WBD328 Audio Transcription

Bonds, Inflation and the GBTC Premium with Lyn Alden

Interview date: Wednesday 31st March

Note: the following is a transcription of my interview with Lyn Alden. I have reviewed the transcription but if you find any mistakes, please feel free to email me. You can listen to the original recording here.

In this interview, I talk to Lyn Alden, a macroeconomist and Lyn Alden Investment Strategy founder. We discuss bond yields, the effects of the rising inflation rate, the GBTC premium, and potential Bitcoin ETFs.

“If there’s a bitcoin ETF that then trades on a major exchange, the more people can essentially access it than if they’re not willing to buy over the counter products...it should increase overall demand”

— Lyn Alden

Interview Transcription

Peter McCormack: Lyn, how are you doing?

Lyn Alden: I'm good.  How are you?

Peter McCormack: I'm really good.  I've got something to tell you.

Lyn Alden: What's that?

Peter McCormack: So, remember last month, when we were talking about yields and afterwards, you sent me that chart with the yields going up, essentially breaking --

Lyn Alden: Yes.

Peter McCormack: And I was like, wow, reading the comments about, it's a disaster; but in my head, I don't actually understand why this is bad because surely, if yields are going up, this is great?  Better interest rates; people are going to be making more money.  I then had a session with Greg Foss and in preparation, I actually went and did some reading.

What I didn't realise is, with the bonds, they're constantly being repriced, being bought and sold in this market and I didn't realise that, as the bond yields are going up, all the old bonds are losing value at the same time; I had no understanding of that.  So, I just nodded and agreed with you and I was thinking, "Shit, I don't understand this!"

Lyn Alden: Yeah, there are a couple of points there because people on those long bonds lose value, existing holders.  I mean, people that are buying now get a better deal.  And then also, it ripples into other asset classes as well.  So, it's one of those things where normally, higher interest rates would be a good thing; it helps basically keep a time value to money; it's a really important thing to have. 

But, because they've driven interest rates so low, we've had such a build-up of debt and then therefore, when those industries try to rise, when you have extremely high debt levels; that causes all sorts of solvency problems, liquidity problems that are important to watch out for.  And then also, because we have equity valuations that are so high, especially in the growth and tech stocks, so those are -- if you do the analysis of discounted cash flow analysis, you're trying to determine what is your discount rate; so, what is your expected rate of return?

If you're in an environment where treasures are yielding 5%, you expect a pretty high return for those equities and so, you're willing to pay a lower price for them.  But if treasuries are 1%, you're willing to pay a higher valuation for those tech stocks, because you're doing that comparison.  So suddenly, when treasuries start rising, you're like, "Wait, well now I've got to pay less for these tech stocks", so you start to get kind of a selloff in some of those really expensive names.

Peter McCormack: Yeah.  It's funny; it's one of those things when, once you start to learn a little bit and you start to get your head round it, you start to see how all the moving pieces work together.  And look, I'm nowhere near there yet, Lyn.  But, I think what it's helped with me is when I hear your monthly report now, rather than glazing over most of it and going, "I've got no idea of what this is about", I'm starting to understand; the pieces of the puzzle are starting to make sense, how it's all interconnected.

Lyn Alden: I'm glad.

Peter McCormack: Well, thank you; I learnt from you; I learnt from the best.  How have you been anyway?  Where are we with bond yields; what has happened this last month?

Lyn Alden: So, lately we've been consolidating.  So, we got that pretty big break-up and then they did continue higher from there.  More lately, they've been kind of going sideways, and so we're below the high level.  We got well over 1.7% on the US ten-year, narrowed down in the 1.6%-something range; so, we've had somewhat of a consolidation.

We also had an FOMC Meeting, which is where the Fed comes out every six weeks and says what they're going to do in terms of monetary policy.  So, this was a bigger one than normal, because there were a couple of lingering questions.  One was that with yields pushing up and with inflation expectations pushing up, the market started expecting the Fed might hike rates sooner than they said before they would. 

So before, the Feds said, "We're not even thinking about raising interest rates and we're looking at multiple years with keeping interest rates at zero" and that's the short end of the curve, right; that's the part that they directly control.  And they say, "We're not even going to do anything".  And the market's saying, "Well, inflation's starting to get a little spunky here and so maybe the Fed will end up having to raise interest rates", so they started to price that in.

So, when Powell gave his press conference, they basically pushed back on that and said, "No, we're really not planning on raising interest rates until inflation actually runs a little bit hot.  So, we're not worried about inflationary expectations and we're not worried about alternative ways to measure inflation".  They're saying that the way the Fed measures inflation, that they're not really willing to raise interest rates until the way they measure inflation is well over 2% for a period of time.

The other big thing was that there's a big open question about the SLR Rule, which is basically a leverage ratio that applies to banks; so, that was temporarily suspended for a year, meaning that banks could hold more treasuries and reserves than they otherwise could.  That allowed them to essentially help finance the US deficit.  That helped basically, if you look back a year ago in March, the treasury market essentially broke.  It became illiquid; there were basically forced sellers, not enough buyers, especially for portions of the treasury market; and so, the Fed had to come in and buy literally $1 trillion of treasuries in three weeks, and they also worked with banks and said, "Okay, we're going to take away this cap so that you can temporarily have more treasuries and that will help smooth things out".

So, there were some questions about whether or not that's going to be extended and so I think for a lot of us, me included, our base case was they probably would extend it a little bit.  But, they actually decided they would not extend it.  But then, they kind of did a middle-of-the-road thing where they said, "Okay, we're not going to extend it.  However, we're open to comments, we don't want anything to break; so we're willing to tweak it in the future if it starts causing an issue".  So, they kind of took that middle-of-the-road approach, which I found interesting.

Peter McCormack: How do they measure inflation?

