Arthur Hayes goes crazy bullish on ETH: We all know when Bitcoin halves, but it always goes up after halving.

In a recent article, BitMEX founder Arthur Hayes expressed strong bullish sentiment towards Ethereum. Besides applying the "reflexivity theory" to the Ethereum merge, he elaborated on how he could explain why these bearish factors, such as speculative increases due to forks and selling pressure in the derivative markets, could not counter the bullish momentum.

This article is excerpted from Arthur Hayes' post, and all views expressed are his personal opinions and do not constitute investment advice.

Legendary investor George Soros' book "Alchemy of Finance" served as the inspiration for Arthur Hayes' article, where he applied the "reflexivity theory" to the Ethereum merge:

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The Theory of Reflexivity refers to a feedback loop between market participants and prices, where participants' expectations influence the market or so-called "fundamentals," exacerbating price movements, but the market, in turn, affects participants' expectations.

Arthur mentioned that this is a brief and incomplete explanation of reflexivity theory, but he will delve deeper into it in the article. For now, the discussion focuses on the relationship between the Theory of Reflexivity and the Ethereum merge.

Factor: The Merge

The merge will either happen or not, this is the future event on the trading market. The success of the merge depends entirely on Ethereum developers and is not affected by the price of ETH.

Event Structure

The merge will bring two main changes:

1. Removal of PoW Block Rewards

The current daily mining reward is approximately 13,000 ETH, and the merge is expected to replace this with 1,000 to 2,000 ETH per day. The rewards will be issued at the same rate regardless of the price of ETH or the usage of the Ethereum network.

2. Fee Burning

Each block will burn a specific amount of Gas Fee, meaning the Ether used to pay these Gas Fees will be permanently removed from circulation.

Total ETH inflation = Block rewards - Burned Gas Fees.

Note: EIP-1559 has been in effect for over a year, but Arthur still includes it as a change after the merge.

3. Potential Change: Deflation

While network usage may be one variable affecting block rewards, Arthur believes that over hundreds of years, this can be considered a constant. Therefore, it can be concluded that:

• Currency inflation = Block rewards > Burned Gas Fees
• Currency deflation = Block rewards < Burned Gas Fees

Arthur points out that believers in ETH deflation generally think that high network usage is enough to offset block rewards with Gas Fees, but one must ask: "What determines Ethereum usage?" Especially when users have other choices like Solana, among others, he lists the variables that influence users' choice of public chains:

1. Mindshare: Which public chain is more well-known? Social media platforms and blogs are the main media for spreading various L1 information.

Arthur believes that mindshare has a reflexive relationship with the ETH price, with a correlation of 0.77 compared to Google Trends and prices.

2. DApps: Who has a more powerful collection of DApps? Which DApps are leaders in their fields? Which DApp has the highest liquidity?

Arthur concludes that the number, quality, and user base of developers are positively correlated, and the number of users is positively correlated with the token price, all exhibiting reflexivity, such as attracting more developers, then gaining more user attention.

After clarifying the structure of The Merge event, we can conclude:

1. The extent of ETH deflation depends on the extent of Gas Fee burning.
2. The extent of Gas Fee burning depends on ETH network usage.
3. Network usage depends on the number of users and DApp quality.
4. The number of users, DApp quality, and ETH price exhibit reflexivity.

There are only two possibilities for this event, success or failure. However, Arthur points out that Ethereum has reached the second-largest market cap without the merge, with the most developers and the most popular DApps. Therefore, as he mentioned in previous articles, he believes that ETH will not drop below the previous low of $800 to $1,000.

But for now, it is essential to determine the market's view on the success or failure of the merge.

Market Sentiment

Arthur cited several data points to support the market's expectation of a successful merge.

1. ETH Outperformance vs. BTC

The chart below shows the trend of the "ETH/BTC" trading pair, indicating that the market expects a higher likelihood of the merge.

2. Sell Pressure in Derivatives Market

Data from ETH futures open interest contracts shows a consistent increase after the June low, with backwardation in trades until June 2023, indicating that the futures market predicts ETH will be lower than the current spot price by the expiration date.

With the increase in open interest contracts and backwardation, Arthur believes this reflects high and increasing marginal selling pressure in the market. There are two reasons why the market shows this data:

• You hold spot positions but are unsure if the merge will be successful, so you hedge your spot positions by shorting contracts at the current higher price.
• You anticipate the merge happening and hope to hold more ETH post-merge, but also want to short contracts to hedge your spot positions.

Based on the market data above, Arthur concludes the following thoughts:

1. Remember that ETH's rise is 50% higher than BTC, and bearish pressure cannot compete with the bulls.
2. The market expects a higher likelihood of the merge, so what will the short sellers do when the actual merge happens?
3. If the merge is successful, spot holders will stop hedging and go long.
4. Once ETH merges, forked coins will be quickly sold off, and those hedging will immediately close their positions.

For investors who believe the merge will proceed as expected, Arthur also provides some strategies.

Trading Decisions

1. Spot ETH: The most direct approach

2. Lido Finance

The value proposition of Lido depends entirely on the success of the merge, making it riskier than holding spot ETH, even if the merge fails, it will still be the second-largest public chain.

3. Long ETH

Higher leverage, higher returns, and long holders can earn additional funding rates.

4. Spread Trading

From the expiration date structure, contracts expiring in December 2023 are the lowest priced, and if the merge is successful, there may be a return to a premium state due to the massive short covering.

5. Bullish ETH Options

Arthur previously mentioned buying call options for December 2022 with a strike price of $3,000 for ETH, not only because the price is lower than September call options but also because there is no need to worry about potential delays in the merge due to technical issues.

Buy the Rumor, Sell the News?

If investors are bullish on ETH, the current question is whether to reduce or close positions before the merge. Arthur points out:

The textbook recommendation would suggest reducing positions before the merge, but reality rarely aligns with expectations. Post-merge inflation will result in structural deflation; therefore, we would expect ETH's performance to resemble Bitcoin's halving. For example, we all know when Bitcoin halving occurs, but the price always continues to rise afterward.

Arthur believes that ETH may experience a slight decline before and after the merge, but due to the reflexivity between deflation, price, and network usage, the price may continue to rise. Sellers before the merge will have to consider buying back ETH as deflation sets in, making it a psychologically challenging trade:

You believe in ETH for the long term, but want to adjust short-term positions. Now you have to spend more money to rebuild your position, which is painful. You always wait for a big drop to buy back, but it never happens, and you can never return to your original position size, missing out on significant gains. Considering these factors and my belief in reflexivity theory, I will not reduce positions before or after the merge.

When to Sell?

Arthur mentions that without leverage, the maximum profit from shorting is the target investment going to zero, but shorting in a rising market could lead to unlimited losses, making the timing of the order crucial.

He believes the best time to short is when market expectations are highest, which is before the merge. Given the high market expectations for the merge, the selling pressure will be swift and strong. He recommends buying put options for ETH with a strike price for March 2023 on September 14.

This is a Reinforcement of Faith Article

Arthur concludes that writing articles is a good way for him to think about trading and increase his confidence in his investment portfolio. If he cannot logically explain the investment reasons, then he must reevaluate his trading decisions.

At the same time, his investment portfolio has undergone significant changes, and he can no longer defend the arguments he made in his previous articles. He states:

I tried to apply Soros' reflexivity theory to the ETH merge, which increased my confidence. I was hesitant about what trades to make before the merge, but once I wrote down my thoughts in a well-known article, I knew what to do. Buy The Fucking Dip!