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How Does the Fed Affect Crypto Interest Rates?

Jordan Bishop • July 30, 2024

Inflation is likely hitting your wallet hard, driving up prices on everything from groceries to mortgage rates. But did you know it’s also shaking up the cryptocurrency market?

Let’s dive into how inflation is reshaping the crypto landscape and what it means for those interested in digital currency.

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The inflation-crypto connection

As central banks continue to battle inflation, interest rates have become a key weapon. In many developed economies, we’re seeing a shift back towards lower rates.¹, ² This has created a ripple effect across different asset classes, including cryptocurrencies.

Why lower rates matter for crypto

When interest rates fall, here’s what happens:

  1. Traditional savings accounts and new bonds offer lower returns.³
  2. Investors look for better-performing alternatives.
  3. Cryptocurrencies become more appealing as one of these alternatives.

Here’s the theory: when low interest rates make other investment vehicles less attractive, cryptocurrencies become more attractive by comparison.

But it’s not just this relative comparison that can make cryptocurrencies more attractive. It’s also because they’re scarce:

  • Most cryptocurrencies have a limited supply.
  • This scarcity can make them more valuable over time.
  • Meanwhile, high inflation reduces the buying power of traditional money, making scarce assets more attractive by comparison.

Bitcoin: A prime example

Bitcoin is a prime example of a cryptocurrency with built-in scarcity. There will only ever be 21 million Bitcoins, and recent “halving” events have slowed the creation of new Bitcoins, making them even scarcer.⁴

With that said, other cryptocurrencies — including Ethereum — are also adopting similar supply-limiting strategies to increase their appeal.⁵,

While the exact link between interest rates and cryptocurrency prices is hard to pinpoint, the fundamentals make sense: scarce items are desirable, and money goes where it earns the highest yield.⁷ So as a result, scarce cryptocurrencies will likely attract money flowing out of less appealing assets.

What to watch for

There are several things to keep an eye out for that may signal a move in the crypto markets is about to take place:

  1. Central bank policies: Keep an eye on announcements from major central banks. Rate cuts often signal a boost for crypto markets.
  2. Inflation data: Higher-than-expected inflation could drive more investors towards cryptocurrencies as a store of value.
  3. Big player adoption: Watch for large companies and financial institutions investing in crypto. This can signal growing confidence in the face of inflation.
  4. Regulatory changes: New regulations have the potential to impact the legality and availability of cryptocurrencies.

How to respond

If you’re looking to capitalize as an investor, here are some details to keep in mind:

  1. Diversify: Don’t put all your eggs in one basket. Investing is inherently risky, so consider a mix of different cryptocurrencies and traditional assets.
  2. Think long-term: Cryptocurrencies can be volatile. A long-term perspective can help you weather short-term fluctuations.
  3. Know your limits: Cryptocurrencies are a speculative investment. Never invest more than you can afford to lose.
  4. Consider dollar-cost averaging: Regular, small investments can help manage the risk of market timing.

Inflation still matters

Inflation’s impact on cryptocurrency is complex and evolving. While lower interest rates generally create a favorable environment for crypto, it’s just one piece of the puzzle. Other factors like regulatory changes, technological advancements, and market sentiment all play a role.

If you’re just getting into crypto today, find out more about crypto for beginners.

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