a vault and a bank. A vault should, if you're going to call yourself a vault, should have full reserve. But a bank is itself a lending operation and so leverage is built into the concept of a bank.

So I do hope that we'll have regulated fully reserved Bitcoin vaults, but to expect that people aren't going to want to lend paper Bitcoin out into the market worldwide, I think it's unreasonable. Listen, even companies like BlockFi that are offering deposits and interest, what they have now that person, they have a Bitcoin liability, BlockFi has a liability to that client, so they no longer have their Bitcoin anyway.

So we're already starting to get into situations where people are willing to invest their Bitcoin, let go of their custody for a return, not knowing if they're ever going to get it back. Even if it's insured, is the insurance in dollars or is it in Bitcoin, because if it's in dollars, you're exposed there to a rise in the price of Bitcoin.

Peter McCormack: Okay, so the interesting thing there, just to help me understand, if a bank can fractionally lend, if they choose to make a loan to you, they're essentially printing money themselves by just changing the digits in your bank account?

Nik Bhatia: That's right.

Peter McCormack: So banks actually can just print money, they can make money out of thin air?

Nik Bhatia: Yes, and so when I talk about the monopolistic money creation powers of central banks and banks, what I'm about, is that central banks on their liability side of their balance sheet, have paper currency and bank reserves. So when they print paper dollars, that's a liability for the central bank and they've created money now. A commercial bank like Wells Fargo or JP Morgan, issues a loan to their client and creates those dollars into the bank account, as long as those dollars are fractionally reserved by reserves at the Fed, Treasuries etc.

So the power to create money is both with the central bank and with the banks and the only way that the banks can create that money, is if they have a banking license. So the power to create money is the central bank and the members of its banking club, they are the power. It's actually not just the banks or not just the central bank, it's them as a system, because the commercial bank is a member bank or a licensed bank under the Federal Reserve for example, they have the power to create money.

Peter McCormack: So like anyone operating with leverage in any market, whether you're a trader or a bank, the job of the bank is to manage risk, right? It's to manage risk of who they're going to lend money out to and going back to the mortgage backed securities and the toxic mortgages that they were offering, that's where the risk wasn't being managed well. That's where the risk got out of hand and a lot of these defaults happened and that's whereby essentially they got liquidated, right?

Nik Bhatia: That's right. Because what happens is...

Peter McCormack: They brought the whole global economy down!

Nik Bhatia: And what happens when people stop paying their mortgages? That's a default for the borrower. The borrower's defaulting, but they're defaulting to somebody. The mortgage holder at that point has an asset that's no longer priced at a 100, but is now priced at 80, priced at 60, priced at 40 and that price draw down is what affected the banking system.

Peter McCormack: Okay, this is the first time I've jumped through a few hoops I've struggled with before, things I've not fully understood. I'm starting to get a clearer picture now.

Nik Bhatia: Let me just say too about understanding the banking system, the repo reserve assets, the treasuries and all that, it's something that I've been studying now through myself, school, professional exams, work experience for about 12 years now and I still feel so dumb, because of how complicated it is and really how many moving parts there are to understand the global financial system. I try to add one part every few months working my up to a thousand, but it takes months and years to understand each one of these concepts by itself.

Peter McCormack: Tell me about it! I feel dumb shit as all the time, especially doing this podcast, because all I do is speak to experts who spend all day researching and writing, researching and writing! Trying to keep up with it all is really, really hard. But today's been really useful, I understand a lot more than I did yesterday, which is great. Okay, so all these considerations for how banking works, central banking works, how governments work, you're obviously a big fan of Bitcoin, what are the key things about Bitcoin that will improve the system for you? What are the most important things?

Nik Bhatia: So the first thing is, think about US treasuries as the world's risk free asset. Not only are US treasuries not available to all 7 billion people on the planet to hold as a reserve asset, but the minimum denomination of treasuries, far outstrips the ability of most people to save in treasuries. Bitcoin, you can save at the most micro level of anything.

Peter McCormack: So it democratizes it to every single person on the planet.

Nik Bhatia: Right, it democratizes it to every single person on the planet, because it's an open system, but it's also an open system with no minimums. So I guess it's more of the same.

