Central Banks Are Driving Many to Cryptocurrencies

Two years ago, Bitcoin was considered a fringe technology for libertarians and computer geeks. Now, Bitcoin and other cryptocurrencies, such as Ethereum, are gaining mainstream adoption. However, mainstream adoption has been propelled by financial speculation instead of by demand for a privately minted and deflationary medium of exchange. After the Fed’s rate hike this week, Bitcoin and alternative cryptocurrencies, such as Ethereum and Dash dropped in value instantly. Bitcoin, for example, dropped by approximately 16% in value while other coins dropped by approximately 25%. However, Bitcoin’s price recovered to the previous high within 18 hours.
The reaction of the cryptomarket to the Federal Reserve announcement provides evidence that cryptocurrencies are seen as a safe-haven investment during times of significant fiat currency dilution. As I wrote for Forbes Austria in April, this is why the demand for Bitcoin is going up in countries that are demonetizing their fiat currencies, such as India and Venezuela. Following the demonetization of the 500 and 1,000 rupee banknotes in November of last year, the price of Bitcoin on India’s largest Bitcoin exchange, Unocoin, shot up to $818 while American exchanges quoted the exchange rate as $709 per Bitcoin. Similarly, Surbitcoin, Venezuela’s largest Bitcoin exchange, saw an increase from 450 accounts in 2014 to over 85,000 in 2016.
Reacting to Fed Policy However, if the Fed continues to raise rates, then the demand for cryptocurrency may decrease. When the Fed closes the faucet on newly printed money, there is less newly printed money that can flow into asset classes such as real estate, stocks, and cryptocurrencies, etc. Therefore, investors will have less demand for assets that hedge against inflation.

This post was published at Ludwig von Mises Institute on June 16, 2017.