Lyn Alden: Core PC.  So it's like, they have a basket of goods and then they factor out things like, you know, things they view as cyclical, like energy costs and things like that.  So they're saying, what is the non-energy, non-food change in a basket of goods that they define, and there are all sorts of quirks about it.  My understanding is that they use like Medicare payment rates as their definition of healthcare inflation, so there are some wonky things in there that overall, probably allow them to understate that a bit; especially if inflation is being driven by commodity prices.

So, in general, that would be a slower moving indicator, so actually sometimes it's higher than headline CPI, if you have a month where you have, like, oil go negative; or if you basically have these big declines in some of these more cyclical commodities; and so, you can actually have core CPI be a little higher.  Whereas, if you have the other way around, where commodities shoot up and gasoline's expensive and people are actually having trouble driving as much as they want to because the gasoline's so high, that really won't show up quickly in core PC, unless it persists long enough that basically, they start raising shipping rates.  That then trickles into stuff you buy in Amazon.

So, it's their particular way of measuring it.  So, whether or not someone agrees or disagrees with it, at least you know that's how they measure it and that's how they said they were going to handle monetary policy until that measure reaches certain numbers.

Peter McCormack: Do you trust the rate though, because we're being told that we here in the UK, that we haven't seen significant changes in inflation.  But, I've sat down and talked to a couple of my friends, and we've been comparing certain things that have been going up in price and we are seeing things, certain things that we buy, go up 5%, 10%, 15%; all different types of things?

Lyn Alden: Yeah, currently there's a huge anomaly and I would say that I think they even admitted in their latest CPI report that they're having trouble collecting data.  And there's kind of weird -- for example, if you look at rents in major cities, those have been down and those factor pretty heavily into some of these numbers.  And so, if you are living in New York City and your rent went down, that could potentially offset some of the fact the other things went up.

But, if you're not living there, and your living standard didn't change and these other goods are going up, then your personal inflationary rate's going to be notably higher, most likely, than the base line.  And so, for example, I did an exercise, it was before this last six months of prices going up, but I calculated my personal by-household inflation rate over a two-year period and it was something like 3% or so, which was higher than the CPI and the PC suggested it would be; but, it was lower than some of the really alternative ways of measuring it.

But of course, everyone has their own basket of goods and so their own inflation rate varies based on their basket of goods.  And a general thing we've seen over the past several decades in developed countries is that services have gone up much faster than inflation; so healthcare costs, educational costs, childcare costs, car repair costs, things like that.  Whereas, goods have continued to go down, or basically undershot inflation; that's due to increasing technology; that's due to offshoring; that's due to automation; and so, for example, you can get a better computer for less cost, you can get a better TV for less cost, you can get a better car for the same cost.  And so, those have been deflationary.

So, if you're a big consumer of healthcare, education, childcare, like who isn't; then your basket could be pretty high.

Peter McCormack: Yeah, we've just got a letter from the school.  My kids' education, school fees, will be going up 4.8%, which is the biggest rise in the whole time either of them has been at the school.  I mean, it's a massive rise.  I actually spoke to one of the teachers about it, because I know him quite well and I was doing the collection.  And he said to me, on the side, that, "The main reason the cost of the fees is going up is to support the teachers' pensions".  He didn't explain why, but he said it's the pensions that are killing them.

Lyn Alden: A lot of them are underfunded, so I don't know about that particular one, but a lot of them, they've not put enough money in, their return expectations are too high, and going back to bond yields -- so historically, pensions are conservative investors; they want bonds in there and so we're back when bonds were yielding 5%.  You could say, "Okay, our target rate of return is 7%, because we're hoping equities are going to yield 9%, bonds are going to yield 5%.  If we do a 50/50 split, we'll get 7% and it will be good". 

But then we say, "Okay, just kidding, bonds are yielding 1.5%" and then it's like, "Well then I need to be more equity-focussed".  And then they get into hedge funds, they get into all these kinds of different alternative investments.  Some of them don't work out very well, so they basically have to go up on their risk curve and many of them are unwilling to put more money in and basically, essentially admit that, "We're going to get lower returns, therefore we have to put more money in or we have to reduce benefits". 

So, you have these kinds of issues build up and that's happening in multiple countries to a different degree.  I mean, that happens here in the United States; in fact, part of this recent bill they passed, the $1.9 trillion, there's a section of it for tens of billions of dollars that helps shore up one of the pension systems.  So, it's not directly related to COVID, it's not a COVID thing, but it's kind of trying to patch this longer-term issue.

Going back to the inflation question, to finish that up, I did a piece on inflation back in November in my newsletter.  I broke it down into different types of inflation.  So you have asset price inflation, then you have consumer goods inflation, and it largely depends on essentially money -- if you increase the broad money supply by quite a bit.

So, if you go back to classical definitions of inflation, just an increase in the broad money supply is, by definition, inflation.  So, often people are arguing about inflation; they have different definitions and then they're talking past each other.  So, without a doubt, there's been monetary inflation; we've had money supply increases.

Then the question is, where does that money go?  The answer is, it goes into whatever's scarce at the time; and whoever has the money, what are their needs.  And so, because we've had an increase in wealth concentration, right, so a lot of that money kind of pooled up in the upper echelon.  A lot of that money went to financial assets, so things like art, wine, gold, high-end real estate, high-end cars, collectibles, equities; all sorts of things like that, even bonds.  Because yields went down, bonds went up in price and so, during that long period of time, we had significant asset price inflation.

Whereas, for example, we were in a period ever since about 12 years ago where we have largely been in a state of global commodity oversupply; so, our oil's lower than it was 12 years ago, copper's lower than it was 12 years ago, even though it's been up a lot lately; it's still lower than it was; it's not at all-time highs, for example.  And if you look at a basket of commodities, they've actually been relatively cheap, and that's kept a number of basic goods down.

