One reason for the weakness in encryption is the U.S. government shutdown. Please be patient and wait for the invisible QE.

Author: Arthur Hayes, founder of BitMEX; Compiled by: Jinse Finance

Praise to Satoshi Nakamoto! The existence of time and compound interest treats everyone equally.

For the government, there are only two payment methods: using savings or incurring debt. For the government, savings are equivalent to taxes. Taxes are not very popular, but spending is very popular. Therefore, when distributing benefits to the common people and the elite, politicians tend to prefer issuing debt. Politicians always like to borrow money from the future to win re-election in the present, because by the time the bills come due, they are no longer in office.

If all governments, due to the incentives of their officials, are inherently inclined to issue debt rather than increase taxes to distribute benefits, then the next question is: how do buyers of government debt finance these purchases? Do they use savings/equity, or do they finance the purchases by borrowing money?

In terms of “American governance”, answering these questions is crucial for my outlook on future dollar currency creation. If the marginal buyers of U.S. debt are purchasing through financing, then we can observe who is lending them the money. Once we know the identity of the debt buyers, we can determine whether they are creating money out of thin air or using their own equity to lend. If after answering all the questions we find that a certain debt buyer is lending by creating money, then we can make the following logical leap:

Government-issued debt will increase the money supply.

If this statement holds true, then we can estimate the maximum credit limit that the buyer can provide (assuming there is a cap).

These issues are important because I will argue that if government borrowing continues as predicted by the “too big to fail” banks, the U.S. Treasury, and the Congressional Budget Office, then the Federal Reserve's balance sheet will also grow. If the Federal Reserve's balance sheet grows, it is positive for dollar liquidity and will ultimately push up the prices of Bitcoin and other cryptocurrencies.

Let's analyze these problems step by step and evaluate this logical puzzle.

Q&A Time

Question 1: Will US President Trump compensate for the deficit by increasing taxes?

Answer: No. He and the Republican Party have just recently extended the tax reduction policy from 2017.

Question 2: Is the Treasury Department currently borrowing money to cover the federal deficit, and will it continue to do so in the future?

Answer: Yes.

The above is an estimate from the “Too Big to Fail” banks and some U.S. government agencies. As you can see, the projected deficit is around $2 trillion, which will be covered by issuing about $2 trillion in debt.

Given that the answers to the first two questions are both affirmative, then:

Annual federal deficit = Annual Treasury debt issuance

Let us analyze step by step the main buyers of government bonds and how they finance their purchases.

Treasury Buyers

Foreign Central Banks

If “American Governance” dares to confiscate the money of Russia (a nuclear superpower and the largest commodity exporter in the world), then no foreign holder of U.S. Treasury bonds is safe. Realizing the risk of expropriation, foreign central bank reserve managers prefer to buy gold rather than U.S. Treasury bonds. Therefore, gold has only started to truly soar since Russia invaded Ukraine in February 2022.

U.S. Private Sector

According to data from the U.S. Bureau of Labor Statistics, the personal savings rate for 2024 is 4.6%. In the same year, the U.S. federal deficit is 6% of GDP. Given that the deficit is larger than the savings rate, the private sector cannot be the marginal buyer of government debt.

Commercial Bank

Are the four major commercial banks in the United States (Note: JPMorgan Chase, Bank of America, Citigroup, Wells Fargo) buying a large amount of government bonds? No.

As shown in the figure, in the fiscal year 2025, the four major banks purchased approximately $300 billion in government bonds. In the same fiscal year, the Treasury issued $1,992 billion in government bonds. Although this group is undoubtedly an important buyer of government bonds, they are not the final marginal buyers.

Relative Value (RV) Hedge Fund

According to a recent paper by the Federal Reserve, RV funds are the marginal buyers of U.S. Treasuries.

“Our research findings indicate that hedge funds in the Cayman Islands are increasingly becoming marginal foreign buyers of U.S. Treasury notes and bonds. As shown in Figure 5, from January 2022 to December 2024, when the Federal Reserve is reducing its balance sheet size through the maturity runoff of Treasury securities, hedge funds in the Cayman Islands net purchased $1.2 trillion in Treasury securities. Assuming these purchases consist entirely of Treasury notes and bonds, they absorbed 37% of the net issuance of notes and bonds, almost equivalent to the total of all other foreign investors combined.”

