Bitcoin
History suggests the crypto market is about to skyrocket due to this little-known fact
History doesn’t always repeat itself, but if it does, it would mean big things for crypto.
Things in the crypto world are looking up. After a brutal crypto winter, many cryptocurrencies are at or near historic highs and the future finally looks bright once again.
However, the situation is likely to get much brighter for one fundamental reason: central banks around the world are starting to cut interest rates.
The two may seem unrelated, but the ties between central bank actions and crypto market behaviors run deep. For investors, this represents an attractive opportunity. A new wave of liquidity could soon be injected into the market, potentially setting the stage for a major crypto boom.
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Central banks start cutting interest rates
In recent days, the European Central Bank (ECB) and the central banks of Canada, Switzerland and Sweden have reduced their reference interest rates. Those changes followed some of the most aggressive rate hikes in decades, which banks instituted in their efforts to curb rising inflation.
While the US Federal Reserve has not yet started cutting rates, there is growing optimism among market watchers that it will do so by the end of this year. Given that the US is still the largest economy in the world, this potential policy shift is seen by many as the last domino that needs to fall to usher in a more favorable environment for risky assets like cryptocurrencies.
Why Interest Rates Matter for Crypto
At first glance, it may seem that interest rates and cryptocurrencies exist in completely separate spheres. Cryptocurrencies operate on decentralized networks with their own monetary policies. However, they are inextricably linked to the broader economy.
Crypto is a so-called risk-on asset class, which means it tends to perform well when investors are more willing to accept more risk in pursuit of profit. This typically happens during periods of high liquidity, when money is cheap and abundant. For this scenario to repeat itself, interest rates will have to be reduced.
To understand why central bank interest rate cuts will benefit crypto, it may be helpful to understand the impact of rising interest rates. When central banks raise interest rates, loans become more expensive, which tends to reduce the amount of money circulating in the economy. High interest rates also make low-risk interest-bearing assets more attractive, further reducing the amount of money invested in riskier assets.
On the other hand, when interest rates fall, borrowing costs decrease and liquidity increases. Lower interest rates also reduce the appeal of savings accounts and bonds. With excess capital circulating, this liquidity typically finds its way into multiple asset classes, including stocks, real estate, and, yes, cryptocurrencies.
Historical evidence
We don’t have to look far back to see evidence of how powerful the impact of lower interest rates on the crypto market can be. In 2020, central banks around the world cut interest rates to near zero in response to the economic fallout from the COVID-19 pandemic. This resulted in an unprecedented injection of liquidity into the global financial system.
The result? The crypto market has grown from around $190 billion to over $2 trillion. Bitcoin (Bitcoin -0.04%), the leading cryptocurrency, has seen its price rise from around $7,000 in early 2020 to nearly $69,000 in November 2021.
One of the most impressive examples of the 2021 bull market was Solana (SUN -1.18%). Taking advantage of waves of increased liquidity (and a lot of speculation), in less than two years, it jumped more than 25,000%.
Maintaining discipline amid the boom
While this round of rate cuts is not as dramatic as the 2020 cuts, they should still bring a significant benefit to crypto. And as is common in cryptocurrency bull markets, this means that some obscure cryptocurrencies will begin to post astronomical gains.
However, while this is easier said than done, it is imperative that investors maintain a balanced perspective and not get carried away by the hype of speculation – most of these cryptocurrencies simply are not good long-term investments.
To successfully navigate this next phase, investors will need to remain disciplined and focus on top-tier cryptocurrencies with proven track records and strong utility. Bitcoin and Ethereum (ETH 0.90%), for example, meet this criterion.
Although this strategy may not be as glamorous as investing in trendy products meme coinsIt is one of the few proven strategies that provides investors with the kind of gains that only crypto can produce.
RJ Fulton has positions in Bitcoin, Ethereum and Solana. The Motley Fool has positions and recommends Bitcoin, Ethereum and Solana. The Motley Fool has a disclosure policy.