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How the Federal Reserve interest rate hike could impact crypto

Federal Reserve chair Jerome Powell. Photo: Tom Williams/CQ-Roll Call, Inc/ via Getty Images
Federal Reserve chair Jerome Powell. Photo: Tom Williams/CQ-Roll Call, Inc/via Getty

The Federal Reserve interest rate hike will rein in individual and corporate spending with a knock-on effect on risky assets, such as cryptocurrencies.

On Wednesday the Federal Reserve announced a quarter-point interest rate hike as prices in the US have risen at their fastest pace in 40 years.

Federal Reserve chairman Jerome Powell concluded a two-day meeting stressing that ongoing increases in the rate "will be appropriate".

This is the first time interest rates have been increased since 2018 and the move comes amid soaring inflation due to successive monetary expansion measures to stimulate the economy throughout the coronavirus pandemic.

Read more: Live crypto prices

But how will the hike in interest rates affect the cryptocurrency sector?

Bitcoin (BTC-USD) has been touted as a hedge against rising inflation, however, it responds to reduced liquidity in the same way as other risky assets.

Since last autumn, when the US Federal Reserve began to taper in its bond purchases, investments in cryptocurrencies have retracted with the reduced liquidity in markets.

Elena Garidis, CFO and co-founder of Defy Trends told Yahoo Finance that crypto will ride out the impact in "relatively stable territory".

She said: "The traditional markets have already priced in two rate hikes, which infers that at this point we could be in relatively stable territory for crypto, specifically bitcoin."

Read more: Club for women in crypto promises to close gender funding gap

However Lisa Loud CEO of Fluid Defi, said that "crypto usually suffers a setback when rates are higher, mainly because low rates inspire investors to look for other ways to earn returns for their capital".

She added: "In this case, we have a bit of a tug of war in play because bitcoin signals are bullish for many reasons.

"I expect it will have an impact, but that impact will be mitigated by two things: first, there is increased demand for Bitcoin as a means of moving currency out of sanctioned countries; and second, a larger amount of Bitcoin capital has moved outside the US due to regulatory conditions."

Watch: Steve Hanke on Milton Friedman's 199 cryptocurrency predictions

Another analyst described how the hike in interest rates will create less liquidity in markets.

The knock-on effect means people will have fewer dollars to spend on "risky" digital investments.

Marcus Sotiriou, an analyst at the UK based digital asset broker GlobalBlock, told Yahoo Finance: "I think bitcoin and the crypto space is unlikely to gain significant traction in 2022.

"This is because the Federal Reserve is taking liquidity away from markets and people may have less money to spend on ‘risky’ investments due to surging inflation."

This is a view reinforced by Caleb Tucker, of Merit Financial Advisors, who spoke to Bankrate and said: "Crypto-assets had been seen as an inflation hedge, but recently they have acted more like other risk assets such as stocks.

“Higher rates will be a headwind for crypto assets going forward.”

Read more: 'Crypto lobby groups are dictating terms in Washington'

However, Dan Raju, CEO of brokerage platform Tradier, sees a rate hike as driving more institutional investment into the cryptocurrency sector.

Speaking to Bankrate, Raju anticipates a "net positive in 2022 because any short declines driven by rate hikes will be offset by greater institutional and retail active trader adoption of this asset class".

Cryptocurrency market capitalisation has risen on the back of several positive factors, such as the EU abandoning critical legislation which would have led to an effective ban on bitcoin mining in the bloc.

The rallying was also due to the news that the incoming South Korean president is bullish about crypto.

Cryptocurrency insurgents are beginning to outperform traditional financial protagonists.

Recent data has shown that ethereum increased its transaction volume throughout 2021 to peak above VISA.

Ethereum moved $11.6tn (£8.9tn) in 2021, with VISA falling behind at $10.4tn in payments volume.

Watch: Can you live exclusively off bitcoin?