So, more of inflation's been in the asset price side, and that causes an issue, if you go back to yields.  Say the housing market, right; if you want to buy a house -- my dad, he was an older gentleman when he had me, so he was basically old enough to be my grandpa, but he bought his first house.  He was a police officer and just in his 20s and just bought a house; it was just not a big deal, and the price was silly, even when you account for inflation.  Basically, the ratio of the value of that house compared to his salary, even without a college degree, was a very manageable way to buy a house.

Whereas now, because we've driven up asset values, including real estate values, it's hard to buy a house; and the only mitigating factor is that because interest rates came down so much, mortgage payments haven't really gone up in the same way that housing prices have gone up.  So, if your house price doubles, or your mortgage rate is half the cost; that basically makes it that your mortgage is more manageable.  But, that also shows a concern when yields start rising, even from pretty low levels, when housing prices are expensive and people are this leveraged; that makes those houses harder to afford.

Peter McCormack: Yeah.  I remember my parents telling me, the first house they ever bought, because I could never understand it when I was a kid, when they told me that the first house they bought was £2,000, I think; and I could never get my head around that.

Lyn Alden: Yeah, it's crazy.

Peter McCormack: Okay, another question on this that's been on my mind is, I've got a lock of friends who are in lockdown and we're about to come out of lockdown.  And, most of my friends have managed to keep their jobs and been working from home and most of them are saying the same kind of thing, that they've actually managed to build up quite good savings, because they've not -- what they can do is have takeaway, right?  They can't go on holiday; they could buy a car, but they can't really; so, everyone's saying they've got a lot of money.

I know what British people are like.  Once they let us out, we're all going to go mental; straight down the pub, on holidays, everything we can do.  That will obviously lead to a sudden increase in demand on certain things.  Would you expect that to lead to some kind of delayed rising inflation?

Lyn Alden: It certainly can, yeah.  So, we've had a period, especially those base effects.  So, back in April of last year, 2020, that was the worst period; so, no one was buying anything other than Netflix subscriptions if they didn't have one!

Peter McCormack: They've gone up!

Lyn Alden: Yeah.  And so, back then, that was a dip in CPI.  Whereas now, when we come into April/May, when you do year-over-year comparisons, those are going to be pretty high headline numbers for many countries.  So, there's that hurdle to get over.

Then, yeah, if you have a large number of people suddenly spending more money on things that they couldn't spend on, that can certainly drive up prices.  For example, I haven't flown anywhere in the past year.  I normally would have done an international flight of some sort last year and that didn't happen.  So, I'm certainly going to do one later this year and some people, I think, will do more than they otherwise would have; they might spend more than they otherwise would have. 

Those places, because some of the supply's been killed, they can raise prices and, say, some of these weaker hotels have folded and some of the airlines took some of their planes out of flight and they said, "Well, there's less supply so we're going to jack up prices".  So, if that kind of happens all at once, that can certainly be an inflationary spike.

You also have to see what happens with energy markets.  So, because we went into this pandemic with a state of energy oversupply, largely due to American shale and Canadian shale, North American shale; that kind of rose over the past decade and disrupted the global OPEC supply issue that we've had for history.  We had a period of oversupply; a lot of it was unprofitable, right.  So, it's not like we just grew up on profitable shale; tons of oversupply; so this comes around and kills demand for the better part of a year, and so we basically had --

Peter McCormack: Quick question, sorry.  Is it unprofitable because it's more expensive to get out the ground than through traditional wells?

Lyn Alden: That's the thing; the maths is wiggly.  So, what they promise is rarely what they deliver.  So basically, the way that shale works is, there's less upfront cost, but then more ongoing cost; because basically, it's like a bunch of smaller wells.  So, say you discover a massive, deep-sea oil find, it costs a ton of money to have that rig in place and get on down there.  But once, you've put that huge capital cost in, the marginal cost of getting the rest of that up is really low.  The same thing with oil sands in Canada; there are huge upfront costs and then once there, it's actually pretty low.

Shale's the opposite.  It's on land; these techniques basically say that you can actually put a small amount of capital upfront and then you get this well.  But then what happens is, that well quickly starts declining, and then you have to keep putting more and more and more money in and it's like they never seem to be consistently free cash flow positive.

So basically, the whole decade, if you look at the industry, they didn't generate free cash flow, so a lot of them don't pay dividends.  Only the top blue-chip shale companies are able to really pay these consistent dividends and so it's not been very profitable.  But, they've been able to raise enough equity from sometimes those pension funds we talked about, but just all sorts of places have been willing to fund them and just put endless, you know, just light money on fire, keep drilling and just not really getting returns for it.

But now, you have some investors are just tired of losing money and they're saying, "Well, I'm not going to invest in that anymore".  And then also, you have ESG mandates, so people say -- the New York pension system says, "We're not going to do oil investments anymore" and some sovereign wealth funds are saying, "We're not going to do oil investments anymore"; so, those companies are less able to keep issuing equity and just keeping drilling and so they say, "Wait, we have to actually finance ourselves from selling oil and therefore, we have to be more conservative with our capex".

So, we've had this thing where oil demand has risen as lockdowns have eased at the same time as a lot of that weak supply came off the market, sometimes because capex projects were cancelled, and some of those wells kept going down in usage.  So now, it's a little bit more tight than it was.  And OPEC, some of them can increase production, but they've also purposely held it flat so that they, in their view, hopefully drive prices a little bit higher.

Peter McCormack: Right.  It's going to be interesting to see how it all plays out.  I'm planning on going mental; I'm going to go out.  We're actually already booked into the pub!  Okay, I'll tell you another funny thing; I've actually got viewer questions for you!  This has never happened before; I'm getting people writing in going, "Can you ask Lyn this?"  I'm going to entertain it. 

This is going to be a bit of a jump to a completely different subject, but I'm going to ask it anyway; the GBTC premium is negative.  Now, I covered this with Zac, but I still didn't fully understand it.  Can you explain to me why there is a premium and why it can go negative, but just keep it as simple as proper Pete 5-year-old language?

