Grayscale Insights: How Can Encryption Assets Become Macroeconomic Hedging Tools When Fiat Credibility Shakes?

Original author: Grayscale

Original Title: The Macro Case for Crypto

Original compilation: Luke, Mars Finance

Key points

For fiat currencies (, credibility is crucial. Today, due to high public debt ), rising bond yields (, and uncontrollable deficit spending ), the U.S. government's commitment to low inflation ( may no longer be entirely credible. In our view, strategies for managing the national debt burden are increasingly likely to involve at least moderate levels of high inflation. If holders of assets denominated in U.S. Dollar ) begin to believe this, they may seek alternative stores of value (.

Cryptocurrencies such as Bitcoin )Bitcoin( and Ethereum )Ethereum( may serve this purpose. They are alternative monetary assets )monetary assets( based on innovative technology. As a store of value, their most important characteristics are programmatic and transparent supply, as well as autonomy independent of any individual or institution. Like physical gold, their utility partly comes from their immutable and politically detached nature.

As long as public debt continues to grow uncontrollably, the government cannot credibly commit to maintaining low inflation, and investors may question the viability of fiat currency as a store of value. In such an environment, the macro demand for crypto assets may continue to rise. However, if policymakers take measures to strengthen long-term confidence in fiat currency, the macro demand for crypto assets may decline.

Investing in the cryptocurrency asset class means investing in blockchain technology )blockchain technology(: running open-source software )open-source software( to maintain a network of computers that manage a public transaction database. This technology is changing the way valuable items—currency and assets—flow across the internet. Grayscale believes that blockchain will fundamentally change digital commerce )digital commerce( and have a widespread impact on our payment systems )payment systems( and capital markets infrastructure )capital markets infrastructure(.

But the value of this technology—its utility to users—is not just about improving the efficiency of financial intermediaries. Bitcoin and Ethereum are both payment systems and currency assets. These cryptocurrencies have certain design features that can make them a safe haven from traditional fiat money ) when needed. To understand how blockchain works, you need to grasp computer science and cryptography. But to understand why crypto assets have value, you need to understand fiat currency and macroeconomic imbalances.

法定货币、信任与信誉 (Fiat Currencies, Trust, and Credibility)

Almost all modern economies use a fiat currency system: paper money (and its digital forms) that have no intrinsic value. It may be surprising to realize that the foundation of most of the world's wealth is an utterly worthless physical object. However, of course, the focus of fiat currency is not the paper itself, but the institutions surrounding it.

In order for these systems to function properly, the expectations regarding the money supply need to be based on something — without any commitment to limit the supply, no one would use paper currency. Therefore, the government commits not to excessively increase the money supply, while the public assesses the credibility of these commitments. This is a trust-based system.

However, history is full of examples where governments have violated this trust: policymakers sometimes increase the money supply (leading to inflation) as a matter of expediency at the time. Therefore, currency holders naturally tend to be skeptical of vague commitments to limit the supply of fiat currency. To make these commitments more credible, governments typically adopt some kind of institutional framework. These frameworks vary over time and place, but the most common strategy today is to delegate the responsibility for managing the money supply to an independent central bank (central bank), which then explicitly sets a specific inflation target. This structure, which has become the norm since around the mid-1990s, has been largely effective in achieving low inflation (chart 1).

Chart 1: Inflation targets and central bank independence help to build trust.

当货币失灵时 (When Money Malfunctions)

When fiat currency has a high degree of credibility, the public does not pay attention to this issue. This is precisely the goal. For citizens living in countries with a history of low and stable inflation, it may be difficult to understand the significance of holding currencies that cannot be used for daily payments or debt settlement. However, in many parts of the world, the demand for better currency is evident ( chart 2). No one would question why citizens of Venezuela or Argentina would be willing to hold a portion of their assets in the form of foreign currency or certain crypto assets—they clearly need better means of value storage.