Peter McCormack: Well you have a dust limit I guess.

Nik Bhatia: The dust limit, but that's negligible. We're talking about a system where everybody in the world can participate really at any amount. So I think that's one of the main things that excites me, is it's an open system and everybody can participate and that's actually what I think everybody that believes in gold, called a gold bug or whatever that has gold as an investment, believes in this ability to own a metal that can't be faked or counterfeited or seized away from you, if you have it in your possession, that sovereignty aspect. Bitcoin as well has that sovereignty aspect to it.

Peter McCormack: Okay, what else though about Bitcoin improves the system? Yes, it's great that everyone else can access it. What are the other things that really stand out for you?

Nik Bhatia: Again, I think it comes down to supply, its strictly limited supply and whatever the supply was, it's the fact that we know what it is going to be. It's not the fact that it's 21 million or that the block reward will go from, 6.25 and be cut in half at some point in time, it's actually just knowing what the schedule is and having that certainty. We don't really have similar certainty in any other asset class in the world.

We know that gold won't just be... The total supply won't increase by 10% next year, but we really don't. It still is a little bit unknown. So I just think that the reason why I love Bitcoin, is that I think that it improves on all the things that gold is lacking and gold really is historically, the world's best money.

Peter McCormack: Yeah and also, going back to the fixed supply, it changes your behavior. It forces you to rethink your behavior. It took me a while dude, I've probably got 10% of the Bitcoin I had at my peak, because I fucked up so many things, I got into mining blah, blah, blah. But now I understand Bitcoin.

Nik Bhatia: I totally agree with you. It really encourages savings and encourages you to knowing that or believing that it's going to be worth more tomorrow than it is today, really just encourages that saving. But thinking of it as better money too, it makes you not want to part ways with it.

Peter McCormack: No, but I want to use it, I still think it's important to use Bitcoin. What I have is I want to make sure at the end of each month, I've got more Bitcoin than I started the month with, but I don't mind using it there. I don't do big ticket purchases, but I do small ticket and I do give a bunch away, but I'm also always accumulating. Some of my invoices are in Bitcoin and 25% stays in Bitcoin.

The other goes to fiat to pay my bills, to run the business. But I've become... Like this whole time preference thing, there's literally a show out today about it, but it has really changed things, like things I'm thinking about buying. Like I gave up smoking this week.

Nik Bhatia: I saw that on Twitter! How's it going?

Peter McCormack: It was very hard, but getting easier. I'm going through gum like a motherfucker! I'm a Juul smoker, very occasional cigarette smoker, but mainly a Juul smoker, but I took up electric cigarettes to get away from cigarettes. But I was like, I didn't smoke most days. I'd smoke here and there, when maybe I'll have a few with a beer, less than a pack a week. With the Juul, you talk about risk free assets, it's risk-free smoking!

I could do it on a plane if no-one catches me, you can do it in bed, you can do it in front of the TV, you can just do fucking anywhere! It doesn't matter, because you didn't feel like it was going to make you stink and you didn't feel like it was unhealthy. But I got to the point where I was having like two or three pods a day, that's 20 to 40 cigarettes, right? My body was feeling achy, I was feeling out of breath and I just felt like shit. I was thinking, "this all comes down to time preference!"

If I get my time preference right, I will handle the breakup with my Juul and hopefully that's going to lead to a better, healthier life. So what I did, I was flying from Portland to San Francisco and I knew that they were banned in San Francisco, so as I got on the plane, I threw it in the bin. I was like, "now I'm stuck. There's nothing I can do for 36 hours" and then got to LA and went down the pub. I ended up buying a pack of cigarettes and I had two, and I was like, "what the fuck am I doing?

I'm using cigarettes to give up the Juul!" So I threw that away, I've now done 48 hours nicotine free. So I'm five days, no Juul, 48 hours nicotine free. It's really, really fucking hard! Anyone who's been a smoker knows, I don't know if you've ever smoked, it's really, really hard. Me as a former drug addict, who had a very bad Class A drug problem at one point, giving up a Juul is the hardest thing. It is far harder than giving up the recovery from a cocaine addiction.

