The last few years have been quite successful for cryptocurrency traders and investors, with numerous cryptos growing tremendously during the period. But the move by the Federal Reserve (Fed) to increase interest rates by one-quarter of a percentage point could impact the value of many cryptocurrencies.
For more than a decade, the Fed has held short-term interest rates at extremely low levels. However, the US Consumer Price Index (CPI) has increased by 7.9% year-on-year in the last update, which is significant more than the target of 2%. This increase was a record high since 1982. What’s more is, Wall Street is expecting the Fed to hike these interest rates about six times this year.
When short-term interest rates are high, businesses and consumers tend to find it costlier and harder to borrow. This discourages people from spending; and thus, effectively cuts the supply of money in circulation. In turn, the move is expected to help constrain the prices of products that Americans struggle to afford, such as used cars and pork. It also constrains investments, like the stocks of retirement savers as well as speculative assets such as cryptocurrencies.
Let’s discuss how this move by the Fed may affect the crypto space.
Impact of Interest Rate Hikes on Crypto Markets
The 0.25% rates hike has given myriads of cryptocurrencies a rude awakening, as many high-flying cryptocurrencies have been returned to earth. The value of Bitcoin (BTC) – which is the most dominant cryptocurrency in the world based on market value – has plummeted by 50% in a matter of months. The crypto powerhouse enjoyed an all-time high value of $70,000 in November 2021 and its value reduced to $35,000 as of the time of this writing.
Ethereum – which is the second-largest cryptocurrency in the world based on market value – recently announced that its price had decreased by around 35% since the beginning of 2022.
According to Crypto Lists, the market value of every cryptocurrency combined is currently at $1.6 trillion. Since November 2021, the market cap has been reduced by a whopping 50%.
Interest Rate Hikes Could Accelerate the Demand for Stablecoins
Since the price of bitcoin has tanked and the Fed is introducing even more interest rate hikes to curb the rising inflation, some crypto analysts and experts think that the demand for dollar-pegged stablecoins could increase significantly. These analysts insist that traditional economic factors such as interest rates and inflation have a significant impact on the price of cryptocurrencies.
The 0.25% interest rate hike was the first since 2018, and it’s expected that it’s the first of many others to follow. Increased rates of interest on dollar-denominated assets will probably surge demand for the dollar, which could strengthen the dollar in 2022. In turn, this would translate to an increased demand for stablecoins – the dollar-pegged stablecoins to be specific. According to Crypto Lists, some of the top stablecoins currently include Tether (USDT), Binance USD (BUSD), and USD Coin (USDC).
Why Stablecoins are Set to Boom After the Rates Hike
Stablecoins are a blend of cryptocurrencies and fiat currencies, such as the US dollar. Since the Fed is set to raise rates several times in 2022, the demand for the dollar will increase substantially, and stablecoins that are pegged to the dollar will also capture this win.
As the US dollar is still the most dominant reserve currency in the world, greenback-denominated assets are likely to be in high demand. Therefore, stablecoins could offer a relatively simple way to access the US dollar.
For the foreseeable future, the demand for dollar-backed assets will always be high, and this includes stablecoins. If the US dollar continues to become more powerful as compared to other currencies, then it will also make dollar-pegged stablecoins more attractive to investors. Besides, the growth of stablecoins would still increase regardless of the dollar’s value.
Presently, the crypto industry is going through a tough run, with Bitcoin (BTC) trading at $40,985 (a decline of 50%) and Ethereum (ETH) at $2,794. On the other hand, the price of stablecoins is designed to be tied 1:1 to the price of a fiat currency, including those tied to the US dollar.
If the global inflationary issues persist and stablecoins continue to become globally ubiquitous, then the stablecoin marketcap will grow tremendously because of inflows from countries with struggling currencies. Ironically, this trend will lead to increased US dollar dominance and a more robust cryptocurrency ecosystem.