It could be said that bitcoin was born in an era of low interest rates.
The world’s first decentralized digital currency was first mined and traded in 2009, at a time when central banks were using unprecedented stimulus in an effort to keep borrowing costs minimal. Following the financial crisis, these institutions cut their benchmark rates close to zero and engaged in asset-purchase programs in an effort to meet this objective.
Interest rates dropped sharply because of these efforts, and as a response, investors began reassessing available opportunities considering the low-yield environment.
What did this mean for bitcoin? For one, investors found the digital currency more compelling since the opportunity cost of foregoing interest-rate payments was lower.
In this low-rate environment, one could argue that investors saw bitcoin as having similar incentives to other safe haven assets, for example bonds. As long as the interest payments provided by these safe assets were modest, investors had little reason to seek them out over bitcoin.
However, should borrowing costs push higher, the digital currency could lose some of its luster. If interest rates start rising, it could draw many investors away from bitcoin and into interest-bearing assets like bonds.
While the global economy has enjoyed a drawn-out period of low interest rates, this situation might change soon, several experts told CoinDesk.
Since bitcoin doesn’t provide investors with interest payments, rising interest rates could make the digital currency less appealing to market participants. Bitcoin’s supply changes only very gradually, and therefore any reduction in demand could prove bearish for prices.
Rising rates a surprise
Any such change in the interest-rate environment would come as a surprise to many, said Robert Johnson, president and CEO of The American College of Financial Services.
Borrowing costs have fallen to record lows after enjoying a steady, downward trend since the early 1980s, stated Johnson.
Interest rates hit all-time highs in the early 1980s, a consequence of Federal Reserve Chairman Paul Volcker’s efforts to bring down the high inflation that began during the previous decade. During the 1970s, the price of a barrel of oil surged in value, which resulted in the US economy suffering both high inflation and stagnant economic growth.
Fed policymakers realized that the central bank would not be able to fight both inflation and economic weakness at the same time, and opted to reign in inflation. They did so by hiking the Fed’s benchmark mark rate up to unprecedented levels.
Amid these efforts, the yields on 10-year and 30-year Treasuries both hit all-time highs in September 1981, reaching 15.84% and 15.20%, respectively.
Since hitting this peak, interest rates have been following a downward trend.
Monetary policy
The current environment of low interest rates could experience significant shifts if monetary policy becomes less liberal.
If the Fed hikes the benchmark federal funds rate at its December meeting, this move would place upward pressure on broader borrowing costs.
Such a rate hike is something Johnson believes is in the cards.
“I believe that the Fed will begin raising the benchmark federal funds interest rate following the US presidential election in November,” he told CoinDesk. “This will initiate a series of rate hikes that will lead to higher rates throughout the economy.”
Scott Tucker, a Chicago-based fiduciary investment adviser, also pointed to the key role played by the election, stating that by waiting until after this event to hike rates, the Fed could avoid appearing politically motivated.
The central bank is eager to increase benchmark rates after keeping them low for so long, he said.
Low inflation
However, there are certainly factors that could hold back such a rate increase, noted Tucker.
Any such developments could prove bullish for bitcoin, or at least help stem downward pressure on the digital currency’s price.
For starters, inflationary pressures have been modest. During the 12 months through August 2016, the Consumer Price Index for All Urban Consumers rose 1.1%, well below the Fed’s target rate of 2%.
In addition to lackluster inflation, concerns about European economies, as well as those of Japan and China, could hinder any Fed desires to hike benchmark rates, Tucker argued. While there are concerns about economic strength abroad, many are also worried about US economy’s tepid recovery.
“The Fed has limited scope to raise interest rates while US economic growth remains moderate and other major economies show anemic growth,” Brett Whysel, a financial expert who teaches Public Economics and Decision Making at City College of New York, told CoinDesk.
Whysel emphasized that raising US interest rates could prove counterproductive by boosting the dollar, which would in turn reduce exports and hinder the broader economy.
Any potential impact on the greenback could be amplified by the fact that both the Bank of Japan, the European Central Bank and other central banks in that particular region have been harnessing negative interest rate policies.
This approach helps devalue their currencies, which makes their exports less expensive relative to those of other nations such as the US.
In spite of all these reasons the Fed might have for keeping rates unchanged at its December meeting, Whysel gave a 50-50 chance the central bank would hike its benchmark rates at the event.
Gradual rate hikes
Even if Fed policymakers opt to hike the benchmark rate at the December policy meeting, the central bank’s officials have repeatedly assured market participants that any upward climb in rates will be gradual to avoid jolting the economy.
In addition, central banks that are using ultra-low interest rate policies and negative interest rate policies may be a long ways off from entertaining rate hikes. Once they do begin the process of raising rates, it may take several increases before market participants feel motivated to purchase fixed-income securities.
Should bitcoin price in steady rate increases, the digital currency may do so rather gradually, giving traders time to respond to any such development.
But, there are many other factors that could affect bitcoin prices aside from central bank policy and its impact on broader interest rates.
While low inflation could make the Fed reluctant to raise rates and therefore reduce the odds of bitcoin prices encountering a potential headwind, high inflation could easily prompt market participants to flock to the digital currency as a safe haven.
Bitcoin could enjoy continued draw as a safe haven should economies like Europe and Japan continue to suffer economic weakness.
However, if these regions enjoy notable improvements in their business conditions and their central banks decide upon rate hikes, these two could provide bitcoin prices with combined headwinds.
But, thus far, bitcoin has had more than seven years to gain adoption, overcome its challenges and rise in price.
Though certain concerns remain unresolved (for example, the question of how to address the digital currency’s block capacity dilemma), its chances of surviving any threats associated with rising interest rates are likely high as the currency has had close to a decade to establish itself.