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Recent news that the US is expecting three interest rate hikes throughout 2022 has led some analysts to suggest that this is the catalyst of the recent downturn in the crypto markets.
Interest rates are one of the most influential factors in terms of market cycles. When interest rates are low it can lead to more capital moving into the markets, which we saw throughout 2021. However, when interest rates are high capital tends to move into safer assets and creates turmoil in riskier asset classes.
US interest rates are determined by the Federal Open Market Committee. The committee is made up of five federal reserve banks presidents and seven governors of the Federal Reserve Board. They determine the rates the banks have to pay to borrow money from each other. These rates have a ripple effect on the market impacting the global economy.
What happens when interest rates rise?
An increasing interest rate means an increase in the cost of borrowing money by financial institutions. This in turn impacts the extent companies and individuals borrow money from the banks.
When banks incur higher costs when borrowing money from other banks, it passes the costs to the consumers. This means credit cards and mortgage rates will also increase. The consumers, therefore, have to higher interest to repay on their debts. By spending more on interest repayments, consumers have less money left to spend on other things, in turn affecting overall economy growth. High interest rates do, however, help manage inflation.
What happens when the interest rates fall?
A fall in interest rates has a positive impact on the economy compared to rising rates. After a longer period of higher rates, the economy will slow as most companies are not expanding. The federal reserve, therefore, would opt to reduce the rates to allow for increased borrowing. With increased borrowing, more money is injected into the economy. Businesses will then enjoy more profits as consumers have more money to spend.
High interest rates and the crypto market
Interest rates affect the crypto market. In the earlier days of crypto, the crypto market was so independent that changes in the traditional economy would not impact it in any way. However, crypto has since become mainstream and has attracted institutional investors, meaning macroeconomic changes do impact the market. This is evident from the fact that the Evergrande crisis affected the crypto market.
Institutional investors have been integral in the rise of cryptocurrencies. For example, Microstrategy has around 121,404 BTC on its holdings while Tesla has 42,000 BTC. These are massive figures that not many retail investors can match.
Institutional investors are only able to invest in Bitcoin due to the available money to spend. With increasing interest rates, companies tend to have less money to spend. Retail investors also have less disposable income, which means reduced investments in all markets not just the crypto market.
Reduced investments in crypto lowers demand and hence can create token values to plummet. This has led some to believe that the news that the US expects 3 interest rate hikes in 2022 to combat inflation is the cause of the recent crash. As investors try to begin hoarding cash, the first assets they sell are the most risky and volatile assets, which crypto falls under.
Will crypto die?
From previous cycles, a crypto bear run can be long. However, Bitcoin won’t die, but may have a prolonged downtrend. Institutional and “whale” investors are not after short-term crypto gains. Instead, they are opting for a hodling trading strategy. Without large-scale Bitcoin withdrawals, the market could remain stable or at least not experience a 2018-style collapse. 2022 will be a very telling year for crypto.
