The Breakdown - US Credit Downgrade Hits—Bitcoin Pumps Anyway

Episode Date: May 20, 2025

Moody’s has officially downgraded the U.S. credit rating, joining S&P and Fitch in knocking the government off its AAA pedestal. NLW breaks down the political reaction, the muted market response, and why institutional investors still seem bullish on Bitcoin despite fiscal dysfunction. Plus, what rising transaction fees and ETF flows reveal about the next phase of the Bitcoin cycle. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/@TheBreakdownBW Subscribe to the newsletter: ⁠⁠⁠https://blockworks.co/newsletter/thebreakdown⁠⁠⁠ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownBW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Monday, May 19th, and today we are talking about a U.S. credit downgrade. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly. All right, friends, well, it has happened. Moody's have downgraded the credit rating of the U.S. government, citing spiraling annual deficits. That means that now all three major credit agencies have

dropped the rating on U.S. debt below AAA. S&P delivered their downgrade in 2011 following the passage of the Budget Control Act. At the time, they said the fiscal control plan, quote, fall short of what would be necessary to stabilize the government's medium-term debt dynamics. They also noted weakening effectiveness and stability in American policymaking and institutions. More recently, Fitch delivered their downgrade in August of 2023, essentially marking the bottom of that economic slowdown. They also cited spiraling debt, but focused on a, quote, steady deterioration in standards of governance over the last 20 years. The agency noted repeated debt standoffs and zero progress on Social Security and Medicare reform. After the bell on

Friday, Moody's concurred and lowered the credit rating on U.S. debt from AAA to AA1. In their statement, they wrote, while we recognize the U.S.'s significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics. The White House immediately asserted that this was a politically motivated decision. Presidential spokesperson Stephen Chung tweeted, Mark Zandi, the economist for Moody's, is an Obama advisor and Clinton donor who has been a never-trumper since 2016. No one takes his quote-unquote analysis seriously. He has been proven wrong time and time again. Posts from the Moody's CEO were then later dug up

congratulating President Biden on his 2020 election win. Treasury Secretary Scott Bessent was a little bit more diplomatic in the way he framed the decision. Speaking with Meet the Press on Sunday, he said, Moody's is a lagging indicator. That's what everyone thinks of credit agencies. There's certainly a reason to think this is slow bureaucratic decision-making rather than a knee-jerk political reaction. Ratings agencies typically only deliver a downgrade as a follow-up to an outlook change with a 12-18-month lag. Their outlook on the U.S. debt was shifted from stable to negative in November December 23, and nothing much has changed in that time. So this decision would be in line with standard policy. Besson also made the point that his plan is to fuel growth rather than push austerity.

With the current deficit that would imply growth at 7%, something the U.S. only achieved for a few years in the early 1950s. Macro-analyst Luke Groman pointed out that the math doesn't work without a ton of inflation, tweeting, when the U.S. Treasury Secretary tells you holders of long-term bonds are going to lose money on a real basis, you should believe him. Maybe the larger point is that nothing much has changed in the past two years. Doge has made some cuts on the margins, but fell short of their $2 trillion target by 90% even on their own optimistic numbers. Trump's big beautiful tax bill, his term, obviously, would increase the primary deficit by $22 trillion over the next decade. That bill is currently stuck in Congress, and it seems unlikely to pass without major compromises.

Opposition to the bill is centered around conservatives calling for deeper Medicaid and green energy cuts. However, the big overarching point from the ratings agency is that structural deficit reduction feels like a political impossibility. Even if conservatives get their way and cut Medicaid to the bone, that decision seems likely to cost Republicans' control of Congress in the midterms. Now, the question, of course, is, does the downgrade actually matter, or is this all just political theater? Tracy Chen, a portfolio manager at Brandywine Global Investment Management said, the downgrade may indicate that investors will demand higher yields on treasuries. It remains to be seen whether the market reacts differently as the safe haven nature of Treasury and the U.S.

dollar might be somewhat uncertain. During the previous downgrades, it's the last It's been difficult to single out the effects outside of other macro factors. Bloomberg reported the dollar had weakened on the announcement, but the move was minuscule compared to volatility from the past month. The 10-year bond is moving up quickly, but remains below one-week highs of 4.55%. The U.S. stock futures fell to levels not seen since Friday morning. Overall, the decision just isn't showing up anywhere in traditional financial markets in a clear way.

