Bitcoin (and cryptocurrency in general) is a risk-on asset. So why has it gone up so much in Q4 2022 and Q1 2023? Interest rates have risen significantly in that time and there are several patterns we can discern that might give some hints of what’s to come in the market.
The crypto sector isn’t benefiting from any new narratives or inventions that would cause prices to go up, which leads us to consider macroeconomic factors.
In 2020, a massive amount of USD was injected into the system. Crypto bulls predicted a bull run as soon as the money printing began, but it took until Q4 to see the effects of this money printing.
USD M1 Supply
Source: https://fred.stlouisfed.org/series/M1SL
Just as interest rates and money supply weren’t immediately a factor, but eventually did cause the takeoff of a bull market, we may be seeing a delayed effect in the opposite direction.
Some are calling this the calm before the storm. Others are saying this 25bps hike is the precursor to a pivot. Either way, the next rate announcement is on May 3rd, 2023, and the world waits with bated breath.
Big Upset in the Credit Markets Right Now
Higher interest rates affect industries that use leverage more than those who don’t. For example, the commercial real estate sector and real estate is generally a high-leverage investment class, but venture capital investments usually aren’t.
We’re seeing a few shifts occur:
- Bonds going down in value because of increased rates.
- Lending on commercial and residential real estate is getting more expensive.
- The beginnings of a banking crisis (as they are on the hook for both of the above factors).
All of this is downstream of an incredible amount of money being printed in the last 3 years. In 2020, trillions of dollars were printed as part of the effort to stem the economic effects of the COVID-19 pandemic. Initially, crypto investors were disappointed that the mix of a crisis and money-printing hadn’t brought a crypto bull run with it, but then later in 2020, the hoped-for bull run appeared.
BTC Price Chart
On a longer time horizon, a campaign of quantitative easing started in the last big financial crisis, and never truly stopped. Both are contributing factors. Easy money generally leads to more money going to risk assets, and 2020 was the perfect environment of low interest rates and massive money printing.
Now in 2023, we are experiencing a rise in crypto prices and everyone is asking whether this is an echo bubble or the real deal.
Unraveling the Effect of the Federal Funds Rate on Investments
Risk assets like crypto and the Fed are closely linked, which is why macroeconomics need to be analyzed to fully understand the markets. The most recent FOMC announcement set a 25 basis point increase in the Fed Funds rate, which brings it up to 4.83%.
USA Federal Funds Rate
Rates have risen rapidly from record lows in the last year, and the general market sentiment is to avoid risks right before these announcements because any increase in interest rates will likely lead to a drop in crypto prices.
What we can see so far is that the anticipation of the rate hikes is causing investors to derisk. From an investor perspective, the upside on holding through a rate announcement and counting on rates staying the same or going down is too low to justify the risk. Better to pull out of the market and wait.
Rumours are flying that with the bank issues, the Federal Reserve will have to lower rates, but that’s not actually true, as shown by the response to the SVB crisis. The US Government backstopped deposits and took on duration risk of their fixed-income holdings, but haven’t changed course. The Federal Reserve’s stated goal is to keep raising rates until inflation is down to ~2%, and they show no signs of slowing down until they achieve their goal.
Notes indicate that the latest FOMC decision was a unanimous vote. The big things to watch (aside from unemployment and inflation) are consumer confidence and spending.
Banking Crisis Will Contribute to Tightening Credit
Tightening credit conditions will be amplified by the zeroing out of these banks. There are less funds available to serve the market and banks will be pushing to lend at higher rates.
With interest rates going up and the price of Bitcoin [BTC:USD] going up, some may conclude that rising interest rates have somewhat counterintuitively led to a sharp rise in Bitcoin’s prices.
There’s a simpler option: the bank crisis may be the intermediating variable that is causing Bitcoin’s comeback
So far, the banking sector has seen issues with Silicon Valley Bank, Silvergate Bank, Signature Bank, Credit Suisse, and First Republic may be next.
This has two effects on crypto that we need to untangle. First, the first 3 banks represent major on-ramps for funds going into cryptocurrencies, and this is fundamentally bearish news for crypto. On the other hand, the real significance of the current banking crisis is that many investors are predicting a Fed pivot.
All deposits are safe and no customers have lost any money, but it is still a “spooky” event for investors and has led to a reshuffling of capital.
Why Are People Investing In Crypto?
Rising interest rates generally remove leverage from the CRE market and that would extend to crypto.
The best illustration of the effect of rising interest rates on Bitcoin [BTC:USD] is the ~8% drop that occurred following the latest FOMC announcement. This is most in line with what convention would expect. So why is Bitcoin going up?
BTC Price Chart
In order to take risk, investors must believe that the Federal Reserve is going to reverse course, and there is currently no evidence to support that as a likely outcome. Additionally, earnings estimates for equities are being revised downwards by JP Morgan, and we expect this effect to continue.
With that in mind, there are 2 rational reasons to own crypto:
- You expect interest rates to rapidly drop
- You expect fundamentals to improve
Considering the fact that rates have been increasing and a rate cut seems unlikely, the market clearly sees fundamentals improving in some way. Bitcoin is running on the “digital gold” narrative and Ethereum is the leading smart contract platform.
The Opportune Time to Unlock Liquidity On Crypto Assets
So while Bitcoin [BTC:USD] has gone up in a rising interest rate environment, high rates are not the cause. Cryptocurrencies are pumping *despite* high interest rates.
At Secure Digital Markets, we are seeing clients unlock liquidity by borrowing against large positions. We have no leverage or borrowings within our company and our lending partner is very well-capitalized. That means the lowest possible counterparty risk for you *anywhere* in the market.
Because of that, many of our clients are taking advantage of our competitive rates and unlocking additional liquidity on their funds so they can buy cryptocurrency at what they believe to be bargain prices.
If you are interested in learning more about the offer, please do not hesitate to set a meeting with James Godfrey, our Head of Lending: james@securedigitalmarkets.com.
About SDM
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