Lyn Alden: Yeah, sure.  So actually, I will go back to pointing out what closed-end funds do.  So, before Bitcoin, we had closed-end funds, and basically they're different than an ETF.  So, an ETF, they can issue more shares; they can reduce the number of shares very easily; and so, it's very easy for market makers to look at their list of stocks that that ETF owns, and they can do things like buy all of them and then short the ETF, if there's a premium; and they can redeem shares to basically put a time limit on how long that premium can exist.  So, they can arbitrage that down so that ETFs virtually have no premium or discount, other than in extreme market events, like March of last year; you had some ETFs had --

Peter McCormack: Yeah.

Lyn Alden: So, whereas closed-end funds are actually this older vehicle where basically, I raise a bunch of capital, so I do an IPO and I build a company but all that company's going to do is invest in a portfolio of stocks.  So, it is a type of structure that is essentially like an ETF, but it's a different structure.  And, there's no constant redeeming or creation of shares; I, say, put 1 million shares out there; I've got money and I invest in this; and those shares will trade hands, but I'm not issuing or redeeming them.

So, I go and invest and my investments do what they will and the market trades those shares.  But, what the market is paying for that basket of stocks might not be the same amount as if you actually add up all those stocks together.  The market cap of my company might be different than the actual portfolio value.  And in fact, on average, the majority of closed-end funds do trade at a discount to NAV, meaning that you have this pile of stocks, this basket of stocks, and the market is paying 90% of what it's worth, or 95% of what it's worth.  So, they're actually trading between themselves at a discount.

Part of the reason they do that is because, that company generally has a fee, like an active management fee that they take out.  It's often the case that that's 1% a year, so the market is saying, "Well, we're going to trade at a discount and so, we're basically going to factor out five to ten years' worth of your fee".  So, the only ones that end up trading for a premium, especially for any length of time, are ones that are so unique that people are willing to buy into them, even though there's a premium to NAV.  Like, maybe there's a star manager and they're saying, "Well, I'm paying a premium for it, but I think she's going to do so well that I think it's fine for that".

Other times, it's just kind of inefficiencies, so a lot of those are done by retail investors and they don't know what a premium is and they're just buying it.  And so, there's a variety of reasons why a fund either could be really good or just the market's weird.  Now, GBTC comes along; they haven't allowed a Bitcoin ETF in the United States, and so they're, "Okay, we're going to be a trust similar to a closed-end fund; we're going to hold Bitcoin", but they have no redemption mechanism.  So, the shares trade for what they will; they hold the amount of Bitcoin that they do; and so, those can be separated.

So, because it falls into that category of, people are willing to pay a premium for it because some people aren't tech savvy, especially over the past several years; they don't know how to open a Kraken account, whatever the case may be.

Peter McCormack: But, they want exposure.

Lyn Alden: Yeah, they want exposure.  Many of them say, "Actually, I want to hold it in my Roth IRA".  And so an American, basically you're a tax-free account, right, and you already have it at Fidelity, whatever the case may be, and you say, "I want to hold Bitcoin in there".  So, by holding a GBTC in their tax-free account, even though they're paying a premium for it, they might say, "Well, I'm getting it tax free and so I'm fine with that; it's a good balance".

So, that's been an attractive vehicle for a lot of people, because they don't have to deal with another account; they don't have to deal with custody; and they're just saying, "Give it to me".  And so, there were times when the premium became silly and there were times when it became lower, but it was generally trading at a premium.

But, now we've seen more and more funds pop up, so you have SkyBridge, you have NYDIG, you have all these other institutions and also just more and more people are willing to open up major exchange accounts; there are other services like Swan Bitcoin.  There are all sorts of ways that make it increasingly easy and cheap for people to access it.  There's just more education, more podcasting, like what you're doing; so, it's easier for people to open up those accounts.

So overall, I think GBTC's competitive advantage has somewhat diminished and arguably, because they're charging, last I checked, a 2% fee, I mean it's a pretty high fee; and, some of these options are lower fees.  So, in some ways, my view is that the market is saying, "Your fee is high and so, we're going to trade that at discount to NAV.  If you're going to charge 2% fee, we're going to pay less for those shares now, because we could just go ahead and we could buy SkyBridge, or we could go to Kraken and just buy Bitcoin there and then not pay any fees on it, other than the initial commission fee and the sale fee".  And so, that's taken that out.

What that did, there used to be an arbitrage where, the one way that GBTC made new shares was, if you were a credit investor, you could go in and say, "Okay, I'm going to buy at NAV", so they got to basically buy at NAV, GBTC would issue new shares, pull Bitcoin into that illiquid fund and the only catch was, if you did it like that, you had a six-month lock-up period, so you couldn't sell.  So, the trade there was you say, "Okay, this thing always trades at a premium.  I can buy at NAV and in six months, I'll be able to sell it and I'll be able to capture that premium".

But, let's say I don't know what direction Bitcoin's going to go.  Some people would just buy it and hold it because they're bullish on Bitcoin.  Other people say, "I don't know if Bitcoin's going to go up or down, so what I'll do is I'll short Bitcoin and I'll buy into this at NAV.  Then, at the end of the six-month period, I don't care what Bitcoin did and my return will be the premium that GBTC's trading at, because I'll just sell my shares and then I can do it again; I can do another six-month lock-up".

Peter McCormack: Oh, okay.

Lyn Alden: So, it was bullish for Bitcoin because --

Peter McCormack: Yeah, I get it.  I'll tell you the bit that's clicked for me now is that, I didn't understand the shorting component because I was like, well, I just didn't understand it.  It's a bit like it somebody on BitMEX wants to go neutral and they've got a long, they take out a short and they're in a neutral position; they're essentially doing a neutral position, but they're capturing the premium?

Lyn Alden: Exactly.

Peter McCormack: Yeah, okay, that makes sense.

