How Do Interest Rates Impact Crypto Prices? (2024)

What is the Federal Reserve?

The Federal Reserve System, commonly known as "the Fed," is the central bank of the United States. It was created by Congress in 1913 to provide the nation with a stable monetary and financial system. 

The Fed manages the monetary policy of the United States — with the power to influence the supply of the US dollar and interest rates. 

The Fed’s decisions impact prices for investors all around the world. 

What are interest rates and why does the Federal Reserve change them? 

What are interest rates? 

Interest rates represent the cost of borrowing money. 

• High interest rates: When interest rates are high, the cost of borrowing money is high. This leads to higher mortgage rates and increased costs for companies due to higher rate business loans. Bonds offer higher yields — which means investors are less likely to invest in stocks and cryptocurrencies. 
• Low interest rates: When interest rates are low, the cost of borrowing money is low. This leads to lower mortgage rates and lower rate business loans. Bonds offer lower yields — which means investors are more likely to invest in stocks and cryptocurrencies. 

What does changing the interest rate do? 

What does raising the interest rate do?: While raising interest rates can slow down the economy, it can prevent the economy from overheating and from inflation getting too high. 

What does cutting the interest rate do?: Lowering interest rates can help stimulate the economy, stimulating investment and making it easier for new businesses to be created. 

How does the Fed decide to raise/lower interest rates? 

The Fed closely monitors economic indicators such as GDP growth, unemployment rates, and inflation metrics like the Consumer Price Index (CPI) to decide whether or not to raise/lower interest rates. 

The process of rate decision-making involves regular meetings of the Federal Open Market Committee (FOMC), where data is analyzed, and future projections are made to guide policy.

How do interest rates impact the crypto market? 

How do interest rate cuts impact the crypto market right away? 

When the Federal Reserve announces an interest rate cut, the cryptocurrency markets often respond with increased volatility in the short term — with a rise in value shortly afterwards. 

Volatility is driven by short-term traders making buy/sell decisions and long-term investors repositioning their portfolios. Because cryptocurrencies are considered newer and more speculative, they tend to be more volatile than other assets during this period.  

For instance, after the Fed's rate cut in March 2020, Bitcoin experienced a significant downturn, crashing nearly 39% that month before rebounding strongly.

What are the long-term impacts of interest rates on crypto?

More liquidity: Over the long run, interest rate cuts tend to be favorable for crypto assets like Bitcoin. Lower interest rates increase liquidity in financial markets, providing more capital for riskier investments, including cryptocurrencies. 

High risk appetite: Because the borrowing rates and yields from government bonds are so low, investors are incentivized to chase ‘riskier’ assets that can offer high returns. 

More development: Low interest rate environments can be a great time for the development of the cryptocurrency ecosystem. In April 2020 — shortly after the Fed cut interest rates — the venture capitalist firm Andreessen Horowitz (a16z) announced a $515 million cryptocurrency investment fund. This investment helped to foster new cryptocurrency projects and businesses. 

Weaker US dollar: Reduced rates can weaken the US dollar, making Bitcoin more attractive as a store of value. 

What other factors can impact the price of crypto? 

While rate cuts generally have a positive impact on crypto, there are other factors that could impact the value of the price of the crypto market. 

The magnitude of the rate cut plays a significant role; larger cuts usually have a bigger impact on crypto prices. 

Additionally, overall economic conditions, market sentiment, regulatory developments in the crypto space, and geopolitical events can influence how the market reacts. Fears of a recession can lead to a risk-averse sentiment, causing investors to shy away from speculative assets like crypto.

How should interest rates impact my investing strategy? 

Let’s walk through a few tips to investing during a change in interest rates: 

Consider your investment horizon

Before you make any investment decision, consider the following question: are you investing in crypto for the short-term or the long-term? 

Typically, long-term investors are more focused on the fundamentals of crypto-assets. While changes in interest rates may lead to price changes in the short-term, it should not have a meaningful impact on the value of your assets in the long run. 

Meanwhile, short-term investors are more focused on making a quick profit. A change in interest rates may make a real difference in your ability to make a profit in the short-term. 

Watch out for volatility 

Remember, interest rate changes can be a period of volatility. Using tools like stop-loss and take-profit levels can help safeguard your investments — helping you mitigate potential losses or lock in gains without having to constantly monitor the market. 

