Bitcoin, the largest cryptocurrency falls as low as $35,600. Other cryptocurrencies followed the same with an even higher intensity as Ether, Solana, and Matic fell by more than 8%, 12% and 10% respectively. Even Dow Jones and Nasdaq saw falls yesterday of 3.13% and 4.99% respectively. This came after the Fed raised the interest rate by 0.5%.
What exactly does it mean when the Fed hikes interest rates? How does it directly impact crypto? What are the reasons for Fed taking such measures even though they know it is going to lead to a major sell-off?
In 2020, the Federal Reserve made a lot of investments in the bonds and securities, to fuel the economy with money so that it can fight the threat to economic downfall due to COVID
The Federal Funds Rate is basically the rate at which the commercial banks borrow and lend their excess reserves to other banks overnight. This target interest rate is set by the Federal Open Market Committee (FOMC), and they meet eight times a year to set the target federal funds rate, which is used to help promote economic growth. The direct impact of changes to this rate is seen in short-term rates on consumer loans and credit cards, as well as on the stock market.
In 2020, the Federal Reserve made a lot of investments in the bonds and securities, to fuel the economy with money so that it can fight the threat of economic downfall due to COVID. Since money is put in the hands of consumers, it fuels the economy back when the consumer buys goods and services, and invests in stocks and crypto, in turn increasing the stock and crypto prices. The Federal Reserve also cut the Interest rates to Zero in March 2020, which means no interest was taken for lending and borrowing between banks, in turn making it easier for consumers and corporations to take loans and spend more due to the increase in liquidity.
But this continuous fueling of money into the economy is not possible. Initially, when there are higher interest rates in the economy, it becomes more expensive for people and companies to borrow. This impacts demand for credit and hence reduces consumer spending and investments. Quite simply, there is less loaned money that can be used to buy things or places to invest in. This directly impacts assets like stocks and cryptos. Here’s how:
- Less money to invest means fewer investments in crypto, leading to lesser activity in the market, or even profits taken away from crypto and stocks.
- Then there is also a change in investors’ mindset, once interest rates start to increase, savings instruments like FDs look more attractive and so investors start taking profits from riskier assets like Crypto and stocks and allocate funds into fixed interest rates FDs or other less risky assets like Gold.
- From the Stocks’ perspective also, due to fewer investments from the companies, there is a lesser chance of growth, and less valuable their stock prices become.
So in theory, once the Fed keeps on raising rates, it should lead to a fall in the prices of Stocks and Crypto, it would also decrease the demand for homes and other goods which are bought with credit.
IT is quite clear that this fall was due to the increase in interest rates, as Fed is trying to fight inflation by decreasing the spending in the US economy and also making it more difficult for consumers to take loans.
Now, as we have understood the impacts of the increase in interest rates on cryptocurrencies, let’s dive into what happened yesterday.
The prices of stocks and all major cryptocurrencies saw a downfall. The overall Crypto market cap saw a fall of approximately 7% yesterday to $1.65 Trillion. It is quite clear that this fall was due to the increase in interest rates, as Fed is trying to fight inflation by decreasing the spending in the US economy and also making it more difficult for consumers to take loans. Clear profit booking has been done over the last 24 hours due to these implications even though historically, May 2022 has been a strong month for crypto assets.