图表 2：政府偶尔会管理不善货币供应 (Exhibit 2: Governments occasionally mismanage the money supply)

The total population of the 10 countries in the above image is about 1 billion, many of whom have turned to cryptocurrencies as a monetary lifeline. This includes Bitcoin and other cryptocurrencies, as well as blockchain-based assets pegged to the US dollar—Tether (, USDT) stablecoin (stablecoin). The adoption of Tether and other stablecoins is just another form of Dollarization (—shifting from the local fiat currency to the US dollar—which has been a common phenomenon in emerging markets for decades.

The world runs on dollars )The World Runs on Dollars(

But what if the problem lies with the dollar itself? If you are a multinational corporation, a high-net-worth individual, or a sovereign nation, you cannot escape the dollar. The dollar is both the domestic currency of the United States and the dominant international currency in today's world. Considering various specific indicators, the Federal Reserve estimates that the dollar accounts for about 60%-70% of international currency usage, while the Euro only accounts for 20%-25%, and the Chinese Renminbi is less than 5%.

图表 3：美元是当今占主导地位的国际货币 )Exhibit 3: U.S. Dollar is the dominant international currency today(

It is important to clarify that, compared to the emerging market economies in Chart 2, the United States does not face similar issues of poor currency management. However, any threat to the stability of the dollar is significant, as it affects nearly all asset holders—not just American residents who use the dollar for everyday transactions. The risk associated with the dollar, rather than the Argentine peso or the Venezuelan bolívar, is what drives the largest pools of capital to seek alternatives such as gold and cryptocurrencies. While the potential challenges the U.S. faces regarding currency stability may not be the most severe compared to other countries, they are nonetheless the most critical.

核心是一个债务问题 )At the Center Is a Debt Problem(

Fiat currency is based on promises, trust, and credibility. We believe that the dollar is facing an emerging credibility issue, as the U.S. government is finding it increasingly difficult to make credible commitments to long-term low inflation. The fundamental cause of this credibility gap is related to the unsustainable federal government deficit and debt.

This imbalance began with the financial crisis of 2008. In 2007, the deficit in the United States accounted for only 1% of GDP, while the debt stock was 35% of GDP. Since then, the federal government’s annual deficit has averaged about 6% of GDP. The national debt has now reached approximately 30 trillion dollars, about 100% of GDP—almost equal to the last year of World War II—and is expected to continue to rise sharply ) chart 4(.

Exhibit 4: U.S. public debt on an unsustainable path higher )

The huge deficit is a problem shared by both parties, and it persists even when the unemployment rate is relatively low. One reason the modern deficit seems difficult to resolve is that current fiscal revenues can only cover mandatory spending (such as Social Security ( and Medicare )) and interest payments ( ) Chart 5(. Therefore, achieving budget balance may require politically painful spending cuts and/or tax increases.

图表 5：政府收入仅能覆盖强制性支出加利息 )Exhibit 5: Government revenues only cover mandatory spending plus interest(

Interest Expense: The Binding Constraint )Interest Expense: The Binding Constraint (

Economic theory cannot tell us how much government debt is too much. As any borrower knows, what matters is not the amount of debt, but the cost of financing it. If the U.S. government can still borrow at very low interest rates, debt growth may continue without having a significant impact on institutional credibility and financial markets. In fact, some well-known economists have taken a moderate view of the rising debt stock in recent years precisely because low interest rates have made financing easier. However, the decades-long trend of declining bond yields seems to have come to an end, and the limits of debt growth are beginning to show ) chart 6(.

图表 6：债券收益率上升意味着债务增长的约束开始显现 )Exhibit 6: Rising bond yields mean the constraints on debt growth are starting to bind(

Like other prices, bond yields ultimately function as a function of supply and demand. The U.S. government continues to supply more debt, and at some point in the past few years, it seems to have satisfied the demand for that debt (at low yields/high prices).

There are many reasons, but the key fact is that the U.S. government borrows both from domestic savers and from foreign sources. There is not enough domestic savings in the U.S. economy to absorb all borrowing and investment demand. Therefore, the U.S. has a massive stock of public debt and is in a significant net debtor position in its international accounts ) Chart 7(. Over the past few years, various changes in foreign economies have meant that international demand for U.S. government bonds has decreased at extremely low interest rates. These changes include a slowdown in accumulation of official reserves in emerging markets and the end of deflation in Japan. Geopolitical adjustments may also weaken the structural demand from foreign investors for U.S. government bonds.

