How bitcoin and other cryptocurrencies can attract investors, tired of low-interest rates
After the 2007–2008 crisis, the global trend was the introduction of negative key rates by Central banks.
Stimulating monetary policy in the short term revives business activity, positively affecting exports through devaluation. However, drastic rate cuts and quantitative easing policies are prompting many States to erect protectionist barriers that suppress international trade.
Also, the “fashion” for a soft monetary policy reduces the profitability of traditional financial instruments. At present, many trillions of dollars worth of government securities with negative yields are circulating on the market.
However, the trend is likely to continue — the rate on 10-year US treasuries is now expected to be below 2%.
The yield on term deposits is not much higher. So the return on investments in risk-free financial instruments barely covers inflation. In such a situation, many investors will inevitably look for an alternative, albeit more risky areas of investment.
In this article, we collected and analyzed information about why investors are tired of extremely low and even negative rates. Why they can rush to the cryptocurrency market, which is still quite tiny in comparison with the world of traditional Finance.
While most traditional investors expect a recession next year, the cryptocurrency market is living its life. And even though the dynamics of many assets leaves much to be desired, the sector of decentralized Finance is rapidly developing.
The era of negative interest rates
Central banks in many countries have been pursuing negative rate policies for years, suggesting that financial institutions must pay to hold excess reserves.
The first one to introduce a negative rate was the Danish Central Bank in July 2012, when the European debt crisis was in full swing. Two years later, the European Central Bank (ECB) took a similar step to prevent deflation. In response to this, to avoid revaluation of the franc, the Swiss National Bank reduced the key rate to -0.25% in December 2014, and now this figure is at the lowest level in the world — -0.75%.
In February 2015, the Swedish Central Bank cut the reverse REPO rate to -0.1%. In the autumn of the same year, the Bank of Norway reduced interest rates on Bank deposits to -0.25%.
In March 2016, the Hungarian monetary regulator lowered rates to negative values. In the same year, similar measures were taken by the Bank of Japan, the result of this policy was a yield of -0.12% on government bonds.
In a conversation with CNBC, former fed Chairman Alan Greenspan said that the day is approaching when the US will pursue a similar policy, it is only “ a matter of time.”
Why would governments reduce the purchasing power of the currency and what is wrong with strengthening the national currency? First of all, let us note that extremely low and negative rates are typical, as a rule, for economically developed countries, which for many decades served as a magnet for foreign investments. And now people are still eager to invest in government bonds of a robust economy.
In reality, the GDP growth rates of these countries have been extremely low for a long time. At the same time, it is not so easy to revive business activity in the conditions of deflation: many traditional fiscal instruments and monetary policy have already exhausted themselves and do not produce the same effect. Moreover, the inflow of foreign capital only strengthens the national currency. This, in turn, causes a decline in net exports and slows GDP growth.
The “fashion” for negative interest rates is tied with serious risks — they can provoke an outflow of deposits, as many will prefer to keep money “under the mattress”. The massive outflow of funds from the banking system is fraught with a financial crisis. Also, the savings of the population can flow from the banking sector to the stock market and other riskier areas for investment, triggering the emergence of bubbles.
On the other hand, negative interest rates reduce people’s incentives to save. As a result, consumer demand can grow, helping the economy to stay afloat. However, in any case, extremely low and negative rates are a sign of non-equilibrium processes and the growth of crisis phenomena. One of the founders of the Austrian school of Economics, Ludwig von Mises, argued that the policy of cheap money inevitably creates an artificial boom, especially in industries producing capital goods; and this boom can not last long.
Rates below the natural level are not the only trick of modern Central banks. Some monetary regulators practice quantitative easing, the essence of which is the active intervention of the Central Bank in the free trade of government debt to control the interest rates of these securities.
The table below shows the rates and yields of 10-year bonds in some economically developed countries:
Importantly, it is unlikely that the Central banks of developed countries will radically change their policies in the foreseeable future: according to the recently revised forecast of the International Monetary Fund, the growth rate of the world economy will decline to the lowest values since 2008.
At the same time crypto lending services offer much more attractive conditions for placing funds:
On decentralized services like Compound and Fulcrum, rates on USDC and DAI coins based on the US dollar can reach 10% per annum and even higher.
Crypto assets and new life of the Carry Trade strategies
Carry trade is a strategy of making a profit in the foreign exchange market due to the difference in interest rates in different markets. In other words, a trader borrows Fiat currency at a low-interest rate for high-yield investments.
In 2004–2008, the Carry Trade using the Japanese yen and dollar was popular. Then the fed raised the rate from 1% to 5.25%, while in Japan this figure remained stable at around 0.5%. Investors borrowed yen to invest in us dollar-denominated instruments. As a result of mass enthusiasm for this strategy, the Japanese currency sank against the dollar by 20%.
Currently, this strategy is not so popular, because, as already mentioned, in most developed countries, interest rates are close to zero. Nevertheless, the cryptocurrency market can breathe new life into Carry Trade.
For example, the well-known Twitter account PlanB is convinced of this. According to him, traders can borrow Fiat at a negative rate and invest in instruments based on cryptocurrencies at, for example, 12% per annum.
The ability to place free crypto assets at interest is not only on the above-mentioned DeFi-services but also on centralized platforms like Binance, Crypto.com, Celsius Network, and BlockFi. Rates on these sites can also change dynamically, but in some places, it may not be possible to withdraw funds on demand, that is, before the deadline.
The halving factor
In addition to making a small profit on the interest rate difference, there is another argument in favor of the fact that buying bitcoin with borrowed Fiat funds at a low rate can pay off.
On may next year, there will be another halving. It will reduce the reward for the extracted block in half and thus reduce annual inflation. In other words, digital gold will become a much more scarce asset, especially compared to Fiat money.
Altana Digital Currency Fund CEO Alistair Milne is convinced of this. According to his calculations, after halving, the weekly value of bitcoins entering the market will decrease by $51.7 million (at $8,200).
Thus, if the Carry Trade scheme “Fiat-crypto” becomes popular, the price of BTC may increase sharply, as at the time the dollar strengthened against the yen.
“Rates declined in September 2007, January 2001 and June 1989. This did not prevent the recessions that began in December 2007, March 2001 and July 1990. The lesson from this is that easy money is not a panacea. If the cycle has begun, the fed will not be able to stop the recession, no matter how hard it tries.”
Since the economy is developing cyclically, bitcoin will have the opportunity to effectively prove itself as a protective asset and a censorship-resistant means of preserving value. The possible growth in demand for the first cryptocurrency during the recession of the world economy is likely to revive the wider market, including the sphere of DeFi.