Lyn Alden: So, it's nearly a risk-free trade and they can do it twice a year and so, if the average premium was like 15%, they could get 15% twice a year, so that's better than a 30% compounded rate, without almost any risk, other than counterparty risk.  If GBTC's custodian gets blown up somehow or hacked; that's a risk.  But basically, besides those kinds of tail risks, you're not taking any kind of Bitcoin price risk.  So, that was a very popular trade.

It also was good for Bitcoin, because it sucked Bitcoin into this black hole.  Basically, once they go in at GBTC, they don't go out.  So, it basically was this buying pressure.  Now, because of this increased competition, that premium went away and therefore, there's no incentive to buy it at NAV, because when your lock-up period ends, there's a good chance that they're going to be worth less than they're worth now, unless -- basically, there are much better ways to buy Bitcoin than to buy the GBTC above current prices.

So, that trade dried up and anybody who was relying on that trade suddenly might have an issue there now, but some of those lenders are smart and they would position themselves so that they were only going to a certain amount of capital on this GBTC trade.  Any good ones should have modelled what happens if that goes away.  So, we might have to lower interest rates, we might have do other things; but it's not like they're going to blow up.

Now, there's potentially the other side of the trade.  So, if a closed-end fund gets to a very large discount to NAV, that makes it more attractive, because you say, "Well, I can do that" and then there are some ways that those closed-end funds can close that discount.  So before, I said they don't really issue shares and stuff, but actually, as an exception, they can.  They can say, "Our thing is now trading at a 15% discount to NAV".

I often use the example of an India Fund.  They've invested in Indian equities; they're often trading at around 10% discount to NAV.  If there's an unusual where they're trading at 15% discount to NAV, a fund manager can say, "We're going to buy back some of our shares" and that helps close the gap.  And if, for whatever reason, the trade's at a premium to NAV, they can actually issue shares and they can kind of play that arbitrage. 

So, they can buy some of the shares back to try to close that gap and then also, if the United States ever allows a Bitcoin ETF, which it seems that the writing's on the wall that eventually, you know; there are so many people applying for one; Canada has one; it's really hard not to have one.  So, if there's ever a Bitcoin ETF, if GBTC's able to convert into ETF; that discount should go away.  So, people can do a thing now where they buy GBTC at whatever discount it's at and then they can short Bitcoin.  They can have a neutral trade with the expectation that in the long run, that gap might go away.

Peter McCormack: So, do you think an ETF is coming, because there are like 17 applications out now, and didn't Fidelity just apply for an ETF?

Lyn Alden: I hear that Fidelity did, yeah.  So, I assume one's coming and I admittedly don't know how it works when everybody wants to.  I don't know how they pick who gets to have one.  So, for most asset classes, there are multiple competitors; so, there are multiple gold ETFs and they might have slightly different nuances. 

Usually what happens, for example, if you take gold ETFs, there was the original one, and that one was super liquid, right; so, if you're doing option trades on that ETF, that's the one you go to, but they can get away with charging a higher fee for that; whereas other ones come along and say, "Hey, we're going to do the same product for half the fee".  So, that's more attractive for long-term holders, but that will generally be because it's a newer product, it's a smaller product, it's less liquid and so, frequent traders and option users will generally stay away from that product and they'll stick with the older, more expensive, more established product.

So, whether you're a buying holder or a trader, which one could be better?  And then, you could have other funds come out and say, "Okay, we're going to actually fully allocate our gold and so we're better, but we're going to charge a pretty high fee".  So, some people that are concerned with re-hypothecation and things like that can buy into that fund.  And so, you have these different trade-offs between these different types of funds.

So, you could see that, to some extent, in the Bitcoin space, where you have multiple ETFs, once they're allowed to use that asset class as an ETF.

Peter McCormack: So, whoever gets -- if it's one, everyone else is going to be so pissed off?

Lyn Alden: Yeah.  I don't fully know the mechanism of how that selection process works and who's going to be allowed and who's not.  The first big question is whether or not they let anyone, but I think eventually they have to.

Peter McCormack: Yeah.  Well, somebody put out a great tweet the other day.  I think maybe it was Frank -- not Frank.  I want to read this, because this actually felt like it was on the money.  Fintechfrank; where are you, mate?  Oh, here we go, "Given all the bullshit that's gone on with the meme stocks this year, if the SEC doesn't approve a Bitcoin ETF, they're either completely ignorant, complacent or corrupt"; I thought that was pretty fair!

Lyn Alden: I think it's fair.  And there have been good comparisons, because one of the ostensible things is, "We're not going to allow a Bitcoin ETF because it's too volatile", but there are triple-leverage ETFs that blow up all the time.  There are volatility ETFs that have this massive decay rate.  Now we have meme stocks being grouped into an ETF and it's kind of this weird construction process and just kind of a questionable product to begin with.  So overall, there are a ton of weird vehicles out there, so Bitcoin would by no means be the most volatile one. 

I think that the concern they've been going with recently and for a while is that they've been concerned about market manipulation; that they want to make sure that it's not a market that a small number of individuals can manipulate.  So, back when Bitcoin was smaller, it was easier for whales to manipulate it; but the bigger it gets, the harder it is to move.  You still see periods where there'll be an alert put out saying, "Gemini just got a whale input" and I know Willy Woo's always on Twitter saying, "That's not what happened".

Peter McCormack: Yeah, I talked to him about that yesterday, about them crashing the market, the Quant guys; because that's twice they've done that.  They did that with the F2Pool data.

Lyn Alden: Unfortunately, that's fuel for the SEC to be, "Oh, look, it's manipulated.  That's why we have to hold off on an ETF for now".  So basically, the extent that a market could be manipulated, especially the type of manipulation they care about is that short-term stuff.  If a group of individuals could say, "We want to short it and then move the market", and whatever they're going to do; that's one thing that I think the SEC has reasonable concerns on.

