The story of Bitcoin is changing as the cryptocurrency space evolves. The positive momentum of the cryptocurrency leader has been reversed this year as the market witnesses seismic shifts. There are many factors that contribute to Bitcoin’s 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 measure of inflation, rose 8.3% from a year ago, slightly lower than March’s reading of 8.5%, but still at historically high levels.
In an effort to curb inflation in the economy, the Federal Reserve is moving toward tighter monetary policy, as indicated by its recent decision to raise interest rates by 50 basis points, the largest increase in more than 20 years. The stock market responded to an extended sell-off, with stocks falling across the board. Cryptocurrencies including Bitcoin, which trades under the symbol BTC, have been falling behind. Bitcoin is down 37% from the new year through May 12, and has fallen more than 50% from its all-time high in November.
As the market expects inflation to remain above the Fed’s target, the central bank is expected to continue raising interest rates throughout the year. If this scenario continues, it is worth exploring these topics on what this means for Bitcoin and how cryptocurrency investors can respond:
- Bitcoin correlation with the stock market.
- Bitcoin matures.
- How do bitcoin investors react to interest rates?
Bitcoin correlation with the stock market
The impact of higher interest rates on Bitcoin is the latest change implemented in cryptocurrencies. During this time, the price of Bitcoin was less volatile. But Bitcoin is not alone. In fact, in the past several months, there have been high correlations between moves in Bitcoin and stock indices such as the S&P 500 and Nasdaq.
Technical stocks in particular are struggling with rising interest rates. E-commerce giant Amazon.com Inc. (Trading code: AMZN) over 35% in the year to May 12, while Apple Inc. (AAPL) by 18% during the same time and Meta Platforms Inc. (FB) more than 42%. Bitcoin tracks this price action. The value of the cryptocurrency leader has been moving between $38,000 and $48,000 for months but has recently fallen below $30,000. This shows that investors are currently viewing Bitcoin as a “risk-on” asset.
Bitcoin followed the decline in the stock market, but not in a drastic way, says William Cai, partner and co-founder of financial services firm Wilshire Phoenix.
Originally, Bitcoin was thought of as an asset unrelated to the broader stock market. In other words, Bitcoin and traditional assets like stocks and bonds will not necessarily move side by side or in opposite directions, which could make the cryptocurrency a portfolio diversification tool that can help guard against downside risks for 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 is still considered a high-risk asset, similar to speculative technology stocks. According to Arcane Research data, the 90-day correlation between Bitcoin and the S&P 500 was 0.633 as of May 9.
“High interest rates in the short to medium term are likely to lead to a slight decline (from) a short-term bullish case (for) BTC,” says Andy Long, CEO of White Rock Management, a global digital mining company.
But in the long run, says Long, in an environment where there are higher interest rates, freer money and a return to quantitative easing, “BTC is hard money that won’t go far.”
Bitcoin is maturing
Bitcoin’s reaction to the Fed’s rate hike actions suggests that it behaves similarly to the general market. Although it has been around for just over a decade, Bitcoin is slowly moving into a mature asset class like stocks, bonds or commodities. Kay says he is no longer risky and such a “marginal asset” that investors liquidate when they are concerned about volatility.
“You used to see a sell-off in the bitcoin market when people got anxious,” Kay explains, but now there is more acceptance. “Bitcoin has merged into the risky asset class,” says Kay. Investors will see the decorative relationship 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 low prices, there is no panic in the underlying technology or the industry as a whole,” Kay says.
As investors and traders try to figure out what crypto’s next moves as asset prices fluctuate, the core asset class and adoption by Wall Street and companies has been nonstop and continues to move forward, says Kay.
How do bitcoin investors react to interest rates?
Activity in the cryptocurrency market has slowed. Experts say most of this is because retail investors are pulling back on cryptocurrencies to match their risk tolerance. On the other hand, institutions have moved to Bitcoin in the past few years.
Retail investors tend to buy when the market is rising and they tend to sell when the market panics, says Yobo Ruan, CEO of Parallel Finance, a decentralized lending and staking protocol. This is the moment retail investors are lowering their exposure — it’s the underlying psychology of retail markets, he says.
Institutions like hedge funds and cryptocurrency mutual funds come in and buy the dip. Rowan explains that some are short-term buyers, but many are holding the cryptocurrency long-term, using the market drop to accumulate bitcoin at a cheaper value.
With inflation continuing to rise, Rowan says, retail investors need cash flow. Rowan says that retail investors are emotional, so they sometimes buy a large amount of bitcoin, and then when bitcoin drops dramatically, they need the money and are afraid of how long the market will take to recover, so they want to take risks.
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 or 10 years,” says Long. If you try to guess the market, the market is in turn good at tricking you, he says.
Looking to the near future, Rowan says that bitcoin could continue to drop: “It is possible that we will see a bottom of bitcoin somewhere between $20,000 to $25,000, which could be a good area for accumulation.”