Thomas Thornton, founder of hedge fund telemetry, said, While Moody's finally made it official, markets have likely seen a diminished U.S. credit profile coming for some time. Unlike the shock of S&P's August 2011 downgrade, this downgrade lands in a market already wary of fiscal dysfunction and tariff risk, meaning the impact on stocks may be more muted than their initial headline suggests. Now, another angle, though, is regulatory. Many institutions and banks are required to hold AAA debt on their books as collateral. However, these allocations generally allow U.S. debt regardless of credit rating, enshrining the Treasury as pristine collateral. Mr. Vicks commented, despite the U.S. credit rating downgrade, technically speaking,

the downgrade applies to the U.S. government, not directly to U.S. Treasury securities. In fact, U.S.Ts are the only major sovereign debt instrument that do not actually carry a formal rating from the credit rating agencies. As a result, there's no ratings-driven increase in risk weights or margin requirements per se. However, the market will presumably reprise treasury yields accordingly, which could affect collateral scarcity and impact the repo market in the coming week. Essentially, there could be a knock-on effect from a repricing, but this won't trigger an apocalyptic sell-off, as it would when commercial bonds are downgraded. If anything, grade just acts to crystallize the narrative that deficit cuts are a fantasy. Wall Street analysts

are no longer hopeful that Elon will balance the budget and instead are figuring out how to position for infinitely expanding U.S. debt. macro analysts Warren Pease wrote, Moody's downgrade is no big deal. No chance of not getting paid back by the U.S., high chance of getting paid back with debased currency, though. Commenting on Bessens called the pump growth to unprecedented levels, Lin-Aldin tweeted, they're basically in the nothing stops this train, so let's accelerate it, phase. While the market reaction looks muted so far, there could be more to come once Monday's session is in the books. As one of the major asset classes with weekend trading, Bitcoin already seemed to be responding. Price was relatively flat on Saturday but pumped to $107,000 on Sunday night.

The pump coincided with CME futures opening after the weekend break, suggesting this is institutions rather than crypto people moving the price. Price did moderate into overnight trading, but Bitcoin still had its highest weekly open ever and got within two percentage points of all-time highs. Trader Jonah Van Borg thinks the catalyst is pretty clear, tweeting, to those who wondered publicly about how Trump's spending cuts could possibly be bullish Bitcoin, spending cuts were never going to happen. They aren't possible. The government will borrow, spend, print, and Bitcoin will pump. One interesting signal coming alongside the pump is that Bitcoin transaction fees have been steadily increasing. It's not by much, but average blockchain

fees have more than doubled from near historic lows in mid-April. And if you've been following Bitcoin Twitter, you'll know that there's a factional war going on around Bitcoin spam. A group of Bitcoin purists are pushing to filter out pictures and other arbitrary information on the blockchain. The opposing group are fighting to make the blockchain more expressive to unlock Bitcoin defy and other functionality. The upshot is a discussion about pushing up Bitcoin fees to deter spammers rather than a code change. Late last week, Bitcoin influencer Jimmy Song tweeted, our mental model of spam comes from email, which has made us feel helpless with respect to Bitcoin spam, thinking that spam will be with us forever. But Bitcoin spam costs Bitcoin to make, and it's a lot

easier to make the cost of Bitcoin spam go up than it is email spam. Jameson Lopp, who's on the side of unlocking more functionality, responded, trust the economics. Regardless of why it's happening, a fee spike would be a positive signal for analysts, even if they aren't plugged into this debate. Each prior Bitcoin pump came with a persistent increase in Bitcoin fees. This cycle is obviously very different with a large portion of trading activity shifting from the network to ETFs. Still, analysts could start to pattern match against previous cycles and see a rise in fees as a very positive sign. Now, the time of recording Bitcoin has been on the way down a little bit. It's at $102,500. But as I mentioned before, that's still a great start to the week.

And the current narrative from analysts is that institutions are holding Bitcoin up. In their weekly report, GlassNode wrote, ETF inflows have since cooled off to around $58 million per day, but the flows show that institutional interest in Bitcoin remains relatively robust. Glass node also showed that on-chain activity showed a strong-by-the-dip response to the April low of $75,000, short-term holders who have held their their position for less than five months are concentrated between 93 and 95K. Glassnode wrote that, as a result, this zone is likely to act as strong support level in the event of any short-term

market pullback, representing an demand zone where investors are likely to see value once again. They noted that 90% of short-term holder supply is now in profit, but doubted we would see significant profit-taking at this stage. Their current model on the market is a stair-step higher with strong accumulation at key levels, putting a floor on future pullbacks. On-chain analyst checked Mady also used the analogy, writing, The Bitcoin price is stair-stepping its way towards supply discovery, a phase of the market where just about every investor is back in profit, meaning it's time to look up at the next price target. And yet, while institutional buying looks strong on aggregate, some individual organizations have weak hands.