But really, there are so many small stocks out there that can be manipulated; there are so many weird vehicles out there that can be manipulated.  Bitcoin will by no means be the problematic one; so I think eventually, it's inevitable, but we'll see.

Peter McCormack: Do the ETFs have to buy the underlying asset?

Lyn Alden: Well, they can have exposure in several different ways.  One example is there are popular commodity ETFs.  So, there's an ETF that follows a basket of agricultural products.  They don't have giant warehouses of grain and soy beans; instead they use futures.  And the same thing with some of the oil ETFs; they don't hold a lot of oil, they buy oil futures.  Some of them actually blew up for that reason and there are futures experts that can go into it way more than me.

But basically, if oil's in a bear market, if you look at the performance of those oil ETFs, they do way worse than oil.  The way that the futures work, as they rolled from one contract to another, they basically had to stepwise downdraft in their value.  So, if oil were to, say, get cut in half, so it goes from $60 a barrel down to $30 and then it, say, doubles again, so goes back up to $60 a barrel, you would expect that the ETF also got cut in half and then doubled. 

Whereas really what happened is the ETF goes down a little bit more than half, and then only comes back part of the way.  So, that has a permanent capital loss, based on the fact that they're using futures, rather than holding giant tanks of oil.  It partially comes down to the stock-to-flow ratio of that commodity. 

So, gold is one where at least some of them, like Sprott, can hold it.  They're like, "We have an actual vault; the metal's in the vault; and that's how we're doing this product".  Other ones, a little bit more questionable, they can say, "We have a vault, but we also use a little bit of derivatives around the margin, because…", whatever the case may be.

So, it really depends on the type of asset that they're doing.  So, there are uranium holding companies, so that's got a pretty high stock-to-flow ratio so they can actually physically hold it; gold, silver, uranium.  Whereas, if you get into those other, those oil, copper, grains, they're almost never going to be holding; it's going to be futures based.

Now, Bitcoin's one where I would say that they could hold it.  Something like Fidelity could be like, "Hey, we have our deep cold storage solution and here's an ETF".  Now, they also could do other options as well.  They could do options in futures to basically synthetically have that exposure, and that might be one of the differentiators between different types of Bitcoin ETF. 

People can say, "I like Fidelity's, but I don't like [such-and-such] because I like the way that they custody it more", so that could open up some differentiation, either in terms of, some of them might be more expensive, but arguably better security, as an example.

Peter McCormack: Okay.  Well, I think they should just let them all go at once.  I think they should set the rules upfront, say, "If you want to follow these rules, you can go live", and just let them all go!

Lyn Alden: Yeah, honestly I don't know how it works when multiple of the same want to do a similar ETF.  There are industry experts that would know that specific process way more than I would.

Peter McCormack: I mean, would you expect a supply shock when they are unveiled on the market; do you think there would be a lot of demand for this?

Lyn Alden: I think there would be a lot of demand because, as an example, I remember we talked about the MicroStrategy thing where, if an ETF -- GBTC trades over the counter, so not only is it not ETF, it doesn't trade on the New York Stock Exchange, it doesn't trade on Nasdaq; it just trades over the counter. 

So, for example, I had different model portfolios and one of them using M1 Finance, which is a good platform, but they can only go on the major exchanges, so I couldn't even have GBTC in that account.  Whereas my other brokerage, Interactive Brokers, I can go ahead and buy GBTC.  I'd also want to have that in my M1 Finance account, but because I couldn't do that, instead I bought MicroStrategy back in August 2020 because they became a Bitcoin allocation essentially; so, that was one I was able to actually access on that particular platform.

If there's a Bitcoin ETF that then trades on a major exchange, more people can essentially access it than they would if they're not willing to buy over-the-counter products and if they're not interested in having an exchange account or something like that.  So, it should increase overall demand, especially asset managers that invest other people's money.  An ETF makes it much easier to be inserted as a slice into a diversified portfolio and say, "Okay, we're going to have a 2% Bitcoin allocation via this Bitcoin ETF that's backed up by BlackRock or Fidelity", or whoever ends up kind of getting that; so that gives them much more comfort, I guess, and better liquidity and things like that.

The Canadian one did very well for that sort of reason and you'd expect that the American one would add a zero to that, probably, or at least if there are five of them, then it gets distributed across multiple ones, whichever ones end up being the popular ones.

Peter McCormack: All right.  I do want to go back to bonds, actually.  I've got a question on this.  Somebody asked, and it's something I'm thinking about, based on talking to you and talking to Greg, and I've got a follow-up based on my conversation with Greg; but, is there a looming corporate bond debt crisis?

Lyn Alden: Potentially.  So, if yields keep rising, if inflation goes up and yields rise, that can put a lot of pressure on credit markets.  So, a number of people have been talking about the possibility of yield curve control, including me, where the Fed can go in and prevent long-term treasuries from rising.  But, a couple of us, like me, have been pointing out that they're unlikely to do that unless something breaks.  So, it could be that the treasury market breaks, or it could that the credit markets break.

For example, if you look back at Q4 2018, we had a big selloff in asset prices, especially growth stocks and Powell did this famous "Powell Pivot", where he said that basically, it was all sparked by, the Fed was raising interest rates; they were reducing their balance sheet; they were still doing quantitative tightening; they kept on saying it was on autopilot, "We're going to keep doing this".  The market freaked out and then Powell came and said, "We're going to be more data dependent; we're going to slow down", and that kind of eased the market.

Now, a lot of people think that Powell did that because the S&P 500 fell 20% really rapidly; but actually, the bigger concern was that the junk bond market froze up.  So, for six weeks, there were no junk bonds issued in the United States and I think probably a lot of other places too.  And basically, that's a bigger issue than equity prices going up and down.  And so, when they see the credit market freaking out, that forced the Fed to intervene more.

So, there is overall, there is a lot of corporate debt in the system relative to GDP in many countries, and one of the ways that they've been able to do that is because interest rates are so low.  But, if interest rates keep pushing up, that does put some pressure on them.  So, I would expect to see some turbulence in some of those areas.