Nik Bhatia: Well I commend you and I'm really happy to see that Bitcoin is a part of that decision.

Peter McCormack: Do you know what someone said to me on Twitter? They said "everyday, whatever you would have spent on your Juul, spend it on sats", and I was like, "do you know what that's a really great idea?" I was thinking someone should do a cigarettes for sats app, like literally you accumulate sats instead of smoking. I mean, what a great idea.

Nik Bhatia: I love it, stacking sats!

Peter McCormack: Dumping cigarettes! All right, cool, so this has been really super useful for me. Where are you in terms of like, when you kind of step above Bitcoin and Lightning, you look down, where do you think we are at the moment? Do you think there's any important areas of development that are being missed? Where are you now with everything?

Nik Bhatia: So one of the things that I like to think about, is the difference in Americans versus the world and in terms of Bitcoin adoption. Americans and I'm an American, we don't have a problem in front of us every day that makes us go to Bitcoin. The problems are more long-term, what I was talking about with my displeasure with trillions and bank bailouts and thinking that it's unfair and wanting a solution, that's not a today problem.

So my interests in Bitcoin are more long-term, but there are people around the world where their interest in Bitcoin is not as a savings technology necessarily, but as a transactional technology or as a savings technology that they need today to avoid central bank profligacy. So my main interest is in the people that are using Bitcoin, because they have to. .It's not people in the United States of America.

Peter McCormack: I get it. Let me tell you something, so you know I've launched Defiance?

Nik Bhatia: Yes.

Peter McCormack: So I've gone from like multicoiner, trader to Bitcoin only, and now I've got to the point where I'm like, "I want to stop thinking of the Bitcoin space" and I'll tell you why. I've been going to conferences and it's Bitcoiners talking to Bitcoiners about Bitcoin. Then someone would go and put some cool tweet online and we're all sharing it and talking about it, but in the end, it's still Bitcoiners talking to Bitcoiners about Bitcoin.

For me Defiance is almost like grouping a bunch of things that feel aligned, drug laws, Bitcoin itself, human rights, censorship, all these things feel aligned and it feels like Bitcoin should be part of that conversation. So I'm trying to get out of thinking in terms of the Bitcoin space, and I'm trying to think about the topics and the communities where this all works together. So I think that's got a bit of an alignment with what you're saying.

Nik Bhatia: Absolutely, I've written a piece called "Bitcoin is a human right". I've written a piece that I hope is going to be published soon, called "Bitcoin citizenship". So I do believe that Bitcoin is a tool that we have the right to use as human beings. It's a tool that is one of the most powerful tools we've ever been given as a species and it compounds with the internet. The internet is the tool itself that allows Bitcoin to be that incredible tool, so it's kind of the internet plus Bitcoin, as this one really powerful tool.

So yeah, it's something that I want to focus on and I want to see it being adopted by the people that need it and it's really just not in this country, even though we all get upset about the Fed printing money all the time, it's just not the same as the way it is in South America what's happening or with countries that have sanctions. There are people in those countries that have nothing to do with what their governments are doing. They need to access financial services as well.

Peter McCormack: So how do we get it out to them? How do we get the message out to them? Because it's like an obvious answer to people, "just put a bit into Bitcoin, you can save" and like you say it's a savings tool, but why is the message not translating?

Nik Bhatia: This is what comes back to what I'm doing here at OpenNode and I think bringing it full circle, Lightning network, the reason that we built on Lightning network and that we believe in Lightning network, Lightning network allows you to use Bitcoin online instantly, instant settlement. This whole idea that we have to wait for Blockchain confirmations, is incredibly important for Bitcoin security. It is essential for Bitcoin security. 

Bitcoin being slow allows us to have that confidence that the asset is ours with every passing minute or with every passing block. We need that, but we also need to be able to spend it at the speed of light without the burden of block confirmations. OpenNode powers this, we allow merchants to accept Bitcoin using the Lightning network and the ability to accept microtransactions instantly is going to change the way that we think about doing business on the internet. 

