The macroeconomic landscape in 2023 is changing, and it will impact the crypto markets, here is why.
The coronavirus pandemic has left a swath of turbulent macroeconomic conditions across the global financial landscape. Initially, central banks around the world pumped vast sums of money into the global economy to offset the stagnation caused by COVID-19.
This caused interest rates to fall to near-all-time lows, fuelling unprecedented venture capital investment and causing the price of bitcoin and other cryptos to skyrocket.
However, inflation soon began to rise, prompting central banks to increase interest rates back up to pre-pandemic levels and making loans more expensive.
This sudden shift in macroeconomic conditions has seriously impacted the crypto sector, with many companies no longer able to afford the cheap money needed to prop their operations up.
Meanwhile, cryptocurrency remains a hot-button issue in financial markets, with investors and policymakers weighing the macroeconomic factors that could influence its growth and performance in the coming years.
As more economic changes unfold in the coming years, investors should remain informed about the market landscape and how it could potentially impact the future of crypto.
Shedding light on the subject, this report will provide an in-depth look at the economic influences that could shape the future of the crypto industry in the coming months and years.
The FED’s interest rates and crypto prices
The U.S. Federal Reserve’s actions influence the global economy, and cryptocurrency is no exception. As the central bank changes its benchmark interest rate, crypto prices often respond. These reactions can be unpredictable, and crypto investors need to understand the nuances of the relationship between the Fed’s benchmark rate and crypto prices.
The impact of low-interest rates
Traditional investments tend to suffer when the Fed cuts its benchmark rate, while crypto investments often receive a boost. Low-interest rate environments make traditional investments, such as stocks and bonds, less attractive to investors, who may consider cryptocurrency a profitable alternative.
The low-interest rate environment also generally combats rising inflation, making the U.S. dollar less attractive, which can drive up the price of cryptocurrencies.
The impact of high-interest rates
Conversely, when the U.S. Federal Reserve raises its benchmark rate, investors often flock to traditional investments to take advantage of the higher yields, causing the price of crypto assets to decrease. Additionally, a high-interest rate environment generally strengthens the U.S. dollar, making it more attractive to investors and thus decreasing demand for cryptocurrencies.
Key facts from 2022:
- Amid the Fed’s second meeting of 2022, bitcoin’s (BTC) price plummeted for one week before regaining its footing. This week marked the Central Bank’s first interest rate increase in four years, with a hike of 0.25%.
- Following the Fed’s meeting on May. 3 and 4, the price of bitcoin soared, but by May. 6, the digital currency had already started to dip significantly. The Fed, which approved a 0.5% rate hike in their meeting and planned to reduce their $9 trillion balance sheet beginning in June, saw bitcoin’s value climb rapidly before beginning the descent.
- After the conclusion of the Fed’s two-day meeting on June 14 and 15, the price of bitcoin plummeted to as low as $17,500. This came in response to the Fed’s decision to increase interest rates by 0.75%.
What to expect in 2023?
The Fed is likely to raise its benchmark overnight lending rate by a quarter of a percentage point at the end of its January 31st-February 1st meeting, with the rate currently sitting in the range of 4.25 – 4.50%. Fed officials estimated in December that the rate could see a 5% mark this year, with no cuts expected until at least 2024.
Although there is no clear indication of how the market will react to this change, investors should brace themselves for volatility as the Fed’s next rate increase approaches. Crypto markets, in particular, may be more heavily impacted due to their unpredictable nature.
Inflation and the cascading effect
Inflation is a general rise in the price of goods and services over time. When inflation occurs, a currency’s purchasing power decreases, meaning that each currency unit can buy fewer goods and services than it did previously. In short, inflation makes products more expensive and can reduce the purchasing power of money.
The domino effect
Cryptocurrency markets typically respond to changes in the global financial system. With inflation, the demand for most cryptocurrencies increases as they are considered safe-haven assets. However, the supply of most cryptocurrencies is limited, so when demand increases, their price goes up.
However, inflation can also harm crypto prices, as it causes investors to become more cautious in their investment decisions. Higher inflation often leads to higher interest rates, making investing in crypto less attractive and driving prices down.
And the indirect effect
Inflation also affects crypto markets more indirectly. Since most crypto trading is done using fiat currency (USD, EUR, etc.), any change in the value of these currencies affects the crypto markets.
For example, in times of high inflation, the value of fiat currencies depreciates, meaning that crypto traders need more currencies to buy the same amount of cryptocurrency. This can decrease the amount of crypto traded since traders have less money to spend.