Trading Strategy:

Buy spot treasury bonds

Compare

Sell the corresponding government bond futures contracts

Thanks to Joseph Wang for providing this chart. SOFR (Secured Overnight Funding Rate) trading volume is a proxy indicator for measuring the scale of RV fund participation in the Treasury market. As you can see, the increase in debt burden corresponds with the increase in SOFR trading volume. This indicates that RV funds are the marginal buyers of Treasuries.

The RV hedge fund conducts this transaction to profit from the price difference between the two instruments. Because the interest rate spread is very small (measured in basis points; 1 basis point = 0.01%), the only way to truly make money is to finance the purchase of government bonds. This leads to the most important part of this article, to understand what the Federal Reserve will do next: how do RV funds finance their purchase of government bonds?

The RV fund finances its government bond purchases through repurchase agreements. In a seamless transaction, the RV fund collateralizes the government bonds it has purchased to borrow cash at the overnight rate, and then uses the borrowed cash to settle the government bond purchase. If cash is abundant, the repurchase rate will trade at or slightly below the upper limit of the federal funds rate. Why?

Let's review how the Federal Reserve manipulates short-term interest rates. The Federal Reserve has two policy interest rates: the upper and lower bounds of the federal funds rate; currently, they are 4.00% and 3.75%, respectively. To force the effective short-term rate (SOFR or secured overnight financing rate) to fall within this range, the Federal Reserve uses some blunt tools. I will briefly introduce them in order of interest rates from low to high:

Reverse Repo Facility (RRP)

Qualified objects: money market funds and commercial banks

Purpose: The overnight cash stored here can earn interest paid by the Federal Reserve.

Interest Rate: Lower Bound of the Federal Funds Rate

Interest on Reserve Balances (IORB)

Qualified subjects: Commercial banks

Purpose: Banks earn interest on their excess reserves held at the Federal Reserve.

Interest rate: Between the lower and upper limits of the federal funds rate.

Standing Repo Facility (SRF)

Qualified entities: commercial banks and other financial institutions

Purpose: When cash is tight, it allows financial institutions to pledge qualifying securities (primarily government bonds) and obtain cash from the Federal Reserve. In practice, the Federal Reserve prints money and exchanges it for the pledged securities.

Interest Rate: Upper limit of the federal funds rate

Putting them together, we get this relationship:

Lower bound of the federal funds rate = RRP < IORB < SRF = Upper bound of the federal funds rate

This is a chart of real-world numerical values that helps visualize the relationships between these key dollar currency market interest rates. At the top, the orange (SRF) and green (federal funds rate upper limit) are equal. Just below is the red line (IORB). The magenta line (SOFR) typically fluctuates between the upper and lower limits. The yellow (federal funds rate lower limit) and white (RRP) are equal.

SOFR is a composite index based on various types of repo transaction rates. Unlike the London Interbank Offered Rate (LIBOR), which is based on bank quotes, SOFR is based on actual market transactions. This is the target rate set by the Federal Reserve. If SOFR trades above the upper limit of the federal funds rate, it indicates cash tightness, which is a problem. Once cash becomes tight, SOFR will soar, and the dirty fiat financial system will come to a standstill. This is because marginal buyers and suppliers of liquidity are using leverage. If they cannot reliably roll over their liabilities at the federal funds rate, they will first suffer significant losses and then stop providing liquidity to the system. What is concerning is that without access to cheap leverage, there will be no participants in the Treasury market. (Note: Last Friday, October 31, SOFR soared to 4.22%, while the Federal Reserve had lowered rates again last week, so SOFR should have remained around 4.00%)

What causes SOFR trading to be higher than the upper limit of the federal funds rate? To answer this question, we must first ask who the marginal providers of cash in the repo market are. Money market funds and commercial banks provide cash to the repo market. Let’s assume they are profit-maximizing entities and examine the reasons for their actions.

The goal of money market funds is to take on the minimal credit risk possible and earn short-term interest rates. This means that money market funds primarily earn returns by placing funds in RRP, lending cash in the repo market, and purchasing Treasury bills. In all three cases, they assume the credit risk of the Federal Reserve or the U.S. Treasury, which is essentially risk-free because the government can always print money to repay its debts. Before the RRP balance runs out, the billions or trillions stored there will provide cash for the repo market. This is because the RRP rate < SOFR rate, so profit-maximizing money market funds will withdraw cash from RRP and lend it to the repo market. But now the RRP balance is zero because Treasury yields are very attractive; money market funds maximize profits by lending to the U.S. government.

