Fed interest rates vs. cryptocurrencies
Changes in interest rates impact cryptocurrency prices through shifts in investor behavior and market dynamics.
The United States Federal Reserve, or the Fed, acts as the central bank of the United States. One of its key responsibilities is to manage the country’s interest rates, which essentially control the cost of borrowing money. A lower interest rate makes borrowing cheaper, increases economic liquidity and stimulates consumer spending and investment. Conversely, raising interest rates discourages borrowing, reduces the amount of money flow within the economy and slows the economy down, which aims to curb inflation.
Asset prices, including stocks, bonds and even cryptocurrencies, tend to react inversely to interest rates. As a rule of thumb, the interest rate can be visualized as a common denominator used to price assets. If this denominator increases in value, most assets fall in price and vice versa. Therefore, highly volatile assets like cryptocurrencies and nonfungible tokens (NFTs) are no exceptions to this.
From a behavioral perspective, when rates are low, banks offer lower savings rates. As a result, investors are more likely to seek out riskier assets like venture capital and crypto to pursue higher returns. This increased demand can drive up crypto prices. On the other hand, rising interest rates make safe-haven assets like savings accounts and bonds more attractive, pulling investment away from riskier ventures like cryptocurrencies and potentially leading to price drops.
The impact of interest rates is particularly pronounced in riskier assets. Cryptocurrencies, with their inherent volatility and lack of established financial history, are especially sensitive to changes in the interest rate environment. This is evidenced by historical price action within the cryptocurrency market. As the price of cryptocurrencies plummets, liquidity leaves decentralized finance (DeFi) protocols, and blockchain ecosystems…
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