Rising Interest Rates and Bitcoin: What Investors Need to Know

Increasing interest rates have been a catalyst for Bitcoin's drop. Does the crypto king have more to fall?

Rising Interest Rates and Bitcoin

The current economic environment provides a ripe ground for large movements in risky assets. Bitcoin is accepted as an asset class, but it's still considered a higher-risk asset, similar to speculative tech stocks. (Getty Images)

Bitcoin's story is changing as the cryptocurrency space develops. The crypto leader's positive momentum has reversed this year as the market is experiencing seismic shifts. There are many factors contributing to Bitcoin's price weakness, but a large part of it has to do with rising interest rates in an inflationary environment.

In April, the consumer price index, the standard gauge of inflation, was up 8.3% from a year ago, slightly lower than March's 8.5% reading but still at historically high levels.

In an effort to reduce inflation in the economy, the Federal Reserve is moving toward a tighter monetary policy, as shown in its latest decision to increase interest rates by 50 basis points, the steepest increase in more than 20 years. The stock market has responded with an extended sell-off, with stocks across the board pulling back. Cryptocurrencies including Bitcoin, which trades under the symbol BTC, have been falling alongside them. The price of Bitcoin fell by 37% from the new year to May 12, and it fell more than 50% from its November all-time highs.

As the market expects inflation to stay above the Fed's target, the central bank is expected to continue to hike interest rates throughout the year. If this scenario follows through, it is worth exploring these themes around what this means for Bitcoin and how crypto investors can respond:

  • Bitcoin's correlation to the stock market.
  • Bitcoin is maturing.
  • How are Bitcoin investors reacting to interest rates?

Bitcoin's Correlation to the Stock Market

The effect of rising interest rates on Bitcoin is the latest change that has been playing out in crypto. During this time, Bitcoin's price has been nothing short of volatile. But Bitcoin is not alone. In fact, in the past several months, there have been high correlations between movements in Bitcoin and stock indicators like the S&P 500 and the Nasdaq.

Tech stocks in particular struggle with rising interest rates. The e-commerce giant Amazon.com Inc. (ticker: AMZN) is down more than 35% for the year through May 12, while Apple Inc. (AAPL) has fallen 18% during the same time and Meta Platforms Inc. (FB) has dropped more than 42%. Bitcoin is following this price action. The crypto leader's value had been moving between $38,000 and $48,000 for months but recently fell below $30,000. This shows that investors currently view Bitcoin as a "risk on" asset.

Bitcoin followed the drawdown in the equities market, though not in a drastic way, says William Cai, partner and co-founder of financial services company Wilshire Phoenix.

Originally, Bitcoin was thought to be an uncorrelated asset to the broader stock market. In other words, Bitcoin and traditional assets like stocks and bonds would not necessarily move in tandem or in opposite directions, potentially making the cryptocurrency a portfolio diversifier that can help protect against downside risks of other assets. However, the correlation between stocks and Bitcoin has increased recently, and experts expect this correlation to continue in the near to medium term.

The current economic environment provides a ripe ground for large movements in risky assets. Bitcoin is accepted as an asset class, but it's still considered a higher-risk asset, similar to speculative tech stocks. According to data by Arcane Research, the 90-day correlation between Bitcoin and the S&P 500 was 0.633 as of May 9.

"Short- to medium-term higher interest rates probably make for slightly less (of a) short-term bullish case (for) BTC," says Andy Long, CEO of White Rock Management, a global digital mining company.

But in the long term, Long says, in an environment where there are higher interest rates, freer money and a return of quantitative easing, "BTC is hard money that isn't going away."

Bitcoin Is Maturing

Bitcoin's reaction to the Fed's actions to raise rates suggests that it is acting similarly to the general market. Even though it has been around for just over a decade, Bitcoin is slowly transitioning into a mature asset class like stocks, bonds or commodities. It's no longer so risky and such a "fringe asset" that investors liquidate when they're concerned about volatility, Cai says.

"You used to see sell-offs in the Bitcoin market when people became worried," Cai explains, but now there's more of an acceptance. "Bitcoin has blended into the risky asset class," Cai says. Investors will see decorrelation over a longer time horizon, but for now, the high correlation is a sign that the asset class is maturing, he says.

"It's a positive sign that in periods of price drawdowns, there's no panic in the underlying technology or industry as a whole," Cai says.

While investors and traders are trying to figure out what the next crypto moves are as the asset prices fluctuate, the underlying asset class and the adoption by Wall Street and businesses has been nonstop and continues to drive forward, Cai says.

How Are Bitcoin Investors Reacting to Interest Rates?

Activity in the crypto market has been slowing down. Experts say most of this is because retail investors are scaling back on crypto to fit their risk tolerance. Institutions, on the other hand, have been moving into Bitcoin in the past few years.

Retail investors tend to buy when the market is going up and tend to sell in a market panic, says Yubo Ruan, CEO of Parallel Finance, a decentralized lending and staking protocol. This is the moment when retail investors will cut their exposure – it's the fundamental psychology of the retail markets, he says.

Institutions like hedge funds and crypto-specific venture funds are coming in and buying the dip. Some are short-term buyers, but many are holding crypto for the long run, and they're using the market drop to accumulate Bitcoin at a cheaper value, Ruan explains.

With inflation persistently high, retail investors need cash flow, Ruan says. Retail investors are emotional, so they sometimes purchase a large amount of Bitcoin, then when Bitcoin falls drastically, they need money and are afraid of how long it will take for the market to recover, so they want to take off risk, Ruan says.

So what can investors do in this chaotic crypto market?

"The best thing you can do with Bitcoin is lock it in a box and look at it in five, 10 years' time," Long says. If you try to guess the market, the market in turn is good at fooling you, he says.

Looking into the near-term future, Ruan says Bitcoin may continue to drop: "We can potentially see a Bitcoin bottom somewhere between $20,000 to $25,000, which can be a good region to accumulate."

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