Why cryptocurrency prices often move in tandem with monetary policy

Steve Leo
February 1, 2023

Even though cryptocurrencies have their own sphere and some ‘traditional’ rules do not apply to them, they do not operate in vacuum. Rather, they still operate within a wider global financial system, as they are still connected to fiat currencies. We at VoltCoins enable you to buy and sell a variety of crypto coins with fiat, but you can also exchange crypto coins for each other and not necessarily have fiat involved in the process.

This connection ensures that cryptocurrencies are affected by monetary policies around the world, especially those of the United States and its central bank, the Federal Reserve (the Fed). In fact, the 2022 crypto bear market can be attributed mainly to tighter monetary policies around the world, and the ensuing risk-off sentiment by investors. 

Higher interest rates are meant to fight inflation
When interest rates increase, money supply decreases, the Fed's balance sheet shrinks, and the cost of borrowing for businesses and individuals rises. This results in lower public company valuations, which creates a decrease in the stock market and a decrease in the disposable income of the general public. 

As a result, investors are likely to drop high-risk investments like crypto in favor of lower-risk investments such as bonds. This means that crypto coins become cheaper, since when you exchange crypto, the same dynamics of supply and demand apply.

Changes in Bitcoin and other cryptocurrencies following changes in monetary policy

Looking at the chart of Bitcoin, we can see that due to rate hikes, Bitcoin at the time of writing has dropped more than 65% from its peak in November 2021. Ethereum, the second largest crypto, has encountered a similar fall during the same period due to the difficulties of riskier assets.

Similarly, cryptocurrencies reached their highest prices earlier in 2021 when interest rates were near zero, due to accommodative policies introduced during the pandemic.

Outlook for 2023

Based on our analysis at VoltCoins, we see that the current year began with central banks displaying a less hawkish tone. The central bank of Canada signaled that it does not currently plan further rate hikes. The Fed is also expected to end its rate hikes sequence soon. What this all means is that cryptocurrencies might see a boost. We are already seeing Bitcoin trade above $20,000 per unit. 

 You can exchange crypto easily on the VoltCoins platform. Like in stocks, the upside trend might continue in crypto until central banks potentially make another statement about raising interest rates unexpectedly. This remains unlikely for the time being, so the bias remains to the upside.

Cryptocurrencies are risk-on assets

Given the above, it is evident that cryptocurrencies cannot be considered as safe havens, nor can they be considered as inflation hedge. Quite the contrary. Cryptocurrencies are risk-on assets that often behave like stocks, even though it is mainly generation Z who is interested in them.

ConclusionCryptocurrencies are not suitable for a risk-off environment, but they can be added to your portfolio with other assets to balance it. Moreover, it is important to understand that cryptocurrencies are a part of the wider global financial system, and the implications of global monetary policy on the cryptocurrency market are significant. You should exchange crypto with caution and due diligence, as they remain highly volatile and risky investments - and that’s what we at VoltCoins are here to provide.

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