The Federal Reserve (Fed, the United States Central Bank) interest rate is one of the main economic indicators that influence global markets, including cryptocurrency. It is also known as the FED Interest Rate, without a translation from English.
The Fed’s interest rate decisions can drastically impact asset prices, altering investor sentiment and the liquidity available in the market. But how does this actually affect the cryptocurrency market?
In this article, we explain what the Fed interest rate is, how its changes affect cryptocurrencies, and what investors can expect.
What is the Fed Interest Rate?
The Fed interest rate, also called the federal funds rate, is the rate that banks charge each other for short-term loans, usually lasting one day. It is the equivalent of our SELIC rate.
This rate is set by the Federal Open Market Committee (FOMC), the arm of the Federal Reserve that decides monetary policy in the United States. The Fed's primary goal in setting this rate is to control inflation, stimulate economic growth, and maintain price stability.
When the economy is overheating and inflation is high, the Fed raises interest rates to slow the economy. When the economy is in recession or in need of stimulus, the Fed may lower interest rates to encourage consumption and investment.
How Does the Fed Interest Rate Affect Cryptocurrencies?
Cryptocurrencies, like other risk assets, are sensitive to changes in interest rates. Although the crypto market is decentralized and operates outside the traditional financial system, it is still heavily influenced by macroeconomic factors, such as Fed decisions.
Let’s explore the main effects that Fed interest rate changes could have on the crypto market.
1. Impact on Liquidity and Risk Appetite
When the Fed raises interest rates, the cost of money goes up, meaning it becomes more expensive to borrow and invest. This reduces liquidity in the markets, as investors and financial institutions become more cautious about making new investments. In periods of higher interest rates, investors tend to flee risky assets, such as technology stocks and cryptocurrencies, and seek safer investments, such as government bonds.
On the other hand, when the Fed cuts interest rates, money becomes cheaper, encouraging investors to take on more risk. With more liquidity available in the market, investors tend to look for assets with higher potential returns, and cryptocurrencies are usually at the top of that list.
Thus, it is no coincidence that periods of rapid cryptocurrency price growth occur when global interest rates are close to zero, both in the US and Europe, as occurred in the 2017 crypto bull market. Likewise, in times of rapid interest rate increases, the tendency is for cryptocurrency prices to fall sharply, as we saw in 2022.
2. Investor Sentiment
Cryptocurrencies are highly volatile and heavily influenced by investor sentiment. The expectation of a Fed interest rate hike often creates a climate of uncertainty in financial markets.
This can lead to investors selling their cryptocurrency holdings to protect their profits, resulting in price drops. A clear example of this was Bitcoin’s behavior in 2022, when a series of interest rate hikes from the Fed contributed to a sharp drop in the cryptocurrency’s price.
On the other hand, when there is a reduction in interest rates, market sentiment may become more optimistic, and investors may feel encouraged to buy cryptocurrencies, hoping that the increase in liquidity will lead to an appreciation of digital assets.
3. Impact on Stablecoins
Stablecoins, which are cryptocurrencies pegged to real-world assets like the dollar, can also be affected by changes in interest rates. When the Fed raises rates, stablecoins that are pegged to the U.S. dollar can benefit from the currency’s strength. This could attract more investors to stablecoins looking for a safer alternative in the crypto market.
However, rising fees could also increase the cost of holding these fiat-pegged assets, which could bring volatility to some stablecoins and impact investor confidence in these assets.
4. Altcoin Performance
Altcoins, or alternative cryptocurrencies to Bitcoin, tend to be even more volatile than Bitcoin itself. When the Fed raises interest rates, altcoins are often the first to suffer as investors either prefer more established assets or hold on to their capital until market volatility stabilizes.
This means that during a rising interest rate cycle, investors may look to reduce their holdings of altcoins and move their capital into Bitcoin or other assets considered safer.
In periods of interest rate cuts, altcoins may experience a faster recovery as investors return to the market in search of more aggressive returns.
Strategies for Crypto Investors
Based on the above-mentioned effects, how can investors prepare and protect their crypto portfolios against Fed interest rate changes? Here are some tips that can help you!
Diversification: One of the most effective ways to manage risk is to diversify your investments. In addition to cryptocurrencies, consider adding traditional assets to your portfolio, such as stocks, bonds, and commodities.
Monitor Fed Policy: Staying up to date on Fed decisions and anticipating potential interest rate changes can help you adjust your investment strategies at the right time.
Long-term strategy: Investors who believe in the potential of cryptocurrencies should consider a long-term strategy rather than trying to predict short-term movements caused by changes in interest rates.
Keep an eye on the Fed interest rate!
The Fed's interest rate decisions play a crucial role in the behavior of global financial markets, and the cryptocurrency market is no exception.
Changes in rates affect liquidity, risk appetite, and investor sentiment, causing significant swings in cryptocurrency prices. Therefore, understanding the impact of Fed interest rates and being prepared for these changes can help investors make more informed decisions and protect their crypto portfolios.
With the macroeconomic environment constantly changing, it is essential that investors stay alert to market trends and adapt their strategies in line with the Fed's decisions.
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Photo by subsri13, available on Freepik