图表 7：美国依赖外国储户为其借贷融资 )Exhibit 7: The U.S. relies on foreign savers to finance borrowing(

As the U.S. government refinances its debt at higher interest rates, a larger proportion of spending is allocated to interest expenses ) Chart 8(. Low bond yields have allowed the debt stock to increase rapidly over the past 15 years without significantly impacting the government's interest expenditures. But now that situation has changed, which is why the debt issue has become more urgent.

图表 8：更高的利息支出是债务增长的约束性限制 )Exhibit 8: Higher interest expense is the binding constraint on debt growth(

Why Debts Can Snowball )

To control the debt burden, lawmakers need to balance the primary deficit (i.e., the budget shortfall excluding interest payments) and wish to keep interest costs relative to the economy's nominal growth rate low. The United States is still running a primary deficit (around 3% of GDP), so even if interest rates are manageable, the debt stock will continue to rise. Unfortunately, the latter issue—sometimes referred to by economists as the "snowball effect"—is also becoming increasingly challenging.

Assuming the original deficit is balanced, the following conditions hold:

If the average interest rate on debt is lower than the nominal growth rate of the economy, the debt burden – defined as the share of public debt in GDP – will decrease.

If the average interest rate on debt is higher than the nominal growth rate of the economy, the debt burden will increase.

To illustrate how important this is, Chart 9 shows the hypothetical path of U.S. public debt as a share of GDP, assuming the primary deficit remains at 3% of GDP and nominal GDP growth can be maintained at 4%. The conclusion is: when interest rates are relatively high compared to nominal growth, the debt burden rises much more rapidly.

图表 9：在较高利率下，债务负担可能会像雪球一样越滚越大 (Exhibit 9: Debt burden may snowball at higher interest rates)

With the rise in bond yields, many forecasters now expect that structural GDP growth will slow down due to an aging workforce and reduced immigration: the Congressional Budget Office (CBO) predicts that potential labor force growth will slow from the current rate of about 1% per year to about 0.3% by 2035. Assuming the Federal Reserve can achieve its 2% inflation target—which is an open question—lower real growth will mean lower nominal growth and faster growth in debt stock.

故事如何收场 (How the Story Ends)

According to the definition, unsustainable trends will not last forever. The uncontrolled growth of the U.S. federal government debt will come to an end at some point, but no one can know exactly how it will end. As always, investors need to consider all possible outcomes and weigh their probabilities based on data, policymakers' actions, and historical lessons. Essentially, there are four possible outcomes, which are not necessarily mutually exclusive ( chart 10).

图表 10：投资者需要考虑各种结果并权衡其概率 (Exhibit 10: Investors need to consider the outcomes and weigh their probabilities)

The possibility of defaulting (Default) is very small, as US debt is denominated in dollars, and inflation is usually less painful than not paying. Fiscal contraction (Fiscal contraction) is possible in the future—and may ultimately become part of the solution—but Congress has just enacted a "Big and Beautiful Bill" that ensures fiscal policy will maintain high deficits for the next 10 years. At least for now, it seems unlikely that deficits will be reduced through tax increases and/or spending cuts. Booming economic growth (Booming economic growth) would be the ideal outcome, but currently, growth is sluggish, and potential growth is expected to slow down. Although not yet evident in the data, the extraordinarily large productivity surge driven by AI technology (AI technology) will surely help manage the debt burden.

This leaves us with artificially suppressed low interest rates and inflation. For example, if the United States can maintain an interest rate of about 3%, an actual GDP growth of about 2%, and an inflation rate of about 4%, theoretically it could stabilize the debt stock at current levels without reducing the original deficit. The structure of the Federal Reserve enables it to operate independently, allowing monetary policy (monetary policy) to be insulated from short-term political pressures. However, recent debates and the actions of policymakers have raised concerns among some observers that this independence may be at risk. In any case, it may be unrealistic to expect the Federal Reserve to completely ignore national fiscal policy issues. History shows that when circumstances become urgent, monetary policy tends to yield to fiscal policy (fiscal policy), and the path of least resistance may be to escape through inflation.