Microtransactions will become a real thing, spending money in the 1 cent to $1 realm will become a real thing on the internet and the companies that institute these types of business models, will open themselves to 7 billion customers. That's how we'll bring them in, we give them something that they want. Right now, they don't know that they need Bitcoin, but what if they can use Bitcoin online to get something that they really need in their country at the micro level. 

That's part of my vision for Bitcoin and that's why I love the Lightning network and why I think that instant settlement, and this is something that Jack Mallers presented on at Bitcoin 2019 in San Francisco, that we were both at together, instant settlement of Bitcoin is so powerful. The Blockchain confirmations that happen every 10 minutes or so, are essential and part of the security, but we need this also to make it a usable experience.

Peter McCormack: Yeah Jack is going to be so pissed at me recently, because it's controversial, you can share your opinion or not, but right now in terms of UX, I've found that some of the non-custodial solutions aren't as easy to use as the custodial. Now I need to spend some time on Jack's app using Zap, but I just think some of the custodial solutions for like a small amount of Bitcoin, $10, $20, $30, actually, it's a really great experience.

Nik Bhatia: I actually completely agree with you.

Peter McCormack: But we're anti- Bitcoin if we think that apparently.

Nik Bhatia: Listen, keeping your Bitcoin in cold storage and knowing how those keys were generated, if that's not part of who you are, then you're not really a Bitcoiner, you're just renting. if you choose to rent $20 of Bitcoin to make your user experience better, that's totally fine, I encourage that. But don't rent your Bitcoin, your life savings worth of Bitcoin or whatever Bitcoin that you have.

You can't rent your Bitcoin, you have to own it. But yes Peter, if you want to rent $25 worth of Bitcoin and play around with a custodial wallet, I don't think that's a problem and I do think that many people in the future will never have a relationship with the Bitcoin Blockchain, they'll just rent the experience from a company or a service provider and that'll probably be okay.

Peter McCormack: All right, cool! Any final thoughts you want to leave people with?

Nik Bhatia: Well, I really appreciate you coming out here, it was great chatting with you. I really love what you're doing with Defiance. I think that human rights is a big deal. I've been very disappointed with the reaction from, well let's just say the reaction to Hong Kong, the situation in Hong Kong is no different than any other human rights situation anywhere in the world. People want a voice and we have to encourage that.

Peter McCormack: To me it's the most important story in the world right now, because this is a fight for freedom. This is a fight for people who want to live free and when I say free, like the UK and the US, I think we've also got a lot of problems, but we can stand up and criticize our government. I can go and stand outside 10 Downing Street and I can criticize our government. We know you can't do that in China. 

So we're watching a group of people fight for their freedom and we're seeing it play out in real time online and in social media and they're either going to win or they're going to lose. We're going to witness seeing a change to a society if it loses and we're going to witness the reaction to their society if they win. It's a real time fight of the people against the state! You shouldn't find it entertaining because it's devastating to watch, but it's just fucking amazing to watch in real time.

Nik Bhatia: When the first protests were going on, in the first couple of days, I literally could not stop watching the YouTube live stream, because this is Hong Kong, this is the Chinese communist party we're talking about here. This is one of the most important situations in the world and it could dictate a lot of geopolitics.

So I'm not some expert on geopolitics, I'm just a keen observer. I like to analyze how these things affect markets and global macroeconomics, but I just encourage and support everybody that gives attention to these human rights issues because that's what freedom of speech is all about and we should protect it.

Peter McCormack: All right man, well listen look, don't tell people how they can keep an eye on your work, read the stuff you're doing and some of your amazing writing. "The time value of Bitcoin", I read that in preparation for my Lightning month, which I tried to schedule to have you on that month, but it never happened. That was really useful to me, I've obviously read some of the other stuff, but let people know where they can find your work.

Nik Bhatia: Sure, so you can find me on Twitter and Medium at @timevalueofbtc. The name is from my original paper that I wrote, "the time value of Bitcoin" and you can also find my work on OpenNode's blog and Tantra's Medium page as well.

Peter McCormack: Nice one! I'll share it out in the show notes, but all the best to you Nik and thanks for this man.

Nik Bhatia: Thanks so much Peter, I appreciate it!