What to expect in 2023?
The U.S. inflation rate, measured by the Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCE), has been a hot topic for investors and economists alike.
Both metrics measure how much money people spend on goods and services. The Fed prefers the PCE due to its broader scope and how it better reflects how consumers adjust their buying habits when prices rise.
The Fed typically allows for a 2% inflation rate, so anything above that is considered too high. In May 2021, the CPI increased by 8% year-on-year compared to the previous year, raising concerns about potential rate hikes in the near future.
Meanwhile, the latest data from the Organisation for Economic Co-operation and Development (OECD) shows that inflation, as measured by the CPI, has fallen to 10.3% in November 2022, down from 10.7% the previous month.
In 25 out of 38 OECD countries, inflation dropped between October and November 2022.
However, inflation increased by 0.5 percentage points or more in Chile, the Czech Republic, Finland, Hungary, the Slovak Republic, and Sweden, with the highest year-on-year inflation rates recorded in Estonia, Hungary, Latvia, Lithuania, and Turkey (all above 20%).
Hence, investors must keep a close eye on inflation data as it significantly impacts cryptocurrency markets. Positive inflation data usually leads to a small market rally, while unexpectedly high figures can tank the markets.
Looming fears of recession
The cryptocurrency market is highly susceptible to global economic downturns, such as a recession.
When the markets experience a recession, a common occurrence is for investors to flock to safe-haven assets such as gold and government bonds, causing the price of the cryptocurrency to plummet.
In addition, the decreased demand for goods and services leads to fewer transactions, further affecting the crypto market. Lower transaction volumes lead to decreased liquidity, meaning it is harder to buy or sell large amounts of crypto without causing a dramatic drop in the price.
Moreover, a recession can lead to financial institutions becoming more risk-averse and cutting back on investment in new technology, including cryptocurrency. This reduces the amount of capital flowing into the sector, further depressing prices.
These factors create a tough environment for the crypto market during a recession.
What to expect in 2023?
A new report by the Mises Institute has revealed a concerning development regarding the U.S. dollar: the M2 money supply has turned negative for the first time in 28 years. This serves as a warning sign of an impending recession – a trend that often begins with a gradual decrease in the money supply.
If a recession does take place, its repercussions for the crypto market will be felt for years to come, from sharp declines in crypto prices to large-scale job losses and lack of funding for the upcoming crypto and web3 projects.
Correlation with stock prices
In the past, digital assets’ uncorrelated nature with the traditional markets was a double-edged sword. While it provided a safe harbor for investors seeking an asset class to protect them from the volatility of stocks, it also came with unpredictability.
The International Monetary Fund (IMF) reported that, before the outbreak of the global pandemic, cryptocurrencies such as bitcoin and ethereum (ETH) had a limited correlation to major stock indices and were regarded as a shield against sharp changes in other investment types.
However, this perspective changed after the extraordinary measures taken by central banks to combat the ravages of the Coronavirus.
While in the past, there was a negligible correlation between the daily movements of bitcoin and the S&P 500, the benchmark stock index for the U.S., from 2017 through 2019, this figure shot up to 0.36 between 2020 and 2021, with both sets of assets moving together.
The S&P 500 saw its worst annual performance in 12 years, closing 19.4% lower than when it began the year at an all-time high. This follows a period of high inflation and interest rate hikes by the Fed, which left the prices of financial assets struggling.
We can expect volatility to continue in the cryptocurrency market in the coming months. However, we should note that there is a slim chance of a rare negative correlation between stocks and cryptos, which could drive up crypto prices.
Energy demand and oil prices
In theory, crude oil and cryptocurrency prices have a negative correlation, meaning that when one goes up, the other tends to go down. This is because both assets are used as a store of value and speculation.
When crude oil prices increase, investors tend to move away from speculative assets, such as cryptocurrency, in favor of more secure investments. This is because the increase in crude oil prices can signal a strengthening economy, leading to increased investor confidence in traditional markets.
The inverse is also true. Investors may consider cryptocurrency a speculative alternative when crude oil prices fall. The decrease in energy prices can signal economic volatility, leading investors to believe that more speculative investments, such as cryptocurrency, may be more likely to appreciate value.
It is important to note that the correlation between crude oil prices and cryptocurrency prices can also vary depending on the market conditions at a given time.
For example, if geopolitical tensions increase, crude oil prices could go up while cryptocurrency prices could remain steady or vice versa. On the other hand, if economic activity slows down, both markets could experience a downturn.
