What Today's Fed Decision Could Mean for Crypto

At 2:30 p.m. Eastern time Wednesday, the Federal Open Markets Committee (FOMC) will discuss the decisions reached during its latest two-day meeting that started yesterday. The announcement will have a huge bearing on the direction of the U.S. economy as a whole. It may have particularly pronounced impacts on both short- and long-term trends for the cryptocurrency industry.

The FOMC is expected to firm up at least two elements of the Federal Reserve’s plans for the year, though both have been broadly telegraphed. There may be more details about the schedule for “tapering” the Fed’s bond-buying program, which more than doubled its balance sheet during the coronavirus pandemic to nearly $9 trillion. The tapering and divestment schedule has significant implications for inflation and capital markets.

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But the real headline issue is the potential for change in the Fed’s interbank interest rate. There is very little chance of a hike actually coming out of the current meeting – the Fed has said it needs to begin the asset taper before hiking rates, apparently for technical reasons. But we already have a solid sense of the direction things are going.

The Fed has previously said it plans three rate hikes this year, in response to rising inflation and an incredibly tight job market. Goldman Sachs, apparently seeing even more pressure ahead, predicts four hikes, with rates rising to 2.5% to 2.75% by 2024. The FMOC could provide more clarity on that schedule today.

If the Fed stays the course, it could amount to a dramatic change to the macroeconomic environment. More to the point, it might be perceived as a major change by investors and employers, who would shift their own choices accordingly. Among other impacts, higher Fed interest rates usually draw capital away from speculative sectors because savers and investors are drawn to safer returns in government bonds. At the margins, this will inevitably pull value out of both tokens and crypto startups (along with tech and venture capital more generally).

The question is how much money will move to more conservative positions, how fast it will move and whether the shift is already “priced in” to markets. The likely impact is unclear in part because of the nuances of the current moment, in which even significant interest rate hikes would still leave rates historically low. Fed rates mostly have been near zero since the 2008 financial crisis, only inching up to 2.4% in late 2019 – before being cut again in the face of another crisis. Prior to the 2008 crisis, the Fed rate had not been as low as 2.4% since 1962.

But will investors see the slow march upwards as the end of the post-crisis era of near-free money? The near-zero-interest environment gave rise to perverse phenomena like “The Startup That Loses Money Forever'' – operations like WeWork or Uber that are able to raise funds on the slim chance of future returns in part because more reliable and solid investments just aren’t available. Heading from 0% to 2.5% doesn’t automatically mean the end of the USD silly season, but it will dampen things to some degree.

Crypto companies have only fairly recently joined the ranks of companies able to attract large amounts of mainstream venture capital. So it’s unclear to me just how rough a tumble the more formalized and regulated portions of the sector could see from a broad investment pullback. On the one hand, we may see fewer initial public offerings (IPO) like Coinbase (where the stock is currently more than 40% down from its opening price).

On the other hand, many, many crypto companies are sitting on big war chests, even after the current crash in bitcoin (BTC) and ether (ETH). A wild example popped on my radar this morning when SingularDTV, which had an initial coin offering (ICO) in late 2016 (and for a short time employed me at a startup crypto magazine called BREAKER), moved a stash of ETH that’s still worth nearly $30 million. No comment on their treasury management and market timing skills, but they’re far from alone among older crypto startups in having gargantuan ETH or BTC bags with the potential to see them through a stretch of tougher capital markets.

See also: Crypto Is About More Than Prices | The Node

The big X-factor in all of this is the stock market. For better or for worse, the Fed has for nearly three decades consistently moved to protect equity market prices. That is absolutely not part of the Fed’s mandate, which concerns only managing employment and inflation. But former Fed Chair Alan Greenspan seemed so consistent in supporting asset prices with looser money that the tendency became known as the “Greenspan Put.”

It turned out to be a long-term mistake that created instability and bubbles, but the mindset has seemed to persist at the Fed. Though the Fed has denied paying any attention to short-term asset prices, the recent plunge of the U.S. stock market (the S&P 500 is off more than 7% since the start of January) would appear to be at least somewhat of an obstacle to a rate hike. The Fed will still project its future hikes, though, and its paramount need for long-term credibility means it would only change course under truly extraordinary circumstances.

But a continued, steep stock market decline might be one of them. It would be incredibly distressing and a fundamentally bad idea for the Fed to keep the zero-interest orgy going as the real economy recovers from COVID-19, but the possibility can’t be entirely counted out. And if Powell does let it ride, the frothiness has just begun.

CORRECTION (Jan. 26, 19:45 UTC): The Federal Reserve announced at 2:00 p.m. ET its decisions to be discussed at a 2:30 p.m. meeting.