After a period of time where it seemed like cryptocurrencies and all financial products with a bit of risk were being shelved in favor of low-risk products such as holding cash or government bonds (specifically the US dollar and Treasuries), the actions of the Federal Reserve and other central banks have caused a roarback in equity markets – and a corresponding increase in cryptocurrency values, writes Forbes journalist Roger Huang.
Since March 15, 2020, when the Federal Reserve cuts rates to zero in an unscheduled rate cut, the S&P 500 had its best quarter since 1998 and bitcoin’s price, about to touch US$5,000 around that time period, is now roaring back above the $10,000 mark.
Understanding the relationship between monetary policy and cryptocurrencies can be a bit tricky, but it’s a worthy exercise. As cryptocurrencies start taking on institutional speculation, their short-term price movements gyrate with the markets. Some of this has been plainly stated before and often observed: some institutional investors think of bitcoin as digital gold.
They’ll use bitcoin as a hedge against the inflation they think will result from excessive unconventional monetary policy. This was the explicit view of Paul Tudor Jones, the billionaire investor loading up on bitcoin.
In this reading, the actions of central banks help create demand for cryptocurrencies by creating the conditions (excessive money supply) wherein a certain class of institutional investors feels the need to hedge their wealth.
But structural changes in monetary policy implementation also auger surprising new developments and support for new cryptocurrencies in ways that go beyond the “cryptocurrency as hedge” narrative.
Alternative financial solutions
Witness the new trend of DeFi, decentralized finance companies that are largely behind the growth in ethereum demand as ethereum gets locked into new financial products. DeFi represents alternative financial solutions built on ethereum that are looking to augment or replace traditional loans.
Typically, there’s a “search for yield” that happens when there are very few options to yield money in deposits or low-risk products. DeFi, with interest rates that range as high as 100% annualized on stablecoins looks like a more attractive option than fiat banks that can offer flat ~1% at best.
Within that structure, it’s clear that there are nuances, and perhaps warnings – products that yield that high likely are pure arbitrage situations that might fade away at any time and they carry with them risks (such as exploits) that might be underaccounted for. Yet, even if there are a lot of question marks – there’s no doubt that coordinated monetary policy around the world is driving people to look for new companies and technologies such as DeFi – an important secondary consequence.
The amount of unprecedented monetary support has also created a short-term window for…