Bitcoin To Surge Over 30X in Case of Hyperinflation? | Interview With Ari Paul

My thesis is that we're in an inflationary market. We're in a bitcoin bull market, a gold bull market in the early stages. This is not a hypothetical in the future. This is a process that has started. If we have a return to something like 1970s, I think probably gold rallies 5 to 10x or more. I think Bitcoin probably rallies 10 to 30x or more.

Hi everyone, I'm your host, Giovanni. Today I'm joined by Ari Paul, co founder and CIO of crypto hedge fund block Tower Capital. Today we are going to discuss macroeconomic trends, investment strategies, and why this specific moment in time could be pivotal for bitcoin. How are you doing today, Ari?

I'm doing well, thank you for having me.

Giovanni, let's start with what was the main trigger that led you to invest in cryptocurrency?

It was really three separate things and I'll be succinct. So one was I had been a trader and an investor on the traditional side throughout my career and markets have become pretty boring in the relative sense. What I mean by that is like when I was, I was at the University of Chicago Endowment as a portfolio manager and I was doing work on things like Risk Premium and Smart Beta, where often the debates were around decimal points. It wasn't about how can we earn a 50% return, it was about how do we increase our return by, you know, 0.3% a year. We were allocating to world, world class hedge fund managers who, you know, we'd be very excited if they were returning a few percentage points of alpha a year. And then on the trading side, similarly, markets have become very efficient. Machine learning algos do most of the volume today. You know, traditional markets are mostly efficient most of the time. And so the opportunity to invest in a blue ocean, wild west kind of industry where we're defining it was both potentially lucrative but also intellectually fascinating. The analogy I like to use is in equities. We had Benjamin Graham write Security Analysis and the intelligent investor 90 years ago. And that kind of defines some of the basic principles of equity investing that we just take for granted today. Things like a price to earnings ratio, things like price to book ratio in crypto, we don't have those yet. You know, in 2017 when, when I launched Blocktower, we were actively debating those things and still are, you know, so fascinating from that angle. Another was the humanitarian side. I had relatives who fled Nazi Germany, some successfully, some not. And I truly believe in cryptocurrency as a defensive weapon against oppressive Regimes. So being part of that movement is very inspiring to me. Actually I kind of combined two things. So one is kind of the inefficiency in the market that's very exciting as a trader and then also the intellectual exploration side.

So after that you founded the block tower capital. And so it's interesting to me to know how would define the investment style of block tower capital, something that sets it aside from other hedge funds.

In traditional markets we have fairly clearly defined strategies and sector and not sectors, but almost asset classes. So for example, within equities you have VC investing and you have Warren Buffett style investing in large cap, traditional equities. And those two are very different because a VC is investing so early in a company's life, so early, often pre revenue, pre sales. And then Warren Buffett is saying, no, I want to look at the last five years of a company's history, I want to look at cash flows. So you know, this huge and usually for a startup to get to the point that Buffett would be interested, you're looking at 10 years, 20 years in crypto. As we know, that span can be months. Right. So you know how we have something like Ethereum that is a liquid asset, you know, a large, large cap, more than $20 billion market cap. And then you have competitors to Ethereum that haven't launched yet, things like Polkadot that you know, within a year might be direct competitors, might be, you know, I'm not saying it will be, I don't know, but, but so it's very hard to separate. Right? You can't really say, I'm only going to look at early stage in crypto, I'm only going to look at mature assets. You have to at least think about the others. I can't be an Ethereum trader without being aware of competitors that may be competing head to head in six months. So all of this is to say when we launched, the view was we should be opportunistic, nimble and flexible. We should be very open minded about the right way to approach this industry. And my mindset was we want to build a firm that has advantages, that can be applied to many different types of strategies. So if we build top relationships with key stakeholders in the ecosystem, if we build general fundamental understanding and expertise that can be applied in many different ways. And then depending on what the market gives us, we can focus more on early stage, more on liquid. Today the way that's played out is we still kind of do most things in crypto. We do early stage investing, we do active liquid Trading, we done a little bit of arbitrage. We're mostly focused on trading liquid assets with a little bit of early stage investing as well.

