In recent years, a wide range of digital currencies has emerged, these includes Bitcoin, Litecoin, Ripple, and Peercoin.
The Bitcoin has been the most prominent of these currencies in terms of both market capitalization and impressive price development.
Its price increased from a zero value base at the time of its conception back in 2009 to a whopping $ 1100 at the end of 2013.
This peer-to-peer cryptocurrency may soon be facing notable challenges the end of 2016 nears.
In the entire duration of its existence, it has enjoyed a zero interest rate environment.
This is set to change as the Federal Reserve looks closer to raising the base interest rates for the first time in nearly eight years, this is set to happen at the December policy meeting.
This has led to a widespread contrasting speculation as to how exactly these changes may affect the Bitcoin price.
FACTORS WARRANTING THE INTEREST RATE HIKE
The Federal Reserve has been responsible for the manipulation of the benchmark interest rate also referred to as the federal fund’s rate in their efforts to grow the United States economy.
This has been the case for the past 20 years. Since the turn of the century, the United States has suffered from two notable economic downturns, these are the 2000 and 2008 recessions.
To mitigate the 2000 recession, the Federal Reserve lowered the benchmark interest rate to a never before seen level.
Many commenters and market experts have attributed this artificially low-annual percentage rate to the 2008 recession.
After 2008, the rate was set at 0.25 % and it has been that way ever since.
However, this zero interest rate policy can lower down the productivity growth and potential output, which can badly affect the long-term growth due to capital investments in speculative assets.
This low-yield interest rate was not conducive for investors and they sought out alternative opportunities.
This is a good news for the Bitcoin price as more investors turned to the cryptocurrency as a viable investment option.
The Federal Open Market Committee (FOMC) can only raise the benchmark interest rate following their next policy meeting to be held in December.
According to the FOMC’s Summary of Economic Projection released in June of last year, the interest rate was expected to increase to around 3 % to 4 % in 2016 and beyond.
POTENTIAL IMPACT ON BITCOIN PRICE
An increased benchmark interest rate would place the bitcoin price in an uncertain position due to two key reasons; decrease in high-risk investment and a strong US dollar.
1. DECREASE IN HIGH-RISK INVESTMENT
Increased interest rates almost always lead to the so-called “cashing yield” phenomenon, where market participants invest in low-risk assets such as fixed-rate bonds.
This is mainly because of the heads up about prices dropping down on such assets and its relation to the potential increase in the benchmark interest rates.
One of the fundamental principles of bond investments is that bond prices and market interest rates which usually move in opposite directions.
If this is anything to go by, then investors and traders could move to these interest-bearing assets since bitcoin investment do not provide interest payments.
Also, at this point, the bitcoin is part of a higher-risk speculative asset. As such, investment outflows to more stable options that will lead to a drop in bitcoin price.
2. A STRONG US DOLLAR
Recent history shows that the bitcoin price has been significantly hurt by a strengthening US dollar.
The US dollar is generally expected to benefit from an increase in the federal fund’s rate since it indicates a strong economy and usually results in investment net inflows.
This will be beneficial for US stocks but may have a negative effect on bitcoin price which has always shown an inverse relationship to the USD.
However, due to volatile nature of the bitcoin price, it is likely that the changes would not be significant enough to cause unprecedented market changes.
There are other more important factors that affect the bitcoin price, the increased interest rates alone is a challenge that this currency will definitely overcome. Also, there is a possibility that the benchmark interest rate may remain unchanged.
Factors that could necessitate unchanged interest rates are the European, Japanese, and Chinese economy and lastly low inflation.
While there is not much certainty as to what would happen if the rates will stay the same, the easy money policy of recent years would likely not affect the bitcoin price.