What is the discount rate?

The discount rate is the percentage that commercial banks pay to the central bank of a particular country when they borrow from it. In the US, the role of the central bank is performed by the Federal Reserve System. It would seem, well, let it do it, what does cryptocurrency have to do with it? To understand this issue, it is necessary to dig a little deeper into the essence of the banking system.

How banks make money

The majority of operations of any credit institution are issuing loans and accepting deposits. If the rates on both products were the same, banks would not make a profit. That is why deposit rates are always lower than loan rates. But how are they set?

This is where the discount rate comes into play. The higher the discount rate, the higher the interest rate on loans and deposits. This is quite logical. If a commercial organization is forced to take out a loan at a conditional 5%, how can it make money? The answer is simple - raise the interest rate so that it exceeds 5%. Naturally, this is not an easy process, deposits also need to be attracted, so the rate on them is growing.

This is all great, but why does the crypto industry attach so much importance to a purely banking instrument?

Impact of the rate on cryptocurrency

The main goal of investors is to make money. Whether this will be done through cryptocurrency or something else is essentially unimportant. Bitcoin and especially altcoins are assets with high volatility and high risks. Investors understand this perfectly well. If the country has high interest rates on loans, then the appetite for risk - for cryptocurrencies - decreases (in Russia, the central bank rate is now a huge 20%).

There are two explanations. On the one hand, loans are becoming more expensive. Thus, it is less profitable to borrow money for investment. On the other hand, deposits are also becoming more expensive and provide a guaranteed risk-free return. Why buy bitcoin, which can collapse by several tens of percent, when there is a source of big money that will definitely not fall in price?

But why do investors pay attention to the indicators set by the US Federal Reserve? After all, central banks set rates all over the world, not just in America.

The Importance of the Fed Rate

America is something of a Mecca for the crypto industry and crypto investors. Cryptocurrencies and everything related to them often come from the US. Why is there such a stir in the States about Bitcoin and Ethereum spot ETFs? Why are Kraken and Coinbase (NASDAQ:COIN) American exchanges? How is it that the largest investment companies are based in the US?

Because it is the United States that remains the leader in terms of capital volumes, and the dollar is the dominant world currency. Most high-tech developments are made in America, although Asian countries are trying to challenge this leadership.

Don't think that rate changes by central banks outside the US don't affect cryptocurrencies. In fact, they do. But the impact is still much smaller.

Okay, if the US central bank rate is such a powerful tool, then why didn’t the latest cut lead to a sharp increase in the value of cryptocurrencies? Why didn’t Bitcoin update its historical maximum?

BTC and Fed Rate in September 2024

The first thing to note is that after the September rate cut, Bitcoin rose to $66,508 or 7.69%. So there was some growth, but it wasn't the maximum.

Second, the Fed did indeed cut the rate by 50 basis points, to 4.75%–5%, but for the US, this is still too unpleasant a rate. The indicator remains the highest in the last 16 years, meaning that the country has not had such expensive loans since 2007.

Source: tradingeconomics.com

Third, the key rate cut was expected. There were disputes about what decision the Fed would make: would it lower the rate by 25 or 50 basis points? But the decision itself was expected. If you look at the data, Bitcoin grew by 17.53% from September 6 to 18. Thus, most of the growth occurred before the decision was made by the American regulator.

Fourth, the mood of crypto investors is largely determined by another pressing agenda - the US presidential elections, which are scheduled to end in early November. Their outcome may have a much greater impact on the crypto industry than a local reduction in the key rate. In this regard, investors are cautious about cryptocurrencies.

Fifth, lowering the rate is not always a guarantee of success. For example, in October 2007, the Fed also began an operation to ease monetary policy. The result was a weakening of the economy, which influenced the global financial crisis of 2008. Such an experience makes investors be cautious when making decisions.

Conclusion

A reduction in the key rate has a positive effect on cryptocurrencies, as it makes credit money cheaper, and as a result, it causes investors to have an increased appetite for risk. If the indicator remains high, then traditional instruments, such as bank deposits, become more attractive.