Markets
History suggests the crypto market is about to skyrocket because of this little-known fact
Things in the crypto world are looking up. After a brutal crypto winter, many cryptocurrencies are at or near all-time highs and the future is finally looking bright again.
Yet the situation is likely to improve much further for one key reason: central banks around the world are starting to cut interest rates.
The two may seem unrelated, but the connections between central bank actions and crypto market behaviors run deep. For investors, this represents an interesting opportunity. A new wave of liquidity could soon be injected into the market, potentially paving the way for a major crypto boom.
Image source: Getty Images.
Central banks start lowering interest rates
In recent days, the European Central Bank (ECB) and the central banks of Canada, Switzerland and Sweden have reduced their benchmark interest rates. The pivots followed some of the most aggressive rate hikes in decades, which banks instituted in their efforts to curb soaring inflation.
While the US Federal Reserve has not yet started cutting rates, market observers are increasingly optimistic that it can do so by the end of this year. Given that the United States remains the world’s largest economy, this potential policy shift is seen by many as the final domino that must fall to usher in a more favorable environment for risk assets like cryptocurrencies.
Why Interest Rates Matter for Crypto
At first glance, it might seem that interest rates and cryptocurrencies exist in entirely separate spheres. Cryptos 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, meaning it tends to perform well when investors are overall more willing to accept more risk in the pursuit of profit. This usually happens during periods of high liquidity, when money is cheap and abundant. For such a scenario to happen again, interest rates will have to be lowered.
To understand why central bank interest rate cuts will benefit crypto, it can be helpful to understand the impact of an interest rate increase. When central banks raise interest rates, borrowing becomes more expensive, which tends to reduce the amount of money circulating in the economy. High interest rates also make lower-risk interest-bearing assets more attractive, further reducing the amount of money spent on riskier assets.
Conversely, 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 is typically found in various asset classes, including stocks, real estate, and of course, cryptocurrencies.
The story continues
Historical evidence
We don’t need to look very far back to see how powerful the impact of lower interest rates can be on the crypto market. 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 led to 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 (CRYPTO: BTC), the leading cryptocurrency, saw 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 (CRYPTO: SOL). Riding the waves of increased liquidity (and lots of speculation), in less than two years it has jumped over 25,000%.
Stay disciplined despite the boom
While this round of rate cuts won’t be as dramatic as the 2020 cuts, they should still have a significant advantage over crypto. And as is common in cryptocurrency bull markets, this means that some obscure cryptocurrencies will start posting 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: the majority of these cryptocurrencies are simply not good. good long term investments.
To successfully navigate this upcoming phase, investors will need to remain disciplined and focus on top-tier cryptocurrencies with proven track records and strong utility. Bitcoin and Ethereum (CRYPTO: ETH), for example, meet this criterion.
Although this strategy may not be as glamorous as investing in coinsIt’s one of the few proven strategies that offers investors the type of gains that only crypto can produce.
Should you invest $1,000 in Bitcoin right now?
Before buying Bitcoin stocks, consider this:
The Motley Fool Stock Advisor analyst team has just identified what they believe to be the 10 best stocks for investors to buy now… and Bitcoin was not one of them. The 10 selected stocks could produce monster returns in the years to come.
Consider when Nvidia made this list on April 15, 2005…if you had invested $1,000 at the time of our recommendation, you would have $767,173!*
Stock Advisor provides investors with an easy-to-follow plan for success, including portfolio building advice, regular analyst updates, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of the S&P 500 since 2002*.
*Stock Advisor returns June 10, 2024
RJ Fulton has positions in Bitcoin, Ethereum and Solana. The Motley Fool holds positions and recommends Bitcoin, Ethereum and Solana. The Mad Motley has a disclosure policy.
History suggests the crypto market is about to skyrocket because of this little-known fact was originally published by The Motley Fool