What happened
Cryptocurrencies lost ground Wednesday as investors continued to attempt to assess the state of the U.S. economy and what steps the Federal Reserve will need to take to rein in high inflation.
As of 1:25 p.m. ET, the price of the world's largest cryptocurrency, Bitcoin (BTC +1.33%) had fallen 3.4% over the prior 24 hours. The world's second-largest cryptocurrency, Ethereum (ETH +1.32%), had fallen about 4%, and meme token Dogecoin (DOGE +1.00%) was off by more than 5%. The stock market was down as well, with the broad S&P 500 index off by about 3.5%
So what
Like many other relatively risky assets such as tech and growth stocks, Bitcoin and most other cryptocurrencies have not fared well recently as interest rates have risen and are on course to head still higher. The Federal Reserve has boosted its overnight benchmark lending rate, the federal funds rate, several times already as it undertakes a fiscal tightening regimen designed to bring inflation back under control. The federal funds rate now sits in the range of 0.75% and 1%, and the price of Bitcoin is down nearly 39% this year.
Image source: Getty Images.
Data released earlier this month showed that the Consumer Price Index (CPI), which tracks the prices of a market basket of goods and services, was up by 8.3% year-over-year in April. While that's still unusually high, it was down from March's 8.5% year-over-year increase, suggesting that inflation may be starting to slow. But comments from Fed Chairman Jerome Powell Tuesday seem to have spooked investors. He essentially said that the Fed will keep raising interest rates until inflation settles.
"If that involves moving past broadly understood levels of neutral we won't hesitate to do that," Powell told The Wall Street Journal. "We will go until we feel we're at a place where we can say financial conditions are in an appropriate place, we see inflation coming down."
Assuming conditions don't change markedly, most investors expect the Federal Open Market Committee will raise rates by 50 basis points (0.5 percentage points) following both its June and July meetings.
When the federal funds rate rises, that increases the yield on safer assets such as U.S. Treasury bills, which in turn makes riskier assets less appealing. Rising rates also make the cost of doing business more expensive, which can hurt corporate earnings -- not that cryptocurrencies are businesses that generate earnings.
In other news, several prominent figures in recent days have made negative public statements regarding the future of Bitcoin. Former Fed Chairman Ben Bernanke said during a CNBC interview earlier this week that he doesn't ever expect consumers to make ordinary, everyday purchases with Bitcoin because it would be "too expensive and too inconvenient to do that."
CRYPTO: BTC
Key Data Points
Also earlier this week, Sam Bankman-Fried, the CEO and co-founder of the crypto exchange FTX, told the Financial Times that he doesn't think Bitcoin has any future as a payments network. In his view, Bitcoin won't be able to scale enough to keep up with demand, largely because of its proof-of-work mining process, which requires massive amounts of computing power and consumes a profligate amount of electricity in the process. Many other cryptocurrencies have moved away from proof-of-work protocols because they are bad for the environment, but Bitcoin is not expected to -- at least, not anytime soon.
Now what
It's very hard to value cryptocurrencies, but given that Bitcoin pioneered blockchain technology and was the first cryptocurrency, and Ethereum is now the main blockchain network for smart contract functionality and decentralized applications, I fully expect both to be here long term. Therefore, I view these two as good long-term investments.
Dogecoin was started as more of a joke and has no real technical advantages or real-world use cases, which is why I would not recommend investing.
