- Cryptocurrencies have numerous risks, including regulatory.
- The biggest risk is the extremely hawkish Federal Reserve.
- High-interest rates make risky assets like Frax Share less attractive.
Cryptocurrencies have held quite well in the past few days. Bitcoin price has remained above $26,000 in the past two weeks while the total market cap of all cryptocurrencies have remained above $1 trillion. At the same time, financial assets like the Nasdaq 100, TLT ETF, and S&P 500 have plunged.
Cryptocurrencies are facing numerous risks that could hurt their prices in the long term. For example, there are regulatory risks in the US and other markets. China banned cryptocurrencies in 2021 and the Securities and Exchange Commission (SEC) has launched a major lawsuit against Binance and Coinbase.
The SEC has also blocked the launch of a spot Bitcoin ETF, making it hard for institutional investors to allocate funds to cryptocurrencies. On the positive side, companies like Grayscale and Ripple have prevailed against the SEC in US courts. This means that the hopes of a spot ETF have risen substantially in the past few months.
Cryptocurrencies have other risks, including low liquidity, reduced interest among investors, and security.
Federal Reserve risks
However, I believe that the Federal Reserve is the biggest risk for Bitcoin and other coins like Frax Share, Maker, and Avalanche. In its meeting last week, the Fed decided to leave interest rates unchanged at 5.25% and 5.50%.
While this was a welcome move, the dot plot pointed to another hike later this year. If that happens, it will bring rates to between 5.50% and 5.75%., the highest level in decades. The Fed is frustrated that inflation is not falling to its 2% quickly enough.
Therefore, if the Fed maintains its hawkish tone, there is a likelihood that cryptocurrencies will retreat for three reasons. First, the Fed is pushing safe yields to the highest level in years. The two-year bond yields have risen to over 5% while the 10-year and 30-year have surged to the highest point in over 2 decades.
Therefore, many investors will decide to move their cash to safe assets. This explains why the US dollar index (DXY) has jumped to the highest point in over six months.
Second, the Fed could cause a recession as financial conditions tighten. Companies and individuals are now paying more money in interest while default risks have jumped sharply in the past few weeks. Also, the yield curve has crashed to the lowest level in decades. As we saw in March 2020, crypto like Frax Share and Avalanche underperform in a recession.
Read more: How to buy Avalanche.
Finally, high-interest rates lead to rotation from risky assets to value ones. Crypto is the riskiest of all.