And regarding the latest market turmoil that marked 2020, how that impacted your strategy at Blocktower Capital.

Yeah, there have been a few impacts. So, you know, a year ago I barely looked at the S&P 500. I barely looked at gold. Obviously I was aware of what they were doing, but I wasn't looking at it hour by hour. This year we do, you know, this year when I look at the price of Bitcoin or ether, it's right next to the price of The S&P 500, the Korean Cosby, you know, global international indices. I mean, that's actually an interesting point. Something we often think about now that we really didn't a year ago is we'll look, you know, US markets are basically closed overnight. You don't, you have some, you even have hours where the S&P 500 futures are closed. But certainly they're less liquid overnight. And yet bitcoin of course is 24 7. So if we want to know what are global equities doing at 3:00am U.S. time, we'll look at Japanese and Korean indices. So basically the volatility and macro Covid, central bank money printing, all of this stuff in traditional markets, the impact of that on us is we've been much more global macro focused, meaning we've been much more focused on what is gold doing, what are US Treasuries doing, what are global equities doing? Because that so clearly is directly impacting the price of bitcoin. Much more so than it really ever did in the past.

You kind of started noticing a higher correlation between bitcoin and traditional assets.

Absolutely. And it's not that whether that correlation should be high or not. If the correlation is low during that regime during that period, we're not going to pay as much attention. When the correlation is high, we're going to be paying very close attention.

So back in 2017, you bet on behalf of Block Tower that Bitcoin was going to reach 50k by the end of 2018. That didn't happen. So as a result, you lost $1 million in a call option premium. Would you repeat a similar bet today?

Yeah, so my first job out of college was actually an options market maker at a firm called Susquehanna National Group. That's a very large. At various points, they've either been the largest or they and Citadel compete head to head for who's the largest market makers in the country. And so that was. I was kind of a professional options trader as my first job. And a key thing that most people don't understand is that if you want to bet on the direction an asset is going to go, you're almost always better off just buying or selling the asset. So if I want to bet that bitcoin is going to go up, I would just buy bitcoin. The reason you trade options is really to bet on other things. So you buy options to bet on volatility or to bet on skew or to bet on kurtosis. So I bought those calls not because I was bullish. It was actually because I was bearish. And I know that sounds weird, like, why would you buy a call to express a bearish view. But literally what went through my head was I thought the market was topping out. I didn't know exactly when or where it would stop. I didn't call the top perfectly. I actually thought when we got to November with Bitcoin at 8,000, I thought that might be the top. And my thinking was, I know we were in a parabolic advance, and I know that when you're in a parabolic advance, if you call the top a little bit too early, you can miss a huge move, right? Bitcoin went from 8,000 to 19,000 in less than a month. So even if I was right that bitcoin was almost at the end of its bull run, I was humble enough to know, you know, I might be off by a month or two or three, in which case I might miss a huge rally. So how do you deal with that as an investor, right? You don't want to be the sucker who's. Who's long at the top, and then things crash 70%. But you also don't want to miss out on 100 or 200% rally. So my thinking was, let me buy some out of the money calls, some calls where the strike is far away from where we are now. I can spend a little bit of money, in our case, a million dollars in premium. And that million dollars, if bitcoin had gone crazy, basically, if bitcoin had just continued what it was doing for two more months, that million dollars would have returned something like 20 million. And if bitcoin does what I think it's going to do, which is go down or stop, that's fine. I lose a million dollars. And that gives me the comfort to have less exposure overall. So one way to phrase this is delta hedged calls. And we did it. We didn't do it exactly that way. But a delta hedged option basically just means you're buying a call and selling bitcoin at the same time. So basically an option can be a way to hedge. To hedge. It was, it was literally a way for me to have less exposure to crypto, but hedge the chance that we were still in a parabolic move that would take us to 50, you know, to $100,000. It wasn't a bet that that would happen. It was a way of saying, well, it might and I want to make sure I have some exposure to that. So would I do it again? I don't regret the trade from 2017. I know it sounds like a big loss, but it wasn't for, in the broader context, it was part of a portfolio. Absolutely. I would do it again if we got the right price. So with an option, it's not just are you going to be right or wrong? There's always a right. It's like Microsoft's a great company, it's profitable. There's some price where you love buying the equity and there's some price where you wouldn't. Right. I wouldn't buy Microsoft Equity at $10,000 a share, but I would love to buy it at a dollar a share. Options are the same way. There's some price that you're happy to pay for volatility. Doesn't matter which way you think the market's going to go. If I think bitcoin's going up, I would still love to buy puts if I could buy them at a really cheap price. Because I'm getting. You're never sure, you're never sure. Bitcoin's going to go up or down on some time frame. So if you can get a great so and that price is the price of volatility, it's basically the implied volume. So this segues into something that might be interesting, which is right now bitcoin volume is near its all time lows. I don't mean that in a literal sense. We have had bitcoin volume trade well under 40, but historically Bitcoin volume has averaged something like 70 to 80. Now the realized volume, the volatility of bitcoin that it's been actually having day to day has been way lower than that. And the implied volume is in between. So. So the implied volume right now is you can buy it for in the mid-40s, something like 45 for short term, 55 for a few months out. And that looks cheap. And so something that's interesting is asking, you know, is it cheap? Is bitcoin volume going to return to the way it's been historically or is this becoming a less volatile instrument? And I'll be frank, I'm not sure. I think the answer is somewhere in the middle. My own, you know, no one knows the answer to that, but my own guess is that bitcoin volume is probably coming down over time as this becomes a more mature asset class as you have more sophisticated players who are, who are making up the volume. But it is also mean reverting. This is fundamentally going to be very volatile for a very long time. So is bit, you know, is bitcoin volume for one month buying it at 45 a good buy? I'm not sure. I don't think it's a bad buy. But you know, I don't know. Are we going to get back to 70 as a historical average? My guess is it'll probably be a little under that.