Last year, the Fed was able to buy corporate bonds, even though they're technically not supposed to.  They did a loophole where they setup a special purpose vehicle with the Treasury.  The Fed can't do it unilaterally; only the Treasury and the Fed together can do something like that.  But even then, they didn't explicitly buy junk bonds, but they were like, "Okay, we're going to buy investment-grade bonds, but if they fell to junk within this certain period, we're also willing to buy them".  They actually ended up not buying a ton, but it was enough to soothe the market, where basically the market took over and kind of pushed those yields back down.

So, there is kind of a long-term issue of debt.  And if you look at -- an example I often use is Japan, where they had a huge corporate debt bubble two decades ago.  Part of the reason they stagnated is because they've been deleveraging that over time.  So, even as Japan's sovereign debt skyrocketed, their corporate debt, as a percentage of GDP and absolute, went down because it essentially had a transfer from the private sector to the public sector.

So over time, it is possible that we see a similar thing in some of these other countries, where corporate debt's pretty high and should ideally flatliners start going down as a percentage of GDP, and whether or not that happens abruptly or over time remains to be seen, partially dependent upon what policymakers do.

Peter McCormack: Have you see Greg Foss's theory on Bitcoin as insurance on the spread of bond yields?

Lyn Alden: I don't think so, no.  So he's basically saying, if yields go up a ton, that volatility would be good for Bitcoin?

Peter McCormack: Yeah.  He's saying that essentially, you can use Bitcoin as an insurance against it.

Lyn Alden: Yeah, potentially.  It's one of those tricky things, because if you have a volatility event that causes illiquidity, like we had in March 2020, then Bitcoin can go down with everything else, sometimes even more because it's Bitcoin.  Whereas, if you have other types of issues where it's not a liquidity issue, but it's a solvency issue, that's generally good for those hedges. 

So, as an example, if we use gold; back in that selloff in 2018 that I talked about, gold did very well, because it wasn't a liquidity issue; it was like a yield -- basically, there was a variety of issues, but liquidity wasn't really one of them.  And so, something like gold was able to do well.  Whereas, in March 2020, gold sold off with everything else, because there was a liquidity issue and people had to force sell certain things. 

So, in a similar way for Bitcoin, if there's a solvency issue, Bitcoin is likely to do pretty well.  If there's a liquidity issue, then Bitcoin can temporarily be correlated to other assets in the market.  But, I'd have to say the specific theory about the credit spread.

Peter McCormack: Do you know what; I'm going to ping it to you.  I'll literally ping it to you and then I can ask you about it next time.  Okay, there are a couple of things I want to ask you about.  We'll see what we can get through.  Firstly, I'm just going to go with a wild out-there one; what do you think of NFTs?

Lyn Alden: I was asked that on RealVision. 

Peter McCormack: I know.

Lyn Alden: It's an interesting technology.  I'm always open for ways that artists can get paid for their creations, whether it's music, whether it's visual files.  There are a couple of issues: one is, the problem with digital art is that you can get an identical version, rather than just a similar copy.  So, for example, if someone has a Van Gogh, another person can get a very good replica Van Gogh, but it's not identical down to the brush strokes; it's very similar to an untrained eye, but it's not an identical product.

The problem with a digital NFT is that you literally have an identical JPG and you just don't have it "signed" essentially.  The other issue that I point out is that basically, you're also betting on the underlying blockchain that it exists on, because say there was a Picasso painting, but he used the wrong kind of paint, so that's dissolving faster than expected, and that happens sometimes --

Peter McCormack: No, it's just a great analogy!

Lyn Alden: And so you say, "Okay, I love Picasso, but the canvas is bad [or] the paint's bad and it's falling apart rapidly", and that would take away from the value of that Picasso.  So, if your NFT is built on a blockchain, you'd better hope that that blockchain, if you're going to pay $1 million for it or tens of millions of dollars for it, you'd better hope that that blockchain's around for the next 50 years.

So, based on how much you're paying for it, you'd better hope that that blockchain continues to be the leader in that field.  So, it might not have to be the biggest blockchain; it might be, say, the biggest utility blockchain, but it better not get displaced by competitors over the next 10, 20 years, otherwise that really takes away the value of that product.

There's another thing where traditional art, usually unfortunately living artists don't sell their art for a ton of money; it's usually when they pass away and then their art starts getting exponentially more expensive.  That's partially because you've just proved scarcity, so that artist can't make anymore.

Peter McCormack: I never thought of it like that!

Lyn Alden: Yeah, those go up a ton.  So, we have the overall question, if the artist does an NFT, could they issue another one on a different blockchain?  There are all sorts of issues like that.  So overall, if you step back for a second and say, okay, people love collectibles, we're obviously willing to pay money for things that are worth more than their materials, and everything's being digitised; it would make sense that there's some foray into digital collectibles; that makes sense.

But then the question becomes, how do they work; what are they built on; what is their mechanism to ensure that it's actually scarce; and then also, is it a mania; are the prices reasonable; what is the probability that most of these are going to hold their value over the next five years?  With some of them, perhaps, but I think a lot of them are not discernibly priced, let's say.

Peter McCormack: All right.  I think we're going to do one more topic and then I'm going to let you go.  So, nobody's talking about Tether anymore; the Tether FUD is over, which is amazing really.  I've just not heard -- I can't even remember the last mention of Tether; it's all gone. 

Lyn Alden: I see the occasional Twitter comment, but that's about it.

Peter McCormack: Probably from someone misinformed.

Lyn Alden: Yeah, my inbox before, when that big article came out, I got like a million Tether questions and I haven't gotten one in like two months.

