What is the Dollar Milkshake Theory? The Fate of Cryptocurrency

Introduction

The U.S. dollar (USD) is one of the world’s strongest currencies. It is the official currency of the United States and several other countries. What happens when world currencies crumble and everyone looks up to the US Dollar?

Picture a prophecy of doom about fiat currencies, with the U.S. Dollar as the sole survivor. This best describes the theory of the dollar milkshake according to Brent Johnson, CEO of Santiago Capital.

According to the IMF, 59% of the world’s reserves are U.S. Dollars.

Source: IMF

As the world’s premier global reserve currency, the U.S. Dollar dominates international trade and finance, thanks to its relatively high interest rates. These attributes make it a coveted fiat currency, regardless of its domestic weakness.

This theory has gained traction in an era where central banks worldwide deploy unprecedented monetary measures to rejuvenate their economies. As nations devalue their currencies, leading to inflationary pressures, the U.S. Dollar only grows stronger.

Cryptocurrencies, especially established ones such as Bitcoin and Stablecoins like DAI, USDT, USDC, etc. could be choice alternatives. This article explores the dollar milkshake theory, its implications, and the relationship with Cryptocurrency, using Bitcoin as a case study.

What is the Dollar Milkshake Theory

The Dollar Milkshake Theory suggests that as central banks around the world are all “mixing” their economies with easy monetary policies (like pouring multiple flavors of milkshakes into a blender), it will be the U.S. dollar (USD) that will “drink up” the global capital (like using a straw to suck up the blended milkshake).

Despite the Federal Reserve’s aggressive monetary expansion, the theory posits that due to a combination of higher U.S. interest rates relative to other developed countries and global demand for dollars to repay dollar-denominated debt, capital will flow into the U.S., leading to a stronger dollar.

Source: CoinMarketCap — The U.S. Dollar Strength, 2022

According to the theory, distinct monetary policies put the U.S. dollar at an advantage over other currencies. The theory argues that the US dollar will strengthen as it becomes a global financial sanctuary despite the inherent weaknesses of the US economy. Such dynamics present profound implications for various assets, particularly cryptocurrencies, as a stronger USD could influence their valuation and adoption globally.

The Basis for The Dollar Milkshake Theory

Several factors contribute to the Dollar Milkshake Theory, some of which include:

1. Divergent Monetary Policies: The financial governing bodies have different policies influenced by politics and government priorities, thus creating a diverse blend of economic conditions worldwide. While these strategies may offer short-term relief, in the long term, they’re crippled by debts and inflation.
2. Higher U.S. Interest Rates: The theory suggests that relatively higher interest rates in the U.S. attract global capital seeking better returns. As the U.S. tries to control domestic inflation by increasing interest rates, It gets relatively stronger compared to other world currencies.
   Following 11 adjustments in under 18 months, the US primary lending rate currently stands between 5.25% and 5.5%, marking its peak in over two decades.
   
   Source: AFP
   3. Global Demand for Dollars: The demand for USD remains robust due to its role as the world’s primary reserve currency and its use in international trade and finance. Most countries in the world carry out their import and export in dollars. Despite this, there are concerted efforts to mitigate its dominance.

BRICS Nation — Brazil, Russia, India, China and South Africa

Source: News 24

BRICS nations have recently decided to conduct trade amongst themselves using their local currencies, a move to counterbalance the dollar’s ascending strength.

Implications for the World Economy

1. Emerging Markets and Debt: Countries with substantial dollar-denominated debt might struggle to service their obligations as the USD strengthens.
   The USD’s ascension could seed a potential global debt crisis, particularly for struggling nations.
2. Global Capital Flows: The theory anticipates a flow of capital towards the U.S. potentially influencing asset prices and investment decisions. As the U.S. Dollar gains more patronage, it depletes the liquidity of other economies.
   According to Tradingeconomics.com, June 2023 saw a net treasury international capital inflow of $147.8 billion, a significant shift from the adjusted $161.6 billion outflow in the month before, marking the highest since July 2022.
   
   Source: Tradingeconomics.com
3. Cryptocurrency Adoption: A stronger USD could prompt countries in regions with unstable economies (as evident in Africa and Asia), to explore cryptocurrencies as an alternative store of value. Stronger digital currencies like Bitcoin and Ethereum, and stables like USDT, DAI, and USDC could become primary exchange mediums.

Source: Reddit — Crypto adoption by Country as of 2021

Implications for the Crypto Community

For the cryptocurrency community, the Dollar Milkshake Theory could imply:

1. Store of Value Comparison: A stronger USD might challenge the narrative of cryptocurrencies as a hedge against fiat currency devaluation.

2. Liquidity Boost: A dominant USD can enhance its role as a primary trading pair, potentially boosting liquidity in the cryptocurrency market.

3. Cross-Border Transactions: Cryptocurrencies could gain traction if the USD’s dominance in cross-border transactions becomes less appealing due to fees or restrictions. As the dollar strengthens, countries could prevent capital flight by regulations or limit dollar availability, making crypto more appealing.