Given the possible range of outcomes, the severity of the issues, and the actions of policymakers to date, we believe that strategies for the long-term management of the national debt burden are increasingly likely to result in average inflation exceeding the Federal Reserve's 2% target.

Bringing It Back to Crypto (

In summary, due to the massive debt load, rising interest rates, and the lack of other viable means of addressing these issues, the U.S. government's commitment to controlling the growth of the money supply and inflation may no longer be entirely credible. The value of fiat currency ultimately depends on the government's credible commitment not to inflate the money supply. Therefore, if there are reasons to doubt this commitment, investors in all dollar-denominated assets may need to consider what this means for their portfolios. If they begin to believe that the reliability of the dollar as a store of value is declining, they may seek alternatives.

Cryptocurrencies are digital commodities rooted in blockchain technology )digital commodities(. They come in various forms, and their use cases often have little to do with "store of value" currencies. For example, public chains can be used for a variety of applications ranging from payments to video games to artificial intelligence. Grayscale classifies crypto assets based on their primary use cases using the Crypto Sectors framework developed in collaboration with FTSE/Russell.

We believe that a small portion of these digital assets can be considered viable means of value storage, as they are adopted widely enough, possess a high degree of )decentralization( characteristics, and have limited supply growth. This includes the two largest crypto assets by market capitalization, Bitcoin and Ethereum. Like fiat currency, they are not "backed" by other assets to give them value. Rather, their utility/value comes from their ability to allow users to make peer-to-peer digital payments without censorship risk, as well as their credible commitments to not inflate the supply.

For example, the supply cap of Bitcoin is 21 million coins, and the current supply is increasing by 450 Bitcoins per day, with the growth rate of new supply halving every four years ) chart 11(. This is clearly stated in the open-source code, and it cannot be changed without consensus from the Bitcoin community. Additionally, Bitcoin is not bound by any external entities—such as fiscal authorities that need to repay debts—that might interfere with low and predictable supply growth targets. A transparent, predictable, and ultimately limited supply is a simple yet powerful concept that has helped Bitcoin's market value grow to over $2 trillion.

图表 11：比特币提供可预测和透明的货币供应 )Exhibit 11: Bitcoin offers predictable and transparent money supply(

Like gold, Bitcoin does not pay interest and is not widely used for everyday payments. The utility of these assets comes from what they do not do. Most importantly, their supply does not increase because the government needs to pay off debt—no government or any other entity can control their supply.

Today’s investors must navigate an environment filled with significant macroeconomic imbalances, the most important of which is unsustainable public debt growth and its impact on the credibility and stability of fiat currency. The purpose of holding alternative currency assets in a portfolio is to provide a ballast against the risks of fiat currency depreciation. As long as these risks are increasing, it can be said that the value of assets that can hedge against this outcome should rise.

什么可能扭转局势 )What Could Turn It Around(

Investing in the cryptocurrency asset class involves various risks that are beyond the scope of this report. However, from a macro perspective, a key risk to the long-term value proposition of certain cryptocurrencies may be the government's commitment to strengthen its management of the fiat currency supply in a way that restores public confidence. These measures may include stabilizing and subsequently reducing the ratio of government debt to GDP, reaffirming support for central bank inflation targets, and taking steps to support the independence of central banks. Government-issued fiat currency is already a convenient medium of exchange. If the government can ensure that it is also an effective store of value, the demand for cryptocurrencies and other alternative stores of value may decline. For example, gold performed well in the 1970s when the credibility of U.S. institutions was questioned, but it underperformed in the 1980s and 1990s as the Federal Reserve brought inflation under control ) chart 12(.

Exhibit 12: Gold performed poorly in the 1980s and 1990s alongside falling inflation

Public blockchains offer innovations in the fields of digital currencies and digital finance. The highest market capitalization blockchain application today is a digital currency system that provides characteristics different from fiat currency—its demand is related to modern macroeconomic imbalances such as high public sector debt. We believe that over time, the growth of the crypto asset class will be driven jointly by these macro factors and the adoption of other innovations based on public blockchain technology.