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Interest rates have been examined extensively for their effect on cryptocurrency markets. This article discusses the potential impacts and scenarios that could arise from rises in interest rates on cryptocurrency markets.
The cryptocurrency sector, particularly in 2020 during the Covid-19 pandemic and facing high inflation at the start of 2022, became more familiar with the concept of it. Interest rates are additional fees lenders receive in exchange for the money lent to individuals or entities. These rates are among the important factors affecting economic balances, inflation, central bank policies, and developments in international markets.
Central banks play a significant role in determining interest rates. Providing certain levels of credit to other banks for liquidity, central banks can influence economic vigor. People often refer to these rates as policy rates, and they could directly impact key economic indicators such as economic vitality, consumer spending, investments, and overall demand.
What Happens If The Fed Raises Interest Rates?
If the US Central Bank (FED) raise interest rates, several effects could occur. Rate increases enhance the yield of risk-free investments. In this situation, individuals and entities may prefer lower-risk interest and similar investment tools, resulting in a decrease in demand for high-risk investments.
This could result in a decline in the demand for shares and cryptocurrencies. Consequently, the quantity of foreign currency may increase, and money circulation may shift towards bank vaults. This could result in a decrease, or tendency to decrease, in inflation. Additionally, an increase in foreign investors wishing to invest in the country can lead to an appreciation of the local currency.
The FED’s interest increase can, in particular, affect company shares. High interest rates reduce the present value of future earnings. This reduction lowers the present value of future income that the company will earn. As a result, it may impact the share prices of some growth companies and loss-making companies. Especially, this could result in the higher pricing of loss-making companies’ shares based on future profit expectations.
In general, an increase in interest rates can affect the value of companies’ shares. Particularly, share prices may be affected if the future money value decreases tied to interest rates.
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How Do Rates Affect The Cryptocurrency Market?
Interest rates typically impact the cryptocurrency market due to their association with macroeconomic factors. Historically, Bitcoin’s correlation with traditional assets such as shares and bonds has been at low levels. This could be due to cryptocurrencies being a new asset class or their speculative appeal. Low correlation could still be the case, as the cryptocurrency market is still new and growing every day.
However, it should not be surprising that macroeconomic factors affecting other major asset classes have started to negatively affect cryptocurrency markets. After all, cryptocurrencies have now become significant assets, attracting attention from millions of individuals as well as Wall Street and other major institutions.
In general, the correlation between Bitcoin and exchanges may show a temporary decline in the short term. However, it is currently observed that Bitcoin moves closely with the Nasdaq Technology Exchange, rising or falling similarly. This indicates that Bitcoin usually shows a similar trend with technology exchanges and moves in the same direction.
High interest rates have two negative effects on crypto markets:
An increase in interest rates typically has various effects on markets. As yields on deposits held in bank accounts increase, investors may prefer the opportunity of risk-free returns and sell their crypto assets to turn into cash. In this case, investors may reduce the flow of investments into the cryptocurrency market, and we could observe downward price pressures on assets.
Also, high rates can decrease the implicit valuations of cryptocurrency projects. Such interest rate increases can reduce the value of a cryptocurrency project by increasing the discount rate applied to the project’s cash flows. Additionally, rates of return on risk-free investment tools like government bonds, securities, etc., can become more attractive, making these so-called “<safe haven” investment tools more appealing, leading investors to show strong interest.
Interest rates are a significant variable in the economy and can influence individuals’ and companies’ savings, consumption, investment, and borrowing decisions. Understanding the effects of changes in interest rates on the economy is important to succeed in financial markets.
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