In this article, you will learn what is the meaning of interest rate and the effect of interest rate on crypto. Rising interest rates and quantitative tightening from global central banks have been a key part of the current bear market. This is because interest rate hikes generally result in a sell-off of risk-on assets such as stocks and crypto.
What is the Meaning of Interest Rate?
The interest rate is the amount a lender charges a borrower and is a percentage of the principal—the amount loaned. The interest rate on a loan is typically noted on an annual basis known as the annual percentage rate (APR).
An interest rate can also apply to the amount earned at a bank or credit union from a savings account or certificate of deposit (CD). Annual percentage yield (APY) refers to the interest earned on these deposit accounts.
The interest rate is the amount charged on top of the principal by a lender to a borrower for the use of assets. An interest rate also applies to the amount earned at a bank or credit union from a deposit account. Most mortgages use simple interest. However, some loans use compound interest, which is applied to the principal but also to the accumulated interest of previous periods.
How Does the Fed Use Interest Rates in the Economy?
The Federal Reserve, along with other central banks around the world, uses interest rates as a monetary policy tool. By increasing the cost of borrowing among commercial banks, the central bank can influence many other interest rates such as those on personal loans, business loans, and mortgages. This makes borrowing more expensive in general, lowering the demand for money and cooling off a hot economy. Lowering interest rates, on the other hand, makes money easier to borrow, stimulating spending and investment.
What Happens To Crypto When Interest Rates Rise?
When interest rates rise, there’s a shrinkage of the money supply, a shrinking of the Fed’s balance sheet, and a price increase for individual and business borrowing. When the money supply shrinks and price increases get put on businesses and individuals, there’s a lowering of public company valuations, thus causing their stocks to decline, and less disposable income for regular folks to invest. This causes them to stop purchasing or even selling assets such as stocks and crypto for fixed-income investments like bonds. This is because when interest rates rise, the promised return on government bonds is higher, thus causing investors to flock to safe-haven assets (risk-off) like bonds.
So when interest rates rise, there’s a spillover effect on crypto that causes crypto prices to decline. This spillover effect is motivated by slowing economic activity, less business investment and activity, and a negative macroeconomic backdrop not conducive to crypto.
However, there are also other factors that led to Bitcoin’s price rise. Nonetheless, a global environment of near 0% interest rates was a significant factor that helped cryptos come to the mainstream and for stock prices to reach new ATHs.
Bottom Line
Rising global interest rates, and aggressive rate hikes from the Fed in particular have negatively impacted cryptocurrencies. This article explains about what is the meaning of interest rate.
