How do the rising interest rates have anything to do with cryptocurrencies like bitcoin crashing?

Rising interest rates and the impending recession are supposedly two of the factors that have been affecting the cryptocurrency market recently.

In fact, they have been blamed as some of the key culprits that led to bitcoin’s recent crash in price after it had risen by more than 1000% within a single year!

But what exactly does this mean? How does the rising interest rate impact cryptocurrencies like bitcoin? How will the rising interest rate affect our lives and those of our descendants? In this article, we’ll explore these questions and more...

 

The Value of Bitcoin is Just a Theory

The value of Bitcoin is simply how much people are willing to pay for it and nothing more. When people begin selling off their Bitcoins, supply increases and its perceived value begins to drop.

If a cryptocurrency has no backing from a central bank or authority, why would anyone accept it as payment if they didn’t believe they could resell it later at a higher price? There’s a good chance no one will want your bitcoins when everyone else wants theirs.

It’s also important to remember that since most cryptocurrencies are capped in number, there's no way for demand and supply ever to reach equilibrium—it's just speculation until then.

 

What Is an Interest Rate?

The Federal Reserve controls one of your most important costs as a business—the cost of credit. When it raises interest rates, it’s making borrowing money more expensive for banks, which translates into higher costs for consumers and businesses.

Generally speaking, if you buy a car on credit and your lender raises its rate by 0.5%, your monthly payment goes up by $15 or so. So if inflation is 2% and you get hit with a 4% increase in rates from a Fed hike, that’s effectively like getting hit with an overall price hike of 6%.

At that point, all sorts of expenses become more expensive for businesses—everything from raw materials to employee wages to heating bills—and companies need to pass those higher costs on to their customers.

 

Why Do Interest Rates Rise or Fall?

Interest rates tend to rise and fall in conjunction with broader economic trends and changes in political climates.

As a simple example, if inflation is beginning to rise, central banks will likely increase interest rates (though governments can also manage inflation through policies that target domestic wages and prices).

These higher interest rates make it more expensive for individuals or companies who are borrowing money. When it becomes more expensive for an individual or company to borrow money, they might be less likely to borrow it.

This could slow down the growth of consumer spending, which would then affect other sectors of the economy, such as housing and retail sales. The same logic applies to stock markets: If investors expect interest rates to rise in the coming months, they’ll buy stocks now while they’re relatively cheap instead of waiting until later when there’s a greater risk that those stocks will become even more expensive.

This reduces demand for stocks—and drives down their price—which creates uncertainty among investors about whether it's a good time to invest at all. So why do people say rising interest rates could cause bitcoin to crash?

 

How Does the Fed Set Interest Rates?

The Federal Reserve often referred to as the Fed, is a U.S. central bank that was founded in 1913. The Fed's main task is regulating banking activities and controlling how much money circulates in American society.

It sets monetary policy for banks and other financial institutions by changing interest rates (the costs associated with borrowing the money) based on the information it gathers from financial and economic data within U.S. borders and around the world. Adjusting these rates affects access to capital for banks, consumers, and businesses alike.

 

Why Does This Matter for Cryptocurrencies Like Bitcoin and Litecoin?

Interest rates are rising, and higher interest rates mean lower bond prices. That’s why investors are selling bonds and buying stocks.

After all, you’re better off paying a dividend than earning a mere pittance of your money in interest payments over time. As we noted last week, 1% annual yields aren’t going to cut it for long-term investors anymore—even in today’s low-rate environment.

Why stay in a guaranteed loss when you can earn potential gains elsewhere? The key for investors is finding quality investments that pay healthy dividends or ones that will hold their value if prices fall (think gold). Rising interest rates make these asset classes even more appealing than they already were. In other words, as interest rates rise, so too should demand them.

In addition to bonds and stocks, there are other safe havens that offer high returns on investment without taking on much risk. One example is real estate investment trusts (REITs), which allow you to invest in commercial real estate without having to worry about things like tenant disputes or maintenance costs.

You get steady cash flow while management handles everything else. Another option is precious metals such as gold and silver; not only do they provide protection against inflation but also serve as an alternative currency option during times of crisis.

 

Should You Be Worried About Rising Interest Rates Impacting the Price of Cryptocurrency in 2018?

Since cryptocurrency is not backed by real-world assets, they are a result of widespread speculation. During periods of increased uncertainty, investors will try to move their money out of riskier investments and into safe-haven assets.

If investors decide that one market is too volatile for their tastes (such as Bitcoin), they may shift those funds into safer markets (like government bonds or gold).

An increase in demand for safer investments will put upward pressure on the prices of those assets and push investors to reallocate their funds accordingly. This could cause Bitcoin prices to fall even more than if interest rates were left unchanged.

Investors should remember that these forces only apply during periods of high uncertainty or economic weakness; if economic conditions are sound, an increase in yields can actually be supportive for cryptocurrencies!

 

Conclusion

If a country’s economy is strong, as determined by its Gross Domestic Product, then an increase in interest rates generally translates into higher demand for investment bonds.

Bonds issued by these countries in turn make their currency more attractive compared to other currencies. This leads to capital outflows from less-developed countries and depreciates their currencies relative to stronger ones such as those of emerging market economies.

As a result, investors tend to sell off their stocks in emerging markets and shift toward stronger currencies that are perceived as being safer for capital preservation due to stronger government stability and foreign-exchange reserves.