It's likely that a situation like the one we saw at the end of 2017, with this parabolic move, with this huge volatility, it's becoming less and less likely.

My mental framework is bitcoin has historically had these boom bust cycles and it's not a perfectly consistent pattern. But generally the boom bust cycles are going longer in duration. So instead of it being a two year cycle, I think it's becoming a three, three year, and then it'll probably be a four year and then a five year cycle and they're becoming less extreme. So instead of it being a 50x up and then a 95% down, it's becoming a 10x up and an 80% down and then it'll be a 4x up and then a 60% down. So I do think we're going to get parabolic advances in the future. It's just instead of it being a 2000% parabolic advance, maybe it'll be a 1000% right. Or a 500% parabolic advance. And so similarly, if I was buying an out of the money call instead of looking for, you know, I mean, the $50,000 strike calls were basically a bet that bitcoin would not only get to there, but could go higher. And bitcoin was already up 20x on the year. Right. Bitcoin started 2017 around 1000 bucks. We were already up 19x. You know, are we ever going to have a 100x increase again in bitcoin? My guess is probably not. It's already such a big asset that would make it, I mean, let me try to do the math on that. We're up. We're at a roughly 170 billion market cap today. You know, it's unlikely that it's going to go from 170 billion to 17 trillion in one move. I mean, that's $17 trillion. You're talking about a meaningful percentage of all the wealth in the world. That's probably not going to happen in a single rally. The way we went from, you know, 6 billion to, you know, close to 200 billion over 2017. So I think I'm betting, I mean, again, no one knows there's risks, but certainly as being in the crypto industry, betting my career on this industry, I am betting that we'll have very substantial advances in the future, just probably not quite as extreme as 2017.

So despite the stock market has been rallying since March. You said you are bearish on equities in the next five years. Why?

