> Blog > Unlikely Bedfellows? A Look at Bitcoin and the Federal Reserve

Published September 20, 2022

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By Donald Gray

In the wake of the 2008 global financial crisis, a group of programmers, cryptographers, and computer scientists worked alongside a pseudonymous figure named Satoshi Nakamoto to launch a peer-to-peer digital payment network that could provide an alternative to the financial status quo of the time.

Unlike traditional currencies, which rely on central authorities like central banks and governments to function, Bitcoin, the first cryptocurrency, was the first decentralized, peer-to-peer payment network that could operate independent of the whims of any central institution or governing body.

Amongst all of the centralized banking institutions in the world at the time, early Bitcoin adopters saw independence from the US Federal Reserve as a particularly appealing quality. In fact, some even saw the nascent cryptocurrency industry as a way to opt-out of the existing financial system altogether and create an entirely digital economy free from the influence of traditional finance.

The ethos of Bitcoin, as laid out in Nakamoto’s original white paper, is one of decentralization, transparency, and borderless connectivity – principles that run counter to the often opaque and centralized decision-making of the Federal Reserve.

But as the cryptocurrency industry has matured and achieved widespread adoption, its relationship to traditional markets has shifted in a number of ways. While Bitcoin still exists outside of the traditional banking system, cryptocurrency valuations as a whole have begun to show high levels of correlation to traditional capital markets.

So what does this mean for the future of Bitcoin? If cryptocurrency valuations perform more like tech stocks than a wholly independent asset class, does this mean that we should start looking towards traditional markets and macro trends for cues on the future of the industry?

To answer this question, we’ll need to dig a bit deeper into how Bitcoin, and the cryptocurrency industry as a whole, fits into the current macroeconomic landscape.

Bitcoin and the Wider Macro Picture

Bitcoin macro

As much as Bitcoin may differ from traditional fiat currencies in terms of its decentralized infrastructure, the reality is that it still exists within the confines of our current macroeconomic system.

While Bitcoin is not subject to the same inflationary pressures as fiat currencies – owing in part to its limited supply of 21 million coins – it’s still susceptible to wider macroeconomic forces. This means that regardless of its independence from central authorities in terms of governance, Bitcoin prices are still influenced by factors like global trade tensions, GDP growth…and yes the monetary policy and interest rates set by institutions like the Federal Reserve.

In other words, while Bitcoin may not be under the direct control of the Federal Reserve, it is today very much influenced by the policies and decisions of the world’s most powerful central bank.

But if Bitcoin was created as an alternative to the traditional finance system, why are the crypto markets seemingly taking cues from the Federal Reserve today? To understand this, we’ll need to take a look at the historical relationship between Bitcoin and traditional finance.

Turbulent Beginnings: Bitcoin and the GFC

The global financial crisis doesn’t get much press these days, but the series of events kicked off by the collapse of Lehman Brothers in September of 2008 had far-reaching consequences that are still being felt today, consequences that have defined the economy we’ve been living in for the past 14 years.

The crisis was initially kicked off by subprime mortgage lending practices and leveraged financial products backed by these mortgages in the United States. These mortgage-backed securities transformed what would have been a severe, but manageable, crash in the US housing market into an existential crisis that brought about the failure of several major financial institutions, and a cascading series of events that eventually engulfed the global economy.

In response to this crisis, central banks and governments around the world took unprecedented steps to prevent an even deeper global economic collapse. In the US, the Federal Reserve lowered interest rates to near-zero levels and implemented an aggressive quantitative easing regimen that saw the Fed’s balance sheet expand from $800 billion in September of 2008 to over $2 trillion by the end of that year.

While these measures were successful in staving off an even worse crisis, they also had several unintended consequences. One of the most significant of these was the creation of asset bubbles in different markets, including stocks and bonds, and bringing about a state of stagflation — economic conditions characterized by high inflation and low growth.

In response to this dismal economic environment and the rapid devaluation of global currencies, people began to look for alternative stores of value that would be less susceptible to manipulation from central banks.

The government’s subsequent decision to bail out the very banks that had caused the crisis — while necessary to prevent an even worse collapse — further fueled a widespread loss of faith in the traditional financial system.

It was during this economic turmoil that Bitcoin was born.

As if to emphasize the importance of this moment in history, the protocol’s pseudonymous creator inscribed a newspaper headline from 2009 that reads “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”, into the first ever block on the world’s first blockchain.

