Interest Rates Explained — AAX Academy
As Bitcoin is on its way to become a global market asset, recognized and adopted by retail and institutional investors alike, it’s important that crypto traders become more and more aware of how the global economy functions and how Bitcoin relates to those dynamics.
In this post, we will look at interest rates, how they affect the economy and why so many people are buying bitcoin now.
What are interest rates?
An interest rate is defined as the proportion of an amount loaned which a lender charges as interest to the borrower, normally expressed as an annual percentage rate (APR). In other words, it is the % rate a bank or other lender charges the borrowers or the rate a bank pays its savers for keeping money in an account.
Interest rates matter.
If keeping money in your account yields you 2% each year, apart from building up compound interest, you might be a little less worried about inflation.
However, if interest rates are negative — basically, if you’re paying the bank to keep your money in their vault — unless new money is deposited into your account, you will eventually see funds dry up, simply for being there.
However, when interest rates are low, it is also cheaper for people to borrow money which could stimulate the economy. More people would be inclined to borrow money to buy a house or some might want to start up a business.
The interest rate charged by banks is determined by a number of factors, such as the state of the economy. It is set by the Central Bank of a country. When the central bank sets interest rates at a high level, the cost of debt rises. When the cost of debt is high, it discourages people from borrowing and slows consumer demand.
Usually, interest rates tend to rise with inflation. As money becomes less valuable over time, lenders will want to make sure that when they are repaid, they are not holding less than before. When this happens, people tend to hold their money in their savings accounts to accrue an interest. Stock markets usually suffer when this happens and businesses will also have less access to capital through debt, leading the economy to slow down. In the worst case, high interest rates could lead to a recession.
From Interest Rates to Bitcoin
But what if interest rates are basically zero and governments are printing new money every day to provide support to businesses and citizens to counter the negative impact of the global pandemic?
Undoubtedly, many people around the world have suffered and are still suffering from the impact covid-19. At the same time, with the economy at a near standstill, those who are still working have had few opportunities to spend their money.
Leaving those savings in the bank, apart from giving some sense of comfort, basically means accepting that every month, the bank will charge you for keeping it there and whatever money is left is slowly losing value due to inflation.
2020 has shown us what can happen as a result of this.
After the market crash in March 2020, tech stocks and other equity markets surged, charting new all-time highs. From an outside perspective, looking at the stock market, few would suspect that the world is in turmoil.
But most spectacular has been the effect on the price of Bitcoin. Crashing alongside equities, oil and gold, Bitcoin was among the first to recover and following it Halvening in May, proceeded to surge to unprecedented heights, showing no signs of abating as it did in 2017.
Now the institutional investors are involved, market dynamics are sure to change. We can expect more price stability — i.e. less pumps and dumps — and one might as well ask, who would want to sell their Bitcoin today, when the chances of mainstream uptake have never been so great?
But as market dynamics change, the crypto trading community might also have to become more savvy in how they decide on the market. Technical analysis is one important part of this, but at the same time investors in crypto will also need to increasingly take stock of what’s happening in the wider economy, and that includes paying close attention to interest rates and inflation.
For new investors in Bitcoin who are wondering if it might be “too late”. It’s incredibly important to realize how the space has changed since the last bull run in 2017.
For those who wish to learn more about where Bitcoin stands today as an investable asset, we highly recommend reading our latest research paper “Investing in Bitcoin in 2021”.
Originally published at https://academy.aaxpro.com on January 4, 2021.
