Why a rise in global interest rate is causing crypto crash
During last week the United States Federal Reserve announced an interest rate hike of 75 basis points (0.75%) in a bid to tame the ever-increasing inflation rate, in which the consumer price index in the United States, the most widely followed measure of inflation, climbed 8.6% year over year in May, beating expectations for a drop to 8.2% from 8.3% in April. This is the biggest hike in the U.S. since 1994.
Asides from the U.S., the Swiss National Bank surprised the market by raising its key rate by 50 basis points. Also during the week, the Bank of England increased its interest rate, hiking for the fifth straight time by 25 basis points.
The talk of macroeconomic policy and how it affects the cryptocurrency market has been a wonder to many in the cryptocurrency space as many are unable to fathom why these interest rates are hammering down on the entire space.
Data from CoinGecko, as reported by Nairametrics revealed that the current bear market has seen a whopping 72 out of top-100 tokens by market capitalization fall more than 90% from their respective all-time highs, in which most of them hit last year.
In a bid to understand how the interest rate hike seen, especially in the U.S., is affecting the crypto spaces, Nairametrics was able to reach out to a few experts to explain.
Ajibola Lawal, Investment Lead at Kaicho Capital explained that the correlation between the hike in Federal Reserve interest rates and the current state of the Crypto markets is one that is in fact, simple to understand.
He stated, “it starts with understanding how the relationship between interest rates, liquidity and risk assets work. Low-interest rates imply access to cheap credit. When there is access to cheap credit, there is lee-room to invest widely in business with this credit, and by implication as well, an appetite for Riskier Assets is increased. However, when this changes and interest rates increase, the cost of financing loans becomes more expensive, and thus drives businesses, Hedge Funds and other entities to lower their credit exposure. In a scenario like this, endeavours that are considered riskier, are avoided so that entities can reduce their exposure.”
He didn’t stop there, he further stated, “In this instance, Crypto is still considered further out the risk curve than more traditional asset classes and while the others have suffered drawdowns just as dramatically, Crypto has taken that, and even worse by comparison. We largely expect that this flight to safety will continue, until general investor confidence in taking risk, is restored.”
Olumide Adesina, Financial market analyst at Quantum Economics explained that the worry of an interest rate hike is the reason why we have experienced major selloffs in the crypto space.
He stated, “Since the beginning of 2022, digital assets have experienced significant volatility as investors weighed in rising interest rates and rapidly rising energy prices. But what does the remainder of the year hold, with numerous rate hikes and possibly the potential that the Fed may have to raise rates even higher to combat stubbornly high inflation? Less money floating around in financial markets is a net negative for investments as a whole, and it’s likely to have a negative influence on digital asset prices as investors focus on capital preservation and core assets.”
He further stated, “For one thing, the withdrawal of liquidity has an influence on volumes in crypto — and elsewhere — since it reduces the amount of capital available to invest. Additionally, higher rates raise the opportunity cost of investing in non-yielding assets like Bitcoin. Those that acquire Bitcoin and other altcoins with leverage may be hit even harder: rising borrowing rates change the risk-reward scenario of such trades, lowering your potential return as your costs rise.”
Temisan Agbajoh, DeFi Analyst at Kudy Financials gave us a comprehensive view of how the interest rate hikes affect the crypto markets.
He stated, “The cryptocurrency markets have seen an unprecedented run from January 2020 with the total market cap sitting at $259 Billion and peaking at $2.535 Trillion in May 2021 before we had the first test dumps back down to $1.17 Trillion in that same month, and then giving us the next all-time high at $3 Trillion in November 2021.
“During this period US interest rates had remained stagnant and Decentralised Finance came into the forefront with unimaginable yields ranging from 100%+ and going as high as 1,000,000%+ for various volatile digital assets and stablecoins which seemed the more risk-averse option still offering rates as high as 20% (RIP $UST).”
He further stated, “In the search for higher yield the crypto markets had massive new entrants and coins did multiples of 2x minimum and unimaginable maximums. 2020 was the year of the federal money printer and that spilt into 2021, with offices being closed down and remote work being the order of the day. The United States government printed the most amount of dollars in their existence during the core lockdown days to alleviate the plight of the citizens as businesses closed down but people needed to eat. The funny thing with economics is that it exists for a reason, the age-old case of too much money chasing too little goods has led to the inflation that currently besets America. The consumer price index, (CPI) which measures inflation increased to 15.60% (year-on-year) in January 2022.
“The federal reserve in a bid to rein in inflation has steadily been increasing interest rates by 50 basis points and the most recent was by 75 basis points – the biggest increase since 1994 – and Chairman Jerome Powell has signalled another big move in July, intensifying a fight to contain rampant inflation. This is an attempt to incentivize people to chase safer yield options; nothing is safer than the US government. Is it working? Apparently not but yet the rates go higher and the money printer has effectively slowed down.
“For the cryptocurrency markets this is a double-pronged problem, people are unable to afford basic utilities and commodities like electricity and food. The next rational decision is to sell whatever digital assets that were previously owned to chase safer yield and/or to afford existence. So, for those that were in profits of multiple X’s they’ve taken profits and chased safer investments. The people not in profit still need money to keep up with the rapidly increasing cost of everyday goods and services and will liquidate whatever assets they have to hold cold hard cash.”
He concluded by stating, “Nobody is bidding for $BTC and any other digital asset when they can’t afford gas to move around, heating for their apartments or food for their children. Don’t be dismayed as this is not limited to the Crypto market, the stock markets have also seen massive devaluations during this period. Is there hope on the horizon? Are we going to zero? In chaos lies the greatest opportunities. Survive and pick winners, re-evaluate your decisions and double down with conviction slowly.”