The Fate of Cryptocurrency

Historically, the cryptocurrency market has closely mirrored global economic trends. When traditional markets falter, cryptocurrencies like Bitcoin have often followed suit.

The strengthening of the U.S. dollar could undermine cryptocurrency prices. As it becomes more valuable and scarce, cryptocurrency becomes less desirable for non-USD holders. Additionally, the perception of crypto as a volatile and risky asset might draw investors away.

A Safety Net

Source: pngegg.com

However, this could be a unicorn event. The fate of digital currencies will depend on geopolitical factors, market stability, and the severity of a potential global debt crisis.

If global instability escalates, digital currencies like Bitcoin may emerge as a digitally safe-haven asset. Cryptocurrency may appeal to investors who seek to hedge against inflation, currency devaluation, capital controls, or government regulations. For example, The Republic of El Salvador has adopted Bitcoin as its official currency and invested in Bitcoin reserves.

Bitcoin: A Contending Straw

Source: SoFi

Bitcoin, the pioneer cryptocurrency, has been acclaimed as the best-performing financial asset of the past decade. One of its defining features is its capped supply at 21 million coins, making it inflation-resistant. With a robust foundation backed by a vast computer network, boasting 100 million wallets and 17,000 nodes, its security is unparalleled.

Bitcoin’s finite supply aligns with the theory’s underlying premise of scarcity driving value. When the U.S. dollar becomes stronger due to global market dynamics, Bitcoin’s scarcity could further highlight its attractiveness as a store of value, drawing in both institutional and retail investors seeking refuge from potential currency devaluation. Hence, it could be another straw competing with the U.S. Dollar for global capital.

It isn’t just its performance or infrastructure that makes it so appealing. Bitcoin is secure, scarce, and fungible. It’s effortlessly portable and easily divisible. Its attributes like low storage costs, programmability, durability, and the ability to be translated across platforms further amplify its value proposition in the evolving financial landscape.

The decentralized nature of Bitcoin ensures it’s resistant to censorship and operates in a trustless environment—an unmatchable edge over the U.S. Dollar.

However, as the U.S. Dollar continues to strengthen, becoming potentially less accessible for the majority, Bitcoin could emerge as a compelling alternative or even become the ultimate currency that drinks up all the fiat currencies.

Stablecoins: A Possible Alternative

Source: Pymnts.com

Stablecoins, particularly those pegged to the U.S. dollar (USD), could be significantly impacted by the Dollar Milkshake Theory. Some of the potential effects include:

Demand Increase for USD-Pegged Stablecoins

If the U.S. dollar strengthens, global demand could increase. Accessing USD might be challenging for individuals, especially in emerging markets, and could turn to USD-pegged stablecoins as a more accessible alternative.

Liquidity and Arbitrage Opportunities

A strong USD could create value discrepancies in stablecoins across different exchanges, especially those not primarily using the USD as a base currency. This could present arbitrage opportunities for traders, thus increasing the trading volume and liquidity of stablecoins.

Interest Rates and Stablecoin Yields

If U.S. interest rates rise (a potential reason for a strengthening USD), it could influence the yield offered by various decentralized finance (DeFi) platforms for stablecoin deposits. Higher traditional interest rates might reduce the yield gap between traditional banking and DeFi platforms.

Pressure on Non-USD Pegged Stablecoins

Stablecoins pegged to other fiat currencies might face reduced demand if there’s a strong preference for the U.S. dollar in the global market. This could result in lower liquidity and trading volume for these stablecoins than their USD-pegged counterparts.

Collateralized Stablecoin Dynamics

For crypto-collateralized stablecoins, a robust USD could mean that more of the underlying cryptocurrency is required as collateral, especially if the value of the collateralized cryptocurrency decreases to the USD.

Potential Regulatory Scrutiny

A surge in demand for stablecoins due to a strong USD might attract increased regulatory attention. Authorities could become concerned about capital outflow into digital assets or potential risks associated with stablecoin platforms.

Cross-border Transactions

In scenarios where a dominant U.S. dollar complicates or increases the cost of international trade, stablecoins become an attractive alternative for cross-border transactions due to their stability and low transaction fees.

Geopolitical Implications

Investors looking to bypass the U.S. dollar in trade, especially if they face sanctions or trade restrictions, might turn to stablecoins as an alternative transaction means. This could increase the adoption and demand for stablecoins on a geopolitical scale.

Conclusion

The Dollar Milkshake Theory, if actualized, would emphasize the importance of the U.S. dollar in the global financial landscape. However, critics argue that it might be an overly simplistic view, undermining the complexities of global economics. Its implications on the cryptocurrency market are manifold, for stablecoins, especially those pegged to the USD, This could lead to increased demand, and wider adoption while less stable digital assets might be relegated. In all, most of the financial world silently wishes that Mr. Brent’s prophecy of Doom doesn’t see the light of day.