I think we've had a series of central bank inflated bubbles and my hunch is that this is the last sustainable one or that this one is unsustainable. So, you know, you think about, we had the tech boom heading into 2000s, and part of that was easy money. We had central banks around the world, particularly in the US with very low interest rates. In 2000s, we had a very explicit Greenspan put and then general Fed put, where this was the first time really in history where there was a consensus among investors that the central bank won't let the market go down. That right. Basically, anytime the market falls 10%, we expect the central bank to lower interest rates and then that'll support the market. So that basically when investors think that risk is lower, it makes sense for them to bid higher for all assets. And when there's more money sloshing around, basically everything is worth more and everything is worth more in dollar terms. You can think of that as a devaluation of the dollar. So we had that in the 2000s, then we had the financial crisis. But we reinflated the bubble very aggressively with banks basically, central banks basically saying all that debt that was on hedge fund and bank balance sheets, we're going to push it onto central bank balance sheets. Well, there's nowhere else to kick the can. Right. We went from basically individual investors to banks, banks and hedge funds, and then we went from banks and hedge funds to central banks. There's no higher entity if central banks. So what do I mean explicitly as the US and governments around the world become increasingly indebted as their debt to GDP ratio goes from 100, 150%, 200% 300%. There's no one to bail them out. There's no next entity you can push that debt to. So at some point, I think probably fairly soon, there's only two choices. Either a country like the US has to default on its debt, or they have to very openly print away the debt. And as an investor, if you know that the US Government can't pay its debts in current dollars, that the only way they can pay their debts is by devaluing the dollar, you're not going to want to own dollars, you're not going to want to own treasury bonds. Right. Because you know you're not going to actually get a Treasury bond that on paper gives you 2% a year. If you know the only way you can get paid back is by the government devaluing the dollars, then your actual return is going to be negative because they're paying you back, but in dollars that are worth less. So what do you want to do then? Well, you start thinking about, maybe I should own gold, maybe I should own Bitcoin, maybe I should own other types of assets that, that are resistant to central bank depreciation.

And that leads me to the following question. So you said that the financial system is on the brink of some sort of collapse and that this is a pivotal moment for cryptocurrency in history. On the other hand, we see that the markets are pretty confident in the economy to recover from the COVID 19 crisis, and they are pretty confident in the central banks to prop them up. A lot of people think that betting against central banks means always losing. Why would people bet against them in this situation?

Yeah. So let me clarify what I mean by collapse. When the Federal Reserve tells us that not tells us. The Federal Reserve right now is buying corporate bonds directly. The Federal Reserve owns a chunk of Apple bonds, which is crazy when you think of it. I mean, it's unprecedented. I mean, it really is kind of crazy that the Federal Reserve is now the single largest investor in the world in public markets. You as an investor now competing directly against the central, against the Fed when you're trading bonds. So far the Federal Reserve has not bought equities, but they said they could if they felt that was necessary. So investors are, are very rationally saying, why wouldn't I buy an apple bond at par if I know that if the bond starts tanking, I can sell it to the Federal Reserve and take a small loss? Right. Like, why I would own. I mean, I would buy beanie babies for $1,000 a Beanie Baby if I knew The Federal Reserve would buy it from me for $950. Right. They're limiting my downside. So it makes sense to bid up bonds. It makes sense to some degree to bid up equities. The question for everyone is really how does that break? What causes a collapse? It breaks when people lose faith in the central bank itself, not in their decisions. I think most of us agree that the central bank is incentivized to just keep buying these assets. It breaks when the Fed's tool that they're using to buy the US dollar we don't want anymore. So at some point when investors fear inflation or fear depreciation of the dollar so much, they say, okay, we understand that the treasury is promising to pass 2%. We understand the central bank is promising to buy these Apple bonds, but we don't want what they're going to give us. We don't want the US Dollars because we're afraid that those may start inflating away at 10% a year or 20% a year. That's the point where it breaks. And I don't know that it's going to be a moment. In some countries, like Weimar Republic, Germany, like Zimbabwe, like Venezuela, you get a fairly clear, you know, over the span of a quarter, suddenly you have rampant hyperinflation. I'm not really predicting that here. I think what's very plausible is we may get something that feels more like the 1970s, that feels more, you know, the 1970s, the US banking system didn't collapse, the US markets didn't collapse, but we had severe inflation. We had, you know, 15, 16, 17% inflation and that repriced everything. So that was calamitous if you were an investor because if you owned a Treasury bond, it was yielding 2% and suddenly inflation 17% the value of your 10 year treasury bond. I can't do the math in my head, but it falls 20%. And that's, I mean for treasury bonds, that's insane for a pension, suddenly all of your liabilities are underfunded. Suddenly you're basically insolvent if you're a pension fund or someone with fixed liabilities. So. So my bet is not that the US kind of way of life is going to collapse or even that US banking will collapse. It's more that if we have a return to something like 1970s, I think probably gold rallies 5 to 10x or more. I think Bitcoin probably rallies 10 to 30x or more. It's actually less clear to me how equities do in that scenario. I'M not sure. Equities in the 70s kind of did badly, but not horribly. So I'm less confident in what equities will do. But in that scenario, gold and bitcoin definitely do incredible well. I don't say definitely. Probably do incredibly well.