Therefore, it is important to consider the economic, financial, and political environment when considering the correlation between crude oil prices and cryptocurrency prices.
Brent crude prices topped the $120 per barrel mark in June and then dropped to a low of $75 in early December as they juggled between recession fears and a price cap on Russian oil.
As of Jan. 20, Brent crude stands at $86.77 per barrel, up from $77.84 on Jan. 4. Interestingly, BTC’s price, at least on this occasion, has positively correlated with crude prices. BTC price experienced a bullish growth from Jan. 6 and reached a 30-day high of $21,438 on Jan. 17.
What to expect in 2023?
It is difficult to predict how crude oil prices will affect crypto prices in 2023. Factors such as economic conditions, political stability, technological advancements, and regulations may all play a role in influencing the prices of both assets.
Cryptocurrencies are still relatively new, and their value is highly volatile, so any changes in the price of crude oil could potentially have unpredictable effects on crypto prices.
Other macro factors affecting crypto markets in 2023
There are several other macro factors that can affect crypto prices in 2023:
The first anniversary of the Russia-Ukraine conflict is a reminder of how cryptocurrencies can be used in warfare. To broaden donor access, the Ukrainian government started to accept crypto donations at the beginning of this year, leading to the formation of the Crypto Fund of Ukraine.
However, the conflict has hurt bitcoin trading volume, with a recent report indicating that a 1% increase in the Russia-Ukraine war leads to a 0.2% reduction in Bitcoin trading volume.
This effect is particularly pronounced post-invasion, with the impact becoming more prominent after one week. If the situation between the two countries continues into 2023, it could spell disaster for the global financial markets, including the cryptocurrency market.
China reopening its economy
As China begins to reopen its economy after the coronavirus pandemic, the cryptocurrency market is expected to see a major impact.
After the Chinese government imposed a ban on cryptocurrency trading and initial coin offerings in 2017, and in late September 2021, the People’s Bank of China (PBOC) banned all cryptocurrency transactions. As a result, many crypto traders and miners in China were forced to move their operations overseas.
With the recent easing of restrictions, these traders are now returning to the market, and some predict that this could lead to an increase in demand for cryptocurrencies. At the same time, China’s reopening could bring new regulations and restrictions on the crypto market.
The Chinese government has previously expressed concerns about the potential for cryptocurrencies to be used for money laundering and other illicit activities. If the government imposes stricter regulations, this could have a negative effect on the market.
In addition, China’s reopening could also impact the global cryptocurrency market. China is one of the world’s largest cryptocurrency markets, and a resurgence of Chinese traders could increase demand for various coins.
Laws and regulations
In 2023, the cryptocurrency market is expected to be heavily impacted by laws and regulations. Governments worldwide are increasingly recognizing the potential of cryptocurrencies and are beginning to implement regulations on their use. As the market matures, more stringent laws and regulations will likely emerge.
Regulations are expected to focus on three main areas: consumer protection, taxation, and anti-money laundering.
Consumer protection regulations will aim to protect customers from fraud and provide greater transparency in the market.
Taxation regulations will make it mandatory for cryptocurrency owners to pay taxes on their gains.
Anti-money laundering regulations will prevent the use of cryptocurrencies for illegal activities.
The introduction of these regulations is likely to have a profound effect on the cryptocurrency market. It is expected to reduce the number of fraudulent activities, increase consumer confidence, and improve transparency.
The bottom line
In 2023, the fate of the crypto market will be determined by a combination of macro-level factors, such as government regulations, consumer sentiment, technological innovations, and broader economic conditions.
Government regulations will play a major role in determining the acceptability and legality of crypto assets.
Meanwhile, consumer sentiment will be determined by the availability of reliable and secure platforms and the level of trust in the crypto market.
Technological innovation will be key in driving the adoption of crypto assets and providing the infrastructure for secure and efficient transactions.
Wider economic conditions will also play a role in the macro environment, including inflation, economic growth, and currency devaluation.
Billionaire investor Ray Dalio recently voiced his opinion that the U.S. economy is undergoing stagflation. This phenomenon is characterized by sluggish economic growth, high inflation, and anemic asset markets, leading to higher unemployment, decreased consumer spending, and reduced profits.
Dalio believes that the Fed will be forced to lower interest rates by 2024, before the U.S. presidential election, to combat the slump, which could last a few more years.
While this may seem like a cause for worry, history has shown that economic downturns can be an excellent opportunity for individuals and businesses to prepare for the next rally.