The Effect of the Rate Hike on Digital Currencies
Inflation is plaguing the U.S. The Federal Reserve is working out all kinds of strategies to bring it under control. The popularity of Fiat currency is increasing day by day. One of them is to hike the interest rates, even after doing the same earlier this year, in March and May. As per the CME FedWatch tool, the U.S. Central bank may raise the benchmark Fed funds rate by 0.5% points. Additionally, the Federal Reserve may go in for more such increases throughout the rest of 2022.
Higher rates of interest have already been displaying an impact on commodities (oil, gold, etc.), stocks, digital currencies, etc. However, crypto enthusiasts are more worried about how their own marketplaces will confront these rate hikes.
What are Interest Rates?
An Interest rate refers to the amount that a money lender charges the borrower. The calculation is done in alignment with the principal amount that has been loaned and is displayed as a percentage. The interest is collected annually, and is, therefore, known as APR (annual percentage rate).
When the Federal Reserve handled interest rates, it offered the lowest rate during the economic crisis of 2008. Then, the rate was 0.00-0.25%. Over the years, it began to increase interest, in alignment with the changing global economic situation.
The Federal Reserve and Rate Hikes
Experienced investors understand that experimenting with interest rates by Central Banks, tends to have an adverse effect on digital currencies.
It began in March 2022, when the U.S. Central Bank announced hiking the base rate. It would stand between 1.75% and 2%, in December. There was an announcement for the next year, 2023, too. It would go up to 3.1%. Even then, the crypto marketplace did not feel the pinch of the announcements too much, for Jerome Powell, the chairperson of the Federal Reserve had already given a warning.
The uncertainties prevailing in the crypto world may be attributed to several factors. One of them is the ongoing effects of the coronavirus pandemic on the economies of nations across the globe. Another is the launching of the battle between Ukraine and Russia. This has led to geopolitical tensions affecting the whole world. A third aspect is advancing inflation, especially in the U.S. In turn, this led to a rise in the U.S. Consumer Price Index, by as much as 7.9%. Finally, energy prices are on the rise, not only in the U.S. but all over the world.
Impact of Rising Rates on Cryptocurrencies
As mentioned earlier, the Federal Reserve had been willing to keep the interest rates as inexpensive affordable as possible. This proved to be an incentive to borrowers. They came forward to interact with investors, knowing that they would be able to repay the loans as quickly as possible. Furthermore, it seemed to investors as if cryptos and stocks were better investments, compared to certificates of deposits (CDs), bonds, etc. Thus, it proved to be a win-win situation for both parties – lenders and borrowers.
However, things change, when there is a hike in interest rates. Lenders refuse to lower them, for they are keen to make profits, and not incur losses. Similarly, businesses and individuals, who desire to borrow, find the extra interest too heavy to handle. They are bound to take longer to repay, and sometimes, not be able to repay at all. Thus, stocks and cryptos become risky assets for both, investors, and borrowers.
Sometimes, investors believe that selling off their digital currencies, in exchange for fiat currencies, is better. After all, their high-interest loans may not fetch much in the way of dividends. As a result, the prices of cryptocurrencies begin to decline. In fact, it has already been in evidence over the last couple of months. For instance, Bitcoin has reached a low of $20k, with experts predicting that it may even go below $10k. Therefore, the Fear and Greed Index is inclining towards the pessimistic side, with investors wondering what will happen next.
Thus, the Federal Reserve’s hike of interest rates will coincide with the lessening of borrowers. In turn, crypto stakeholders might decide to ditch their risk-incurring assets, such as cryptocurrencies and stocks. They will want to move towards assets that are more risk-off in nature, such as bonds, savings accounts, treasury bills, etc.
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