So in an op ed you wrote in December last year, you said that 2020 was going to be the year when bitcoin will prove to be the reflationary hedge allocators are looking for. Are you still convinced of that prophecy?

I think the reason I said that, I do think we see some triggers that suggest this is not a hypothetical in the future. This is a process that has started. And I say that because we're starting to see traditional hedge fund managers talk about this in size, they're ready, they're psychologically primed. And now we've got people like Paul Tudor Jones saying, I think this is happening. You know, Paul Tudor Jones said he bought bitcoin not as a one week bet or one month or even one or even one year. He said, I think this has started. I think we're now in a regime of at least higher inflation risk where we want to be accumulating bitcoin and gold and where we're in a bull market, basically. So how exactly that bull market plays out, I would say that's my thesis. My thesis is that we're in an inflationary market. We're in a bitcoin bull market, a gold bull market in the early stages. And that means you'll have retracements. You might have six months of sideways, like, you know, we just had a few months of sideways movement in bitcoin. It's hard to know when things go parabolic and I think it could kind of happen at any time. So I'm wary of giving exact timing predictions. But basically for myself, I want to be sitting long, these assets ready for, you know, I don't know when, like, right, if we're in a bull market and things are kind of gradually rising on average, I don't know when things go vertical, but I would rather be kind of ready for that.

On the other hand, yeah, this looks like a great opportunity for bitcoin to prove, to prove its value. But on the other hand, if in this situation, in this specific historical situation, this outcome doesn't play out as you described, that could also cause great harm to bitcoin itself because it would just devaluate the theory, the thesis behind bitcoin. Don't you think so?

Yes, there's definitely some money in bitcoin right now, explicitly betting on that inflationary story. If we have a deflationary world, which could happen basically, if central banks and treasury departments don't print enough money, if the crisis around Covid and there's a lot of other things that could go wrong, we could have trade wars with China escalate. We could have geopolitical turmoil from many different angles that could be deflationary in nature. In a deflationary scenario, gold and bitcoin probably do badly. How badly? I don't know. It might just be badly in a relative sense. So look, there's risk. There's no, there's. I can't promise anything. There's no guarantees in life and investing. 1. One way that I think, though, that I think makes gold and bitcoin so attractive today is we don't need inflation to happen. We need the fear of it to increase. So as an options trader, one way I would think about this is if you buy a call or a put, you don't. If I buy calls on bitcoin, I don't need bitcoin to go up to win. I can win if the volatility of bitcoin increases and then the price of both calls and puts increases. So one way to think about it is bitcoin is kind of like a call on inflation. We don't need inflation to increase for bitcoin to go up. We need investors to worry about inflation more. So Paul Tudor Jones, he said, it's not that we're seeing inflation today, it's that I'm worried about inflation. And so to me, I want to own more Bitcoin as a hedge. And basically the, the. If you think about a distribution, right, like there's a normal distribution curve about what's going to happen. So in the past, the distribution of inflation, the middle was basically 2% inflation a year. And an extreme event would have been 5% inflation a year or a negative 2% or a little bit of deflation. Now the distribution is much flatter. It's kind of like now an extreme event on inflation is 20% inflation and or negative 10%. It's a more volatile world. It's a riskier world in both directions. And insofar as bitcoin is kind of like a call option for many, for many traditional investors on inflation, bitcoin wins to that. And I think it's likely to continue winning to that. So I think bitcoin probably is higher in a year either if we get inflation or also in the base case also if this just Continues to be a volatile, scary world.

