The federal funds rate is the main tool used by the U.S. central bank, known as the Federal Reserve (Fed), to regulate monetary policy.

It controls the cost of borrowing money between banks, which in turn affects the interest rates that businesses and consumers pay on loans.

This price plays a major role in directing economic activity by increasing or decreasing the financial liquidity available in the markets.

When the Fed lowers interest rates, borrowing becomes cheaper, which boosts investment and consumer spending and increases liquidity in the market.

Conversely, when interest rates are raised, borrowing becomes more expensive, which reduces liquidity and aims to curb inflation by slowing economic growth.

How do Fed rate changes affect cryptocurrency prices?

The prices of various assets, including cryptocurrencies like Bitcoin, are affected by changes in the Federal Reserve interest rates.

The relationship between them stems from changes in investor behavior and market dynamics.

The impact of lowering interest rates:

When interest rates fall, returns on safe assets such as bonds and bank accounts also fall.

This prompts investors to seek higher returns by investing in riskier assets such as cryptocurrencies.

As a result, the demand for cryptocurrencies increases, causing their prices to rise.

Effect of Raising Interest Rates: When the Fed raises interest rates, safe assets like bonds become more attractive, offering guaranteed returns and lower risk. This draws money out of riskier assets like cryptocurrencies, reducing demand for these assets and thus driving down their prices.

Investor behavior and the impact on liquidity

One of the main factors that links the Federal Reserve interest rates to cryptocurrency prices is investor behavior. When interest rates rise, investors tend to reduce their investments in riskier assets like cryptocurrencies due to increased opportunities in safe assets. This can lead to a downturn in the crypto market, as liquidity becomes limited.

Cases from history

In 2018, during Janet Yellen’s tenure as Fed chair, interest rates were gradually raised to combat inflation, which led to a collapse in Bitcoin prices. Then, in 2021, when interest rates were very low, Bitcoin prices saw record highs.

Market volatility

Cryptocurrencies, by their very nature, are highly volatile assets, and the impact of Fed rate changes becomes more pronounced. A rate hike can put pressure on the market, leading to massive sell-offs and significant losses.

Can interest rate changes have a long-term impact?

Despite the negative effects of higher interest rates in the short term, some investors may see cryptocurrencies as a hedge against inflation in the long term.

Unstable monetary policies could also boost confidence in cryptocurrencies as an alternative to government money.

In conclusion, the article expects that the Federal Reserve’s decisions will continue to play a major role in the future of the cryptocurrency market, as investors will need to have a thorough understanding of this impact to take advantage of opportunities and mitigate risks.