Peter McCormack: Well, I'm hearing a lot of energy questions at the moment; people saying, "Can you just cover energy; can you make a show about energy?" which I am going to do.  But, I think we are seeing a different type of FUD, which is the governments will ban Bitcoin.  We've had whatever Mike Green was talking about, but Ray Dalio specifically.  What are your feelings on that and actually, how did your debate/discussion with Mike go; I haven't watched it yet, but I'm going to certainly watch it?

Lyn Alden: So, I enjoyed it.  That one had an institutional audience, so it was actually, we structured that more as a conversation than a debate, but of course we had opposite sides of the conversation.  And I think it was probably similar in tone to when he discussed with Nic Carter.  So, I haven't got a chance to listen to it back, so it's a basic conversation about the risks and defences against those risks.  He'd point out a risk; I would say, "Well, here's why I don't view that as a primary issue". 

So, we kind of walked through that; it was only an hour or two, so we didn't exactly cover everything.  But, I'd recommend people check it out and I think it's going to be posted on YouTube at some point, if it hasn't already.

So, overall with the government banning FUD, this has been a long-known concern within the Bitcoin community; it's not like people haven't thought about it.  And of course, we have seen smaller countries do different attempts to try to ban it.  You have issues there where people often point out that it ends up trading at a premium there, so it actually doesn't reduce the price.  The latest big one is India looking to ban it.  They had kind of a failed attempt before, where the Supreme Court knocked it down.  This is attempt number two, and so we'll see how that goes.

So in one sense, a country can't ban Bitcoin; they can just ban themselves from Bitcoin; they can just exclude themselves from it.

Peter McCormack: That's what they're doing.

Lyn Alden: Yeah, and they can only do it part of the way, because it's really hard to enforce, because it's just information; you're banning information, which is really challenging to do. 

The big concern that people have is, what if the United States ban it?  Unlike, say, India banning it, if the United States somehow came out with a ban, it would be, at least in the intermediate term, bad for the price, because you'd have forced selling.  It's not like India holds a massive amount of Bitcoin; it's not like there are multi-billion-dollar institutions that are just going to have to divest billions of dollars of Bitcoin.

So, if the United States did it, that would be a massive price shock to the protocol and so we would see how that would develop.  The problem with the United States banning it is it's hard to do, because essentially a ban on Bitcoin is a capital control, so that's tricky.  Also, you're banning information, right, so you'd have constitutional challenges against that.

So overall, there are a spectrum of options; and the direction they've gone in, to their credit, is to say, "Okay, Bitcoin's here; it's a digital commodity so we're going to tax it like a digital commodity", they want to know who's trading it around, which is natural; governments always do that.  That's actually one thing I talk about with Mike, is basically that a lot of the criticisms about Bitcoin privacy could be levelled at cash.  Governments aren't super popular about cash either.  So, there have been basically KYC laws and things like that, so those are some of the more benign restrictions on it.

Then you can go up and say, "Okay, what if they say, 'Okay, we're not going to ban it, but we're going to put all sorts of limitations on institutions being able to own it'?"  That's a much easier thing to enforce, because no major institution's going to do something that's against the law, so it's enforceable and it's less freedom-restricting on individuals and less capital controls.  They just say, "If you're a fund over this much, we consider it too risky to have Bitcoin and therefore, screw you".

That's still a pretty extreme option, because they can put limits on how much can be held in order for it to be open to criticism; they can do things like that.  So, that's the more realistic thing I'd be concerned about, is basically things that slow down institutional adoption, because that would overall be one of the demand drivers.  Whereas an outright ban seems very challenging and it's one of those things where, one of the arguments is that the bigger it gets, the more likely it is to get banned.

But, the alternative view that I've taken, especially since my articles back in mid-2020, was that the bigger it gets, in some ways the harder it gets to ban; because once the donor class owns it, so all the political donors own it; once there are Bitcoin senators; once it's firmly entrenched in Fidelity, NYDIG, BlackRock; someone has a Bitcoin ETF maybe; there are banks custodying it; let's say Coinbase goes public and then you have this big entity built around it; you have corporations with it on their balance sheet; that gets much harder to outright ban, because then you're going after the capital of the donor class.  So, that actually becomes very unlikely.

So, my main concern is watching these other types of activity that are lower on that spectrum that would essentially put brakes on institutional adoption and things like that.  I think those are the more realistic concerns to keep an eye out for.  Also, we had the scare during the end of Mnuchin's period, where they were pushing things that would make self-custody harder.

So, I think the bigger concern is around the margins, rather than something like, "It's illegal for Americans to own Bitcoin".  But, people have to keep everything on their radar, because there are countries like India that are pushing forward with that sort of thing.

Peter McCormack: Yeah, it's going to be really interesting to play out.  I think that's one of the most interesting things to track this year, with the increase in adoption.  But my view is, it would be cutting off your nose to spite your face for the US to ban it, because so much of the wealth of Bitcoin is now held in the US, it would be economically damaging.

Lyn Alden: Exactly, and that's some of the education that people have been using.  That's also part of what I say, that the bigger it gets, the more wealth you're destroying if you try to ban that.  So, you basically have to hope the regulators realise that and they see that the United States owns a ton; Europe owns a ton; that them trying to ban it would actually, in many ways, hurt their own citizens, their own institutions, by reducing the price of an asset, at least temporarily, that a lot of their people own.

Peter McCormack: Do you know what; there's a whole bunch of stuff that I haven't got through that I wanted to talk to you about: network effects; I wanted to talk to you about fee-based security.  We're just going to have to wait until next month.

Lyn, as ever, it's amazing, I've learnt so much; you're the best, you really are the best.

Lyn Alden: Happy to keep coming on.

Peter McCormack: Yeah, this is amazing; people love it.  The show last month did something like 90,000.  Every one has gone higher.  We'd better crush 100,000 this time!  Listen, have an amazing month.  I'm sure I'm going to see you everywhere and talk to you before then, but appreciate you coming on.  Everybody loves your show that you're doing here, so thank you so much.

Lyn Alden: Thanks for putting it together.