The Impact of Higher Interest Rates on Cryptocurrencies
When the Federal Reserve (Fed) introduced restrictive monetary policies by increasing interest rates in 2022, it led to a decline in valuation not only in equity markets but also in cryptocurrencies. Octavio Sandoval, director of investments at Illumen Capital, offered insights into this phenomenon. Sandoval stated, When the Fed introduced restrictive monetary policies by increasing rates in 2022, this caused equity markets and cryptocurrencies to appropriately decline in valuation. This indicates a clear correlation between central bank interest rate policies and the performance of asset markets.
Challenges for the Federal Reserve
The Fed is now facing a significant challenge in balancing its duties. Setting interest rates too low can exacerbate inflation, which the Fed is duty-bound to control. Conversely, setting interest rates too high can risk pushing the economy into a recession. Octavio Sandoval highlights this challenge, noting that The chances of them getting it right are so close to zero as to be negligible. This precarious situation could foreshadow a significant shift in investor behavior.
The Onset of Economic Maladministration
A significant turning point may be approaching, marked by the Fed's efforts to tighten monetary policy through increased interest rates. According to Sandoval, There comes a point in economic maladministration where nothing works anymore, and this is it. As more people recognize this predicament, there will be a shift away from traditional investments, leading to a sudden surge in demand for fixed supply assets like cryptocurrencies.
The Law of Supply and Demand
As the Fed seeks to reduce liquidity in the market by increasing interest rates, it will create an environment that attracts more investors to the cryptocurrency space. This, in turn, is expected to drive up the price of cryptocurrencies, a phenomenon explained by the simple law of supply and demand. Increased interest in cryptocurrencies will lead to higher prices as supply remains limited.
No Direct Connection to US Interest Rates
Despite the common perception, there is no direct connection between US interest rates and cryptocurrency prices. The crypto ecosystem doesn't have a significant number of traditional banking functions such as loans and deposits that would be directly impacted by interest rate changes. Instead, the floating price of any currency, including cryptocurrencies, is heavily influenced by foreign exchange (Forex) futures markets, which are in turn impacted by the interest rates of the banking industry that manages that currency.
Impact on Speculative Activity
While higher interest rates may reduce speculative activity across various financial markets, this isn't a straightforward transfer for cryptocurrencies. Higher interest rates can dampen speculative enthusiasm, as cryptocurrencies are fundamentally speculative tokens. As such, the higher the interest rates get, whether in the USA or globally, the less interest we can expect in cryptocurrencies.
No Significant Benefit for Broader Investors
The broader investor base, including the poor and working-class individuals, may derive some benefits from cryptocurrencies, but the high-risk nature of speculative trading means these individuals cannot afford to lose significant sums. For example, 100,000 satoshis (approximately $1,000) may be insufficient to pay essential bills like electricity, indicating that speculative trading is not a viable financial strategy for the majority.