The State of Wisconsin Investment Board failed the first test of Bitcoin investing and sold it all on the first major drawdown. The board is tasked with managing the state pension and manages over $162 billion in assets. They made a tiny $160 million Bitcoin ETF purchase in quarter one of last year before doubling down in Q4. New SEC filing reports, however, that they dumped the allocation last quarter, reducing their Bitcoin exposure to zero. We don't know exactly when they sold, but it seems unlikely they made a loss on the trade given the time of their initial purchase. Still, the pension fund got to watch Bitcoin rocket back up to near all-time highs immediately after they sold,

an introduction to Bitcoin that's all too familiar for many first-time buyers. Wisconsin still does have exposure to Coinbase and MicroStrategy, though these are less than $20 million each. Macroscope highlighted that this doesn't really change the state of play, commenting, Wisconsin's initial buy was important because it helped validate Bitcoin as an acceptable investment for a rigorous type of investor with a high public profile, i.e. pensions and endowments. That validation is unchanged. Brown University, Emory University, and the state of Michigan reported Bitcoin ETF positions in the most recent quarter. The response on crypto-twitter, meanwhile, was fairly predictable, with Bitcoin Lobowski tweeting, have fun staying poor, Wisconsin.

I will only remind us that part of why Bitcoin is such a great asset is that it can be sold really easily. It has the store of wealth properties, but in an incredibly liquid package. Selling is not a bug, it's a feature. It's just that those of us who have been around for a while know that the first rule of Bitcoin is you just don't sell your Bitcoin. About one institution that has no intention of missing out is Abu Dhabi's sovereign wealth fund. The fund added around $28 million worth of BlackRock ETF and Q1, bringing their total holdings to more than 510 million. Now, what's interesting here is not that this is a meaningful portion of their $1.7 trillion fund, but a demonstration that they're willing to buy the dip, and a suggestion that

they're looking to build a larger position over time. Other financial disclosures from large trading firms this quarter are interesting and show a few different behaviors overlapping. Citadel advisors, the wealth management division of the market-making giant made a big acquisition. Their Ibit position held on behalf of customers almost tripled in Q1 to around 182 million. That's in line with Goldman Sachs, who increased their holdings by 40% to $1.4 billion, becoming the largest institutional holder of iBit. The trading firms, however, seemed to be pulling back, with Millennium Management slashing their exposure by 40% to $823 million. Millennium had been the largest iBit holder with over $1.4 billion of iBit shares, but the position was always expected to be offset against

bearish options or futures positions as a basis trade rather than an outright long, which, if that was the case, would make sense that risk was cut as volatility picked up. Matt Hogan, the CIO, a bitwise, commented, witnessed in the first quarter was the collapse of the premium that people were paying for Bitcoin futures, which had set up a very lucrative basis trade. But that premium collapsed and reached its nadir around the end of March, so I'm not surprised to see hedge funds trim their holdings. Finally, a little follow-up news from the end of last week. Wall Street analysts have completely brushed aside the Coinbase hack. The company had said that the incident allowed bad actors to get access to the private information of around 1% of monthly active users, which seemed to be

around a million people, and Coinbase set aside as much as 400 million to reimburse the victims of fishing attacks. On the same day, the New York Times reported that the SEC was looking into potentially inflated user metrics around the time of the IPO. In the crypto world, the attack was a big deal, with many concerned about a wave of wrench attacks enabled by the data leak. On Wall Street, however, it seemed like no big deal. The stock has already filled the 7% drop associated with the news and is back to trading at three-month highs. Key bank analysts wrote in a note, Coinbase has long been viewed as a high-quality safer platform across the crypto ecosystem and has enjoyed a flight to quality in recent years. Given the nature of the data breach and the planned remedy,

we don't expect that to change in such a way that it erodes broad customer trust. Then you might remember that on Friday, Galaxy Digital uplisted to the NASDAQ, which was a bit of a mixed bag. The stock saw an 8.5% gain during the morning session before giving most of it back in the afternoon. It still closed up 3% on the day, and investors can't be too disappointed with the firm completing the long process of getting listed in the U.S. with a stock up 25% year-to-date. After opening trading on Friday, CEO Mike Novograt said, I think we're at the beginning of the race, not the end of the race. Sometimes it feels like it's been such a struggle.

You ring the bell and you're crossing the finish line, but really, it's the starting bell. After Eitoro's successful IPO earlier in the week, this was yet more validation that the window does seem to be open for crypto companies. Novograt said, I think we're at the beginning of what will be a trend of other crypto companies going public. And so, friends, that's where we stand heading into this week. Theoretically, it should be a little bit more muted heading into Memorial Day in the U.S., but who knows?

For now, appreciate you listening, as always. And until next time, be safe and take care of each other. Peace.