Over the next decade, Bitcoin would grow from a novel concept on the fringes of the internet global phenomenon. The unique combination of a fixed supply, decentralized governance, and censorship-resistant transactions made Bitcoin an attractive store of value in an era of quantitative easing and asset bubbles, and a steady stream of both retail and institutional investors have adopted the asset.

Running on its own network and removed from the global banking system, Bitcoin maintained correlational independence from traditional markets for the vast majority of its existence, but this would change after Covid-19 shuttered economies around the world and sent shockwaves through global financial markets.

Today, Bitcoin and the wider cryptocurrency markets are showing higher levels of correlation to traditional markets than at any time in their respective histories.

Bitcoin and the Covid Economy

The Covid-19 pandemic nearly brought the global economy to a standstill. In the spring of 2020, it was apparent that the world was in for a collective economic shock, but the extent and severity of the economic downturn was impossible to predict.  

With the specter of 2008’s financial crisis hanging heavily over the economy, the Federal Reserve injected unprecedented levels of liquidity into the market while simultaneously lowering interest rates to near-zero levels.  

These drastic monetary measures highlighted Bitcoin’s use-case as a hedge against inflation, and its price began a steady climb after the new reality of life under Covid-19 became clear. 

The social and economic effects of Covid-19 will be studied for decades to come, but one of the most profound trends of this era was the entrance into the market of millions of new investors. 

The combination of stimulus checks, a population restricted to the confines of their own homes, and the advent of social trading drove a new class of investors into both traditional and digital markets, with many young investors drawn to ‘riskier’ assets like cryptocurrencies and high-growth stocks

As the revolution in mobile investing began to blur the lines between the cryptocurrency and stock markets, Bitcoin and the wider cryptocurrency market began to show higher levels of correlation to high-growth assets like tech stocks in traditional markets.  

High liquidity and low interest rates in the markets also gave cover for increasing numbers of institutional investors to venture further into the cryptocurrency space as well. With firms like Grayscale, Paypal, and Merill Lynch all making either direct investments in cryptocurrency by adding digital assets to their balance sheets or structural investments in the space, increasing levels of institutional investment signaled a new era of mainstream adoption for the cryptocurrency space.  

All of these factors contributed to the historic bull run to Bitcoin’s all-time high in November of 2021.  

But while institutional investment in Bitcoin is widely regarded as a bullish signal for the digital asset’s price movements, it’s also important to remember that this type of investment, especially from publicly traded companies, forms a direct link between the cryptocurrency space and traditional capital markets.  

In other words, while institutional investment is a welcome development for the cryptocurrency industry, it increasingly exposes digital assets to the same macroeconomic forces that reign over traditional markets. As recent history shows, the most powerful of all these forces, is the Federal Reserve.

2022: Year of the Bear?

2022 has been a tumultuous year for the cryptocurrency space and the global economy overall. With mounting geopolitical uncertainty fueled by events like Russia’s invasion of Ukraine, historic levels of inflation, and a lingering pandemic wreaking havoc on the global supply chain, governments and central banks around the world have been forced to take action to stabilize their economies and quell inflation.  

In the US, this has taken the form of a sharp reversal from the recovery-era’s loose monetary policy. In January of this year, the Federal Reserve announced a regimen of quantitative tightening (effectively removing liquidity from markets) and impending interest rate hikes to cap inflation that’s running above 9% at the time of writing.  

The Fed’s simultaneous raise of interest rates and reduction of market liquidity prompted an overall downturn in both traditional and digital markets, with high-growth assets like tech stocks and cryptocurrencies receiving the brunt of the selling pressure.  

The cryptocurrency space, which began showing higher signs of correlation to tech stocks in the fall of 2021, has also moved in tandem with the stock market’s Fed-induced downturn.  

The precipitous decline of crypto markets in the spring of 2022 unearthed systemic issues at several major firms across the industry. The meltdown of algorithmic stablecoin TerraUSD and its sister coin Luna revealed a network of over-leveraged financial contracts between many high-profile firms in the space and the overall result has been a perfect storm of factors that placed immense downward pressure on cryptocurrency prices in the first two quarters of 2022.  

Since the Federal Reserve’s change in monetary policy, the total market capitalization of all digital assets has declined from its all-time-high of over $3 trillion to a market cap of under $1 trillion at the time of writing.  

Liquidity has dried up from some exchanges, and prices across all digital assets are down. The cryptocurrency market has clearly entered a bear phase, but does this mean that the industry faces the existential threat that some in the media have portrayed?  

Furthermore, does this mean that the asset class forged in resistance to the global banking cabal will be forever susceptible to the trends and whims of the traditional financial system?  

