Tuesday, March 28

Fed as a guide: How the US Federal Reserve is influencing the crypto market

Crypto market far from highs
Fed monetary policy as a stress factor
Digital dollar as a contradiction?

For the first time since the beginning of the corona pandemic, the US Federal Reserve wants to raise the US key interest rate again. The first interest rate hike could take place as early as March, and the economic conditions continue to speak for it, Fed Chair Jerome Powell said recently. This is how the currency holders are reacting to the development of inflation: In the USA, inflation is at its highest level in 40 years – price stability, the guarantee of which is one of the core tasks of the US central bank, has not been given for some time.


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Fed has fueled the crypto market

The supply of cheap money should therefore be significantly reduced, if not stopped completely. However, this cheap money was one of the guarantors of the strong development of the crypto market during the COVID-19 pandemic. A lot of money flowed into digital systems during this time, and there was also state support, which many governments decided for their citizens – part of this income was also invested in the crypto market.

The market fed on the attractiveness of riskier investments, which also include Bitcoin & Co., in times of low interest rates. In addition, crypto advocates repeatedly fueled the inflation protection aspect of digital investments, which also led to a partial shift from gold to crypto investments.

What happens after the turnaround in interest rates?

How dependent the crypto market is on the central banks has become apparent in the past few weeks, as the probability that the Fed will turn around interest rates has increased continuously. Crypto assets such as Bitcoin, Ethereum & Co. were not only much more volatile than recently, in line with the stock market, the prospect of an imminent increase in the key interest rate in view of high inflation also led to an enormous sell-off on the crypto market. Cryptocurrencies are miles away from their November 2021 highs just a few weeks later.

Because not only is the Fed cutting the steady flow of money for the crypto market with its upcoming decision, a higher key interest rate is also making investments in fixed-income assets more attractive at the same time – at the expense of riskier investments, which include digital currencies. The fact that Bitcoin & Co.’s significant price slide is taking place in times of strong inflation also fuels the doubts of many investors that crypto assets protect against currency depreciation – another reason for investors to withdraw their money from the crypto market.

The consequences of the turnaround in interest rates will meanwhile not only be felt in crypto investments, the stock market will also react in the wake of the central bank decision. Hyped tech stocks in particular, which benefited from low interest rates, are likely to feel the effects of this. In the future, investors will take a closer look at balance sheets and business models more critically: against this background, growth stocks with no prospect of profitability in the near future will probably have less money to expect – both from the investor side and from the investor side. However, a stock market crisis is unlikely to come in handy for the US central bank, so many observers are anticipating a moderate interest rate adjustment. This in turn could also dampen the panic in the crypto market.

Fed’s crypto ambitions as a contradiction?

But the US Federal Reserve could increase the headwind for Bitcoin & Co. in other ways: it is currently working on a regulatory framework for cryptocurrencies. Even if a ban on cryptos is not on the cards, at least in the USA, increasing regulation could become one of the greatest threats to the digital market.

At the same time, however, the Fed is pursuing its own cryptocurrency ambitions and had at least explored the possibility of issuing a digital dollar. In a recently published study titled “Money and Payments: The US Dollar in the Age of Digital Transformation”, currency custodians took a close look at CBDC and also articulated a number of benefits that so-called CBDCs (Central Bank Digital Currencies) bring with them would bring. Among other things, the Fed mentioned the possibilities of financial services for the unbanked, with greater security and liquidity at the same time. In addition, digital central bank money brings the advantages of cryptocurrencies – such as faster and cheaper transactions – with it. “A CBDC would be the most secure digital asset available to the general public without any associated credit or liquidity risk,” the study said. Even if the Fed has not taken any concrete steps towards a digital dollar, the working paper provides a basis for discussion for a possible CBDC.

But the Fed’s report does not only contain positive things, because the currency holders are also critically examining a possible digital dollar and in this context specifically mention a danger for the role of the banks and thus also indirectly for the monetary policy control mechanisms of the US Federal Reserve itself .

It remains to be seen how possible efforts by central banks such as the Fed to establish CBDCs will affect the crypto market. However, such a step should not remain without consequences.

Editorial office finanzen.net

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