What is BTFP? Why is it referred to as the direct reason for Bitcoin’s rise from 19K to 27K?

Introduction

Silver Gate Bank collapsed over the weekend due to a run on the bank, causing a panic sell-off of USDC and the US dollar to become unanchored, falling all the way to 0.86 USD exchange rate. The bankruptcy of Silver Gate Bank also raised public attention to the biggest problem facing US banks: the devaluation of US bonds. The Federal Reserve had to introduce BTFP, which briefly means that the Fed allows banks to use US bonds as collateral, lending out cash on a 1:1 basis to solve potential bank runs.

The spark for inflation: $4.189 trillion

The US printed $4.189 trillion during COVID. A large amount of hot money flowed into the market, and it takes a long time for the economy to digest the cash. COVID caused a reduction or halt in economic activities for many businesses. Businesses lacked liquidity, and giving them cash could not stimulate economic growth. This led to excess cash flowing into the stock market and cryptocurrency. For banks, excess reserves became even more excess, with slower lending and repayment on one hand and still having funds flowing into the bank on the other. For example, Silver Gate had a large amount of cryptocurrency during this period, such as Bitcoin and Ethereum. This capital had to be transformed into assets through other means in order to ensure that the bank could earn profits in a situation where businesses lacked liquidity. Bonds were a very good choice at this time.

So the bank purchased US bonds.

Inflation is starting to rise

Due to the influx of a large amount of money exceeding the economic load, the demand for goods is limited while supply exceeds demand. Companies increase prices to earn more income, and thus prices begin to rise. The Federal Reserve started to shrink its balance sheet at the fastest speed to deal with high inflation. Interest rates have begun to rise. However, the large deposits of big banks are provided by large corporations, and raising interest rates means they will obtain more reserves from individual investors while paying corresponding interest. Banks make profits through loans, and in the situation where economic activity is still weak, loans from banks have not become easier with the balance sheet reduction. Therefore, big banks often only raise interest rates long after the Federal Reserve has raised them. Small banks, on the other hand, differ by quickly following suit and raising interest rates.

This leaves banks with more illiquid cash. At the same time, banks bought government bonds in the market printing $4.189 trillion worth in 2020, and the reduction in the balance sheet has led to a continuous decline in the value of these bonds. For example, a $100 government bond purchased in 2020 may only be worth $60 in 2022. The calculation of government bonds is very complex, but it still boils down to the basic economic principles of supply and demand. This is why banks like Silver Gate have gone bankrupt even though they did nothing but buy government bonds.

It’s not just Silver Gate Bank, as subsequent reports show that the stock prices of multiple banks have plummeted. This indicates that the proportion of government bonds purchased by banks during the previous round of currency expansion was quite high. Therefore, the Federal Reserve had to take emergency action and introduce the BTFP, which allows banks to use government bonds as collateral to borrow 1:1 from the Federal Reserve.

The balance sheet reduction only treats the symptoms (solving short-term inflation) and does not actually solve the economic problem

A large amount of money printing has led to an excess of liquidity in the economy. The excess funds have created a lot of bubbles, and the reduction of the balance sheet has burst these bubbles but has not changed the economic situation. The first to be hit is the banks, the center of liquidity. The heart has problems.

Because of the introduction of BTFP, banks can borrow from the Federal Reserve at a 1:1 ratio, making government bonds that were not favored now popular with banks. The federal government can continue to issue government bonds to increase operations. With the surplus funds from the previous round, this hidden amount may reach $4.4 trillion, exceeding the previous $4.189 trillion.

It is difficult to imagine what such a huge amount of money would cause in the current economy. It can be expected that the Federal Reserve’s decision after next week’s meeting will cause a huge fluctuation in the price of Bitcoin and may quickly stop raising interest rates in the following months.