When volatility is expected, some investors prefer to reduce exposure to highly speculative assets.

Diversifying your assets 

Diversification is key to balancing risk and reward. 

In a higher interest rate environment, it’s wise to focus on low risk assets — like cryptocurrencies with strong fundamentals and real-world use cases. In a lower interest rate environment, you can take more risks with more speculative cryptocurrencies. 

Some investors choose to have a balanced portfolio that can thrive in any interest rate environment — featuring a mix of low and high-risk cryptocurrencies, as well as traditional assets like stocks and bonds. 

Don’t try to time the market 

Remember, it’s difficult to find the optimal time to enter the market in the wake of an interest rate cut/hike. It’s recommended that you focus on the fundamentals of your crypto-assets, rather than try to ‘time the market’. 

For long-term investors, dollar-cost averaging—making regular, smaller investments—can help average out price fluctuations. 

How to predict potential Fed interest rate changes 

While no one can predict the Fed actions with 100% certainty, the following three steps can help you make educated guesses on whether the Fed will cut/raise interest rates. 

1. Monitor Key Economic Indicators

The Federal Reserve makes rate decisions based on several economic factors, most notably:

• Inflation: The Fed aims to keep inflation under control. When inflation is higher than expected, the Fed is more likely to raise rates to slow the economy down. 
• GDP Growth: If the economy is growing faster than the Fed’s target, there’s a good chance rates will rise to prevent overheating. On the other hand, if growth is slow, the Fed may lower rates to stimulate the economy.
• Unemployment: A low unemployment rate can be a sign that the economy is doing well, but if it drops too low, the Fed may raise rates to prevent inflation from rising.

Keeping an eye on these economic indicators can help you better understand the general state of the economy. 

2. Follow the Federal Open Market Committee (FOMC)

While FOMC meetings are closed-door, the Fed releases minutes of these meetings and holds press conferences. Investors study these reports and announcements to better understand the Fed’s view of the economy. 

3. Look at Blue Chip Forecasts

Private sector forecasts, like the Blue Chip consensus, contain predictions from leading economists who monitor the same data as the Fed. The Blue Chip consensus can help you better understand the state of the general economy (and better predict any course adjustments the Fed may take).

Risks of over-relying on Fed policy for investment decisions 

It’s important to note that interest rates are not the only factor that should drive your investment and trading decisions. 

Other factors such as technological improvements, regulatory actions, and general investment sentiment can also impact cryptocurrency prices. 

Remember, the complex ways that supply and demand can interact make it impossible to predict whether the value of cryptocurrency will go up or down. 

How do interest rates impact other assets?

Here’s how interest rates impact assets outside of crypto: 

• Stocks: Higher rates typically lead to lower stock prices. Higher borrowing costs for companies means lower profits. 
• Bonds: There is typically higher demand for newly-issued, high-interest bonds. Prices fall for existing bonds, since they offer lower interest rates. 
• Real Estate: Higher interest rates mean higher mortgages. This reduces the demand for housing, typically leading to lower real estate prices. 

How do other central banks impact the price of crypto?

The policies of other governments and central banks around the world can impact global crypto prices. 

For example, China announced a complete ban on all cryptocurrency transactions and mining in September 2021. Within 24 hours of this news, Bitcoin’s value fell by 8%. 

How does investor psychology impact the market when interest rates change? 

Interest rate changes can impact the level of fear and greed in the crypto market. 

For example, if crypto investors believe that the price of BTC will go up during a rate cut, they may push its value artificially high. Investors may buy in due to FOMO (fear of missing out), increasing buying pressure. 

This type of herd behavior is why it’s important to avoid emotionally-driven trading and investing decisions — especially during volatile periods like the aftermath of an interest rate change. 

In conclusion 

Understanding the Federal Reserve and its interest rate policies can help you become a better trader and investor — no matter the general economic conditions. The key is to stay informed and be aware of potential risks and opportunities. 

Sources 

Bâra, Adela, and Simona-Vasilica Oprea. "The Impact of Academic Publications over the Last Decade on Historical Bitcoin Prices Using Generative Models." Journal of Theoretical and Applied Electronic Commerce Research, vol. 19, no. 1, 2024, pp. 538–560, https://doi.org/10.3390/jtaer19010029. Accessed 2 Oct. 2024.