What is the federal funds rate?
The federal funds rate, also known as the “federal funds rate,” is a key tool used by the U.S. central bank (the Federal Reserve) to influence economic activity. This rate is the interest rate at which banks borrow money from each other overnight. This impacts the broader financial landscape, affecting the cost of borrowing for businesses and individuals. The Fed adjusts interest rates in order to control inflation and stabilize prices, which promotes economic growth. Whether interest rates are raised, lowered, or left unchanged, they have broad implications for various assets, including cryptocurrencies.

The effect of interest rates on the economy

Interest rates have a dual effect on the economy, as they can stimulate it or slow it down. When the Fed lowers interest rates, borrowing becomes cheaper, which increases economic activity as businesses and consumers borrow more due to lower costs. Conversely, higher interest rates make borrowing more expensive, reducing spending and investment, which cools the economy if it is too hot. This process is very delicate because interest rate increases have a direct impact on financial markets, including the cryptocurrency market.

How do federal interest rates affect cryptocurrency prices and #bitcoin ?

Changes in federal interest rates have a significant impact on investor sentiment, which in turn impacts cryptocurrency prices. Since cryptocurrencies are relatively new and highly volatile assets, they respond strongly to major economic developments such as interest rate changes. Here’s how these changes impact cryptocurrency prices:

Liquidity and investment flows

The direct impact of Fed rate changes on cryptocurrencies is seen in the level of liquidity in the financial system. When the Fed lowers rates, additional liquidity is injected into the economy by making borrowing cheaper. This excess liquidity often flows into riskier assets such as stocks and cryptocurrencies. In this case, demand for cryptocurrencies increases, which drives up their prices.

Conversely, when the Fed raises interest rates, liquidity is reduced. Borrowing becomes more expensive, and investors reduce risk on volatile assets like cryptocurrencies, favoring safer assets like government bonds or savings accounts. Demand for cryptocurrencies decreases, causing their prices to fall.

Risk appetite and investor sentiment

Asset prices are largely determined by investor sentiment, which is heavily influenced by interest rate changes. Cryptocurrencies are considered high-risk assets due to their volatility and lack of clear regulatory oversight. When the Fed cuts interest rates, it sends signals that monetary policy is becoming more accommodative, which boosts confidence in riskier assets.

Conversely, when the Fed raises interest rates, it signals a more cautious approach to the economy. Investors reduce risk and prefer safe assets, which leads to lower demand for cryptocurrencies and thus lower prices.

Opportunity cost of owning cryptocurrencies

The concept of “opportunity cost” plays a major role in investment decisions, and is largely dependent on interest rates. Opportunity cost refers to what an investor loses when choosing a particular investment over another. When interest rates are low, the opportunity cost of owning cryptocurrencies is low because returns from traditional investments such as bonds or savings accounts are minimal. But when interest rates rise, the opportunity cost increases, making other investments such as bonds more attractive than cryptocurrencies.

Leverage and Marginal Orders

Leverage is a common practice in cryptocurrency investing, where investors borrow money to maximize returns. As interest rates rise, borrowing becomes more expensive, putting pressure on leveraged investors. This can lead to them receiving margin calls to raise capital or selling assets to cover their liabilities, further exacerbating the price decline in the cryptocurrency market.

Historical examples of the effects of interest rates on cryptocurrencies

  • Interest rate hike in 2018: Under former Fed Chair Janet Yellen, a series of interest rate hikes led to a significant drop in the price of Bitcoin, which fell from $20,000 in December 2017 to $3,200 in December 2018.

  • Interest Rate Cuts During the Pandemic: During the pandemic, the Federal Reserve cut interest rates to near zero, which led to a boom in cryptocurrency prices, including a rise in the price of #بيتكوين to more than $68,000 in November 2021, before later falling with expectations of a rate hike in 2022.