How will the US interest rate hikes affect cryptocurrency prices?
*This article does not constitute financial advice.
With rampant inflation at record highs (in March, the annual inflation rate was 8.5%, a 40-year high), the US Federal Reserve has approved a series of interest rate hikes. In early March, it was announced that the interest rate was set to increase by 0.25% each month. Then in late March, the Fed announced that the target will be raised to 0.5% increases each month until at least June of 2022.
This aggressive tightening of the US economy has huge implications for cryptocurrency, both in the short and long term. With a higher interest rate, costs of borrowing to purchase assets increase, discouraging banks and consumers from purchasing riskier assets like technology stocks and cryptocurrency. Consumers are also incentivised to save their money due to higher rewards. Overall, this has a short-term (1–2 years) effect of discouraging purchase of cryptocurrencies. As cryptocurrency is still a nascent industry with small market caps and high volatility, in times of uncertainty like these, buyers are less incentivised to buy and are more likely to switch to safer assets, such as cash or blue-chip stocks. Thus, expect incoming volatility.
That being said, the interest rate hikes may not have as big an impact on prices as expected. From 2016 to 2018, the Fed raised interest rates from 0% to 2.5%. This did not stop cryptocurrencies from surging, with Bitcoin making almost a 50x from $429 in January 2016 to $20,000 in December 2017. However, in 2018, the party ended and cryptocurrencies entered a near 2-year Bear market.
This suggests that interest rate hikes may have a dampening effect on prices, but the effects will not be felt immediately. Furthermore, the current interest rate targets are more aggressive than in 2017 (after all, inflation was not so bad in 2017), which may have an even greater short-term impact on cryptocurrencies.
Long-term however, these interest rate hikes show the value of cryptocurrencies traditional fiat currencies like the US dollar. M2 supply is the total supply of US dollars circulating in the economy. The interest rate hikes is in effect a reduction of M2 supply, which shows just how vulnerable fiat currencies are to manipulation by central governments. This is in stark contrast to most cryptocurrencies, especially Bitcoin and Ethereum. Bitcoin has a fixed maximum supply of 21 million, not a single 1 more. With an annual inflation rate of around 1.66% and halving of the mining rate every 4 years, the increase in circulating supply is only going to slow down. With the upcoming Ethereum “Merge”, the triple halving will reduce ETH’s issuance rate by about 90%, making ETH’s supply deflationary (the supply of ETH will actually start decreasing at about 0.5% annually). Evidently, the supply factors of cryptocurrencies leave little uncertainty for investors and buyers will be pleased to know that the supply cannot be manipulated by centralised bodies like the government.
On the demand side, investors in the long run will turn to cryptocurrencies as a way to escape the traditional financial systems and protect their purchasing power. This is already prevalent in areas such as Turkey, where inflation has led to investors turning to Bitcoin and causing the BTC/TRY valuation to reach all time highs. Institutions are pouring into cryptocurrencies literally in the trillions. According to Yahoo Finance, Ethereum moved $11.6tn in 2021, with VISA falling behind at $10.4tn in payments volume. With more and more financial tools available in the DeFi space that trumps those of traditional finance, the demand for these will only increase exponentially.
With the government’s complete control of monetary supply and interest rates, investors will also want to escape to cryptocurrencies to free themselves from being manipulated by the government. This will again drive demand up long-term. After all, no one can control the supply of Bitcoin and Ethereum unless they somehow manage to control more than 50% of all participating nodes, which are spread all around the world. Dan Raju, CEO of brokerage platform Tradier, sees a rate hike as driving more institutional investment into the cryptocurrency sector. Speaking to Bankrate, Raju anticipates a “net positive in 2022 because any short declines driven by rate hikes will be offset by greater institutional and retail active trader adoption of this asset class”.
All in all, the tightening of the US economy in response to rampant inflation is likely to dampen cryptocurrency prices temporarily and lead to fear and uncertainty in the market. However, this also exposes the flaws of current monetary policies, of which cryptocurrency and blockchain technology are in prime positions to address. With increasing demand alongside slowly inflating supplies (or even deflating in some instances), the prices of cryptocurrencies will only move higher in the long run. As such, long-term investors may want to use this as an opportunity to dollar-cost-average (DCA) into the market. Please feel free to share any opinions in the comment section below.
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