Crypto is often touted as a hedge against inflation and, with options like stablecoins, a safe place to park money during turbulent economic times.
So why have the prices of leading cryptocurrencies like Bitcoin and Ethereum been tumbling, along with the stock market, in light of Federal Reserve posturing to raise
interest rates to curtail inflation?
While there’s maybe not one clear answer – there are a number of opinions about how the cryptocurrency world could shift as the Federal Reserve moves.
Understanding The Not-So-Separate Relationship Between Crypto And Traditional Assets
First, it’s important to note Bitcoin’s correlation to U.S. equities, at least in the short term, has actually been positive.
NYDIG researchers Greg Cipolaro and Ethan Kochav noted “while bitcoin has historically been uncorrelated to other asset classes, such as equities, bonds, and gold, since March 2020, bitcoin’s rolling 90-day correlation to US equities has been consistently positive.”
The prices of leading cryptos like Bitcoin and Ethereum, like with the stock market, began to fall right after the Fed’s December meeting. Bitcoin fell nearly 8% from January 5th-6th, while the NASDAQ also plunged on the 5th amid it’s biggest single-day drop since February 2021. As of late January, Bitcoin had lost nearly half of its value from November amid fears of hawkish Federal Reserve action.
Now comments from Federal Reserve Chair Jerome Powell on January 26th indicate concrete moves to raise interest rates. According to him, “the committee is of a mind to raise the federal funds rate at the March meeting, assuming that the conditions are appropriate for doing so.”
The nation’s central bankers have left rates at near-zero since March 2020 as a response to the coronavirus pandemic.
Some within the crypto industry believe higher rates on dollar-denominated assets could translate into stronger stablecoin demand. Hopes are that as the dollar strengthens against other world currencies, stablecoins, which are a relatively simple way to gain dollar exposure, would become more attractive.
Stablecoins have already realized immense growth over the past year as the DeFi world continues to expand. According to Fitch Ratings, stablecoin assets jumped by about 450% across 2021, with the eight largest stablecoins (accounting for 98% of the market) at a collective market cap of $152 billion by December 13th.
In fact, the Federal Reserve even released a report earlier in January that detailed some of the costs and benefits of a government-issued and backed cryptocurrency.
Could There Be More Questions Than Answers With How Crypto Markets Will Respond?
Others are taking more of a wait-and-see approach, noting how the crypto market has changed immensely over the past few years. For example, a Grayscale note before Powell’s remarks on January 26th explained how the crypto world had “stronger fundamentals” than past market cycles.
Indeed, reminders about how the crypto world has matured is leading some to argue a definitive boom or bust cycle is imminent.
In contrast to what’s been seen in the past, crypto companies are now able to collect large amounts of venture capital. Some also sit on large piles of assets even years after fundraising rounds.
SingularDTV, which had an ICO in 2016, moved $30 million in Ethereum to Coinbase on January 25th. Speculation is crypto companies with large financial reserves could help them weather tougher capital markets and keep the digital asset world moving regardless of the interest rate.
Other questions still remain about how much of crypto and stock market slides have already been priced in, especially since even a large interest rate increase would still leave rates somewhat low in relation to historical data.
Federal Reserve officials already hinted late last year there would be multiple rate hikes in 2022 to respond to inflation and the job market. Goldman Sachs even predicted four hikes this year.
Ultimately, there’s arguably still more questions than answers when considering how the late January move by the Federal Reserve to raise interest rates will impact the crypto market. If forced to make a projection, we would suggest that money flows out of speculative crypto investments, and into assets like stablecoins, which would in turn still boost crypto markets as a whole.