You said that in times of market turmoil like the one with witnessed earlier this year, retail traders should bet against professional traders, since professional traders are handcuffed by their businesses. Can you explain a little bit what you mean by that?

Most of the time you can't compete against the pros and you don't want to because the pro, the professionals have better information, better access, better lower cost of capital, better tools. How are you going to beat them at their own game? Right? You're not. It's like maybe you could in theory if you spend 10 years. But why? You know, I'm not going to compete against Michael Jordan at basketball without having spent 20 years, you know, becoming a pro. Right, so. But there's an exception. There are moments when the professionals are at a massive disadvantage. And that happens because the professionals have to be in the game every day. They have to be in the game for bureaucratic reasons, psychological. So I'll use Susquehanna as an example. There are professional market makers who are designated market makers in many products. What that means is they get a special deal with an exchange, they get special rights and privileges and transaction fees, but the obligation is they have to constantly be quoting. They have to constantly show the market a bid and ask all the time. And if they don't, they get penalties. There's penalties, you get fined. And the idea of the reason exchanges do this is they want to make sure, they want to incentivize liquidity. So if you're a Susquehanna trader and you're constantly showing bids and offers all day long, what happens if the market goes in one direction? Really, really extremely. Right. What happens if we get a massive sell off where it's only sellers day after day and equities are down 30%? Well, you're probably long. It's very hard not to be long because every day your customers are selling, selling, selling to you and you can't find a bid to sell. So if you're a really good trader, maybe at the end of that you're only long a little bit. You've only lost a little bit of money. But most traders will have a huge long position and will have to be down a lot of money. Because basically trading market making is about being the casino. It's about balancing bids and offers. It's about balancing order flow of buys and sells. And most of the time that's great, it's very profitable and you're able to balance it. But sometimes when things go crazy, you only have one sided order flow and you as the market maker end up with a lopsided position that you don't want to have at that moment, the professionals are stuck. They can't like. And it's not just market makers. This is true also of endowment. Like I was at the University of Chicago Endowment as a portfolio manager right before I launched Block Tower for four years. And value investors, it's the same thing. So a value investor like a Warren Buffett, he's sitting on a lot of cash right now. If the market starts selling off, he'll start buying. If the market sells off way more than he expected, at some point he'll be out of money, he'll just run out of cash and he won't have any more money to invest. And equities may get to a price where he wishes he could invest, but because he's a professional investor, because he's constantly looking at these markets, he's probably already fully invested. So at that moment you get to buy the same equities Warren Buffett bought, but at a better price than him. He's handcuffed, he's already long, he's already bought all of those. So why did you get that opportunity? Because you're not looking at markets every day. Because you didn't feel the pressure that he felt. Right? Because if you're Warren Buffett and equities are down 30%, you may think they might fall 40%. What if they don't? What if that was the bottom, what if equities then go on a 10 year bull run? Well, you're kind of, you're kind of screwed, right? Because you missed the opportunity of the decade to buy equities. And that was your only job, that was your job, was to buy that dip. But as a, as a retail investor, you don't have to buy bitcoin, you don't have to buy gold, you don't have to buy equities. You can kind of just wait for, you can wait for the perfect opportunity. So what does perfect opportunity mean? Nothing's ever perfect. But I think it means when I see professionals panicking, when I hear from friends on Wall street that they have a massive long portfolio and stuff, that they got long way too early, that they're looking to flatten their books, that they know it's a great time to buy, but they're already so ready, so exposed, that's when I personally, as a retail, I'm a retail investor in most assets, right? I'm a professional investor in crypto, but in traditional equities, I'm a retail investor. And that's when I would buy. That's when I would buy equities.

That was Ari Paul, CIO and co founder at Block Tower Capital. I'm your host, Giovanni. As always, if you enjoyed the interview, don't forget to like and subscribe. See you next time.

Cointelegraph, like, subscribe and Hodl.