Crypto, Rate Hikes and the Outlook for Digital Assets

After powering crypto to new heights in 2021, investors are navigating uncharted territory as decades-high inflation, tighter monetary policy and reduced central bank stimulus put risk-on assets on the back foot.

The shift in market conditions follows an incredible year that saw once-dubious investors flock to crypto in droves. Led by younger investors, the number of people around the world with crypto investments increased more than a third.¹

“Crypto went mainstream last year,” says Marc Despallieres, Chief Strategy & Trading Officer at Vantage, the multi-asset broker offering CFDs on forex, commodities, indices, cryptocurrencies and shares. “Investors briefly pushed the combined market cap for cryptos past $3 trillion in November. The market then tumbled in December and limped through the first quarter of 2022. As stimulus wanes and the Federal Reserve starts raising rates, we’ll see whether crypto behaves like a traditional risk-on asset class or breaks from the norm.”

Bitcoin vs Inflation

The U.S. consumer price index accelerated to a fresh 40-year high in February on the back of rising food, gas and housing costs.² President Biden’s ban on Russian energy imports amid the country’s invasion of Ukraine is exacerbating inflation woes due to tighter oil supplies and higher gas prices. 

Against that backdrop, expectations for a string of Federal Reserve interest rate hikes have sent markets into confusion. The Fed raised rates by 25 basis points in March. Fed Fund Futures now show the market pricing in further rate hikes at all six of the central bank’s remaining meetings this year. In turn, crypto and other risk-on assets that benefited from the prevailing low-rate, low-yield environment over the past decade could fall out of favor.

“Typically, investors pivot to defensive assets including gold, government bonds and safe haven currencies during risk-off scenarios,” says Despallieres. “After a long period of market exuberance, risk-on assets started this year in retreat. The situation in Europe has accelerated declines in assets including CFDs on stocks and crypto.”

Don’t count crypto out just yet—at least not bitcoin. The crypto outperformed most stock indexes throughout the first four months of the year. In the wake of the recent crypto rout spurred by a flight from the TerraUSD stablecoin and the Terra blockchain, bitcoin is down 37.2% this year, underperforming most indexes. Yet many seasoned investors remain optimistic.

“If the stock market keeps dropping, Bitcoin may breach $30,000,” Bloomberg Intelligence wrote in a report in May. “But our Bitcoin outlook versus the ebbing risk-asset tide is limited downside versus the potential for the benchmark crypto to just keep doing what it has been -- outperforming most assets.”

This current market scenario will also test bitcoin’s inflation-hedging credentials. Enthusiasts have long argued that bitcoin is the one of the world’s best hedge against rising consumer prices due to its limited supply, which protects it from devaluation at the hands of a central bank unlike traditional currencies. In fact, some argue that bitcoin will eventually displace gold as the go-to store of value in the face of inflation.

The jury is still out. A little over a decade old, bitcoin doesn’t have a long enough history to determine whether it will hold its value over time. Skeptics point to bitcoin’s persistent volatility and speculative nature. If inflation pushes the economy into a recession, they argue a further step away from risky assets could easily undo the inflation-hedging narrative. This year will be the first true test either way.

Ethereum Down but Not Out

Ethereum continues to gain favor among traditional investors. It outperformed bitcoin last year, powered by rising adoption and declining supply. The Ethereum blockchain lies at the heart of global efforts to digitalize finance, and the long-delayed shift from a Proof of Work to a Proof of Stake consensus mechanism will likely prove the next big catalyst—or roadblock.

Year to date, ether has fallen 47.2%.² Despite the poor performance, a report from Bloomberg Intelligence suggests ether’s long-term potential remains intact: “In a risk-off period like 1Q, it makes sense that Ethereum would give back some of its roughly 3,000% appreciation since the end of 2019, but the No. 2 crypto is a key part of technology revolutionizing finance, with implications for the price.”

While Ethereum remains the dominant Layer 1 blockchain and will continue to lead the financial revolution, a host of “Ethereum killers” are gaining momentum. Among them are Solana, Cardano, Tezos, Polkadot and Algorand. Each boasts unique strengths and will likely play an important role in shaping that future if they can weather the ongoing market tumult.

Beyond Bitcoin and Ether

While bitcoin and ether are the main attractions for traditional investors, some are increasing their exposure to alt coins. Many are tied to nascent trends including decentralized finance (DeFi), play-to-earn gaming (GameFi) and the metaverse.

Arguably more speculative than bitcoin, alt coins have taken a bigger hit amid the current market rout. For instance, the Bloomberg Galaxy Defi Index, which tracks 11 of the biggest DeFi protocols, has fallen 66% year to date. And the lion’s share of metaverse-related cryptocurrencies posted huge declines.

Still, more mature projects remain attractive in the longer term. Case in point, total value locked in DeFi contracts currently stands around $211 billions compared with $63 billion the same time last year.³ And venture capital firms invested $4 billion into GameFi in 2021—with many of those projects likely to launch this and next year.⁴

“In crypto CFD trading, the greatest risks lie in less-established speculative projects that do not yet offer real-world utility,” says Despallieres. “A few outliers will certainly buck the trend, but, broadly, investors shouldn’t expect the reported returns from previous years across a larger swathe of the asset class until there’s a big shift in the prevailing market narrative.”

*Past performance is not an indication of future results.

[1] Data Reportal

[2] Bloomberg

[3] DeFi Llama

[4] DappRadar