As money market funds exit the game, commercial banks must fill the gap. They would be willing to lend reserves to the repo market because IORB < SOFR. The factors that limit banks' willingness to provide cash at a “reasonable” level (i.e., SOFR <= the upper limit of the federal funds rate) depend on the abundance of their reserves. Various regulatory requirements force banks to maintain a certain amount of reserves, and once their balance sheet capacity decreases, they must charge increasingly higher rates to provide cash to the repo market. Since the Federal Reserve began quantitative tightening in early 2022, banks have lost trillions of dollars in reserves.

Since 2022, the cash available for the repo market held by the two marginal providers of cash—money market funds and banks—has decreased. At some point, neither was willing or able to provide cash to the repo market at rates equal to or below the upper bound of the federal funds rate. At the same time, the supply of cash that can be offered to the repo market at reasonable rates has diminished, while the demand for that cash has been rising. The increase in demand is due to former President Biden and now Trump continuing to spend massive amounts of money, which requires the issuance of more government bonds. The marginal buyers of this debt—RV funds—must finance these purchases in the repo market. If they cannot reliably obtain funding daily at rates equal to or slightly below the upper bound of the federal funds rate, they will not buy government bonds, and the U.S. government will be unable to finance itself at affordable rates.

Due to a similar situation in 2019, the Federal Reserve created the SRF. As long as acceptable forms of collateral are provided, the Federal Reserve can use its money printing machine to provide unlimited cash at the SRF rate. Therefore, RV funds can be assured that no matter how tight cash becomes, they can always obtain funds in the worst-case scenario at the upper limit of the federal funds rate.

If the SRF balance is above zero, then we know that the Federal Reserve is cashing checks for politicians with printed money.

Government bond issuance = Increase in the supply of dollars

The above chart shows (SOFR - Federal Funds Rate Upper Bound). When this spread approaches zero or is positive, there is cash tightness. During these periods, the SRF (lower half of the chart, in billions of dollars) experiences significant usage. Using the SRF allows borrowers to avoid paying the higher, unmanipulated SOFR rate.

Invisible Quantitative Easing (QE)

The Federal Reserve can ensure that there is ample cash in the system to facilitate the repurchase needed for RV funds to purchase government bonds in two ways. The first is to create bank reserves by purchasing securities from banks. This is the textbook definition of quantitative easing. The second is to freely lend to the repurchase market through the SRF.

As I have said many times, quantitative easing is a dirty word. Even the most financially illiterate civilians now understand QE = money printing = inflation. When inflation intensifies, ordinary citizens will vote for the opposition. Given that Trump and Bessent want the economy to run hot, they do not want to be blamed for high inflation caused by credit-driven economic expansion. Therefore, the Federal Reserve will do everything it can to solemnly claim that its policy mix is not quantitative easing and will not fuel the fire of inflation. Ultimately, this means that the SRF will become a channel for printed money to enter the global financial system, rather than using quantitative easing to create more bank reserves.

This will take some time, but the exponential expansion of government bond issuance will eventually force the SRF to be reused repeatedly. Keep in mind that the Besant not only needs to issue $2 trillion a year to fund the government but must also issue trillions of dollars to roll over maturing debt. Invisible quantitative easing will soon begin. I don't know when it will start. But if the current conditions in the money market persist and the scale of government bonds grows exponentially, then the balance of the SRF as the lender of last resort must also increase. With the growth of the SRF balance, the amount of legal dollars in the world will also expand. This phenomenon will reignite the Bitcoin bull market.

Between now and the start of invisible quantitative easing, people need to preserve their strength. The market is expected to experience fluctuations, especially before the end of the U.S. government shutdown. The U.S. Treasury is borrowing money through its debt auctions (negative dollar liquidity), but has not spent (positive dollar liquidity).

The Treasury General Account (TGA) is about $150 billion above the target of $850 billion, this additional liquidity will only be released into the market after the government reopens.** This withdrawal of liquidity is one of the reasons for the current weakness in the crypto market.**

With the upcoming four-year anniversary of Bitcoin's historical peak in 2021, many will mistakenly interpret this period of market weakness and dullness as a top and sell off their positions—provided they haven't been wiped out in the altcoin crash a few weeks ago.

This is a mistake; the operational mechanism of the dollar currency market does not lie. This corner of the market is shrouded in obscure jargon, but once you translate the terms into “printing money” or “destroying money,” it becomes easy to know how to dance.