Right now, the answer to both questions is a resounding no, but this year’s turmoil may present an inflection point for the cryptocurrency industry. To maintain the space’s independence from centralized authorities, we may need to retool how we think about investing in digital assets. 

A New Way to Look at Crypto Investing

While a bear market is not fun for anyone in the short term, these periods have historically presented opportunities for industry-wide growth and rejuvenation.

Despite the immediate pain-points of the recent market declines, it’s important to remember that the long-term picture for cryptocurrency remains as bright as ever. The principles of decentralization, transparency, and borderless connectivity that form the basis of the blockchain industry are as sound now as they were when Satoshi released the Bitcoin whitepaper in 2008.

To protect these tenets and decouple the industry from the influence of central banking, though, we’ll need to rethink our approach to cryptocurrency investing at the individual level.

Up until now, cryptocurrency headlines have been dominated by price speculation and the market’s reaction to economic trends and forces. Despite taking place almost every day, technological breakthroughs in the blockchain space rarely find their way into the mainstream media, and when they do, it’s often in the context of market upswings and drops.

The media’s myopic focus on price movements has led to a situation where many investors are more concerned with when to buy or sell than what they’re actually buying or selling. This mentality has been one of the factors that’s contributed to the recent increase in correlation between cryptocurrency and traditional capital markets, which in turn introduces increased levels of centralization to our decentralized industry.

For those who see the potential for cryptocurrency to be a world-changing force for good, a bear market provides the perfect opportunity to break the cycle of price speculation and invest in the long-term growth of the space. This not only positions investors to benefit when the bulls come home, but a wide-scale effort on this front would also help to shield the industry from macroeconomic influences.

5 Tips for Entering a Cool Crypto Market:

Tips to prepare for crypto growth

Look for projects with strong fundamentals. In a bear market, a project’s underlying infrastructure is often a better indicator of its future potential than recent trend-lines will show. Look for projects with practical use-cases, strong teams, sound governance models, and vibrant communities around them.

Consider a longer-term investment model. During periods of volatility, it’s always tempting to react to short-term price movements. By investing with a longer time-horizon in mind, you can avoid the FOMO trap and make more informed decisions about which projects are worth investing in from the beginning.

Diversify your portfolio. One of the best ways to manage risk in a bear market is to diversify your holdings across different projects and asset classes. By investing in a mix of established and emerging projects, you can protect your portfolio from the downside while still participating in the upside when the market turns around.

Incorporate new investment strategies. Bear markets present an opportunity to experiment with new investment strategies and find what works best for you. If you believe in the long-term success of a project, dollar-cost averaging is a great way to build a position over time without having to worry about timing the market.

Stay up to date with industry trends and macro developments. The cryptocurrency industry is in a constant state of flux, and new breakthroughs are happening all the time. But focusing on the industry exclusively isn’t enough to make informed investment decisions anymore. Being aware of macroeconomic trends and world events is just as important in this moment, and understanding how cryptocurrency fits into the bigger picture will help you make more informed decisions about where to allocate your capital.

Bitcoin and the Fed: The Macro View

As more people and institutions incorporate cryptocurrency into their lives and businesses, digital assets will only become more integrated into the wider global economy. With this in mind, completely decoupling cryptocurrency markets from the influence of centralized authorities like the Federal Reserve may not be possible or even desirable to some.

While it’s difficult to pinpoint a direct correlational relationship between Bitcoin and the Federal Reserve, it’s increasingly important to consider how macroeconomic trends could impact the future of cryptocurrency. The Federal Reserve’s directives have a profound effect on global markets, and it’s likely that these policies will continue to influence the cryptocurrency market in some fashion for years to come.

The cryptocurrency industry was founded on the principles of decentralization, transparency, and independence from centralized authorities. By refocusing our investment attitudes from price speculation back to the technology and teams behind projects that exemplify these ideals, we can strengthen the foundations of this industry and increase cryptocurrency’s resistance to the edicts of centralized authorities like the Federal Reserve.

With this in mind, the current bear market isn’t so much a crisis as it is an opportunity to build a stronger, more resilient foundation for the future of the industry. It’s time to get back to the fundamentals, and invest in a decentralized future we can all believe in.

Disclaimer: This article is for informational purposes only. The opinions expressed in this piece are the opinions of the author and the author alone. None of this is intended to be investment advice, nor a recommendation to buy, sell or trade any specific asset. FTT DAO bears no responsibility for any losses incurred as a result of the information or opinions expressed in this article. Always remember to do your own research before investing in any digital asset, and please trade responsibly.

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