The market for cryptocurrency is largely volatile and is, in a way, highly responsive to some key macroeconomic factors that exist in the market. The factors like inflation rate, interest rate, and GDP growth rate are important pointers that influence investors and markets. Also, fiscal actions, changes in the rules, and a stable economic environment all concern the demand and the value of crypto assets.
These macroeconomic factors are important for investors and other stakeholders in order to have a proper view of the world and its risks and to be able to invest in cryptocurrency with some sort of solidity.
The paper shows the correlation between macroeconomic factors and cryptocurrency markets, making it possible to predict the market's movement and find the best investment strategy.
Inflation hit its highest figure in four decades in 2022, driven by rising energy prices. However, inflation around the world and economic growth are moderating more sharply and widely than expected at the outset. IMF records show that the world’s inflation rate reached a high of 8% a year and is expected to reduce to 6% by the end of 2022.
The Federal Reserve raised the federal funds rate in the United States by 25 basis points during July 2023 up to a level of 5.25-5.5Ϲ, the highest in the country compared to the past twenty-five years. This was implemented in order to curb any threats of inflation and maintain stable prices.
Cryptocurrencies operate on decentralized networks and utilize encryption for transaction security and new unit generation. They interact with inflation in complex ways, yielding both positive and negative implications:
Positive Effects:
Some cite factors as reasons for cryptocurrencies to gain demand and, by extension, value, especially if there are inflationary forces at play.
Unlike the common form of money, cryptocurrencies have fixed and manageable quantities; hence, their value is not devalued by increased supply.
Regarding inflationary policies implemented by local governments, cryptocurrencies, being international and borderless, provide users with opportunities to bypass such measures.
Negative Effects:
Inflation may erode the stability and acceptance of such cryptocurrencies, especially due to their volatility in the market. It might reduce their efficiency when it comes to making payments.
Limitations arising from technological advancements and regulating entities can further limit the use of cryptocurrencies, thus preventing their widespread use.
A new form of competing digital money, including central bank digital currencies, or CBDCs, may threaten crypto’s dominance.
Inflation's impact on cryptocurrencies can be either positive or negative, depending on several factors, including the kind and rate. Some other factors involve the source of inflation, the features and performance of the cryptocurrency, and the behavior of the users. Therefore, it cannot be assumed that inflation always has a clear impact on cryptocurrencies and might even differ depending on the time span and the emergencies.
The most effective measures or policy influences affecting the cryptocurrency market include:
Monetary policy can be defined as the set of rules and regulations that govern the flow or volume of money in an economy. It is also composed of several aspects, including inflation rate, interest rates, exchange rates, and economic growth. In some cases, like in a cryptocurrency, monetary policy can be a decentralized system. In other cases, like in a main branch bank, the policy will be centralized.
Fixed supply: The concept of artificial inflation cannot impact other commodities, particularly since the number of bitcoins is fixed. Actually, there is a predefined scope for the number of coins created. It equals 21 million, and the rate of new Bitcoin creation is reduced two times per four years. While this may lead to fluctuations and consequent deflationary processes.
Variable supply: It is possible to artificially set various prices for different cryptocurrencies, such as Ethereum, which has variable and unlimited emissions. The network consensus mechanism regulates the level of difficulty. This kind of monetary policy can decrease the money's desirability and purchasing power while incentivizing the miners and validators who secure the network.
Algorithmic supply: Ampleforth is an example of a cryptocurrency that is both elastic and algorithmic, suggesting it can alter its supply in response to market fluctuations. As for its supply, it is US dollar-based, and every 24 hours, the number of coins in each consumer’s purse changes. While managing volatility and possibly putting efforts into the constant pricing of cryptocurrencies, this kind of monetary policy may add to confusing users.
The IMF 2023 presented a board paper entitled ‘‘Elements of Effective Policies for Crypto Assets’’ to respond to emerging crypto assets associated problems. The goal is to put forward a fully integrated and synchronized policy approach to these problems.
Members are provided with a nine-part framework to support the proposed classification of the components. This network can help them design comprehensive, logically structured, and interlinked policy initiatives.
In August 2021, the IMF released a working paper titled “The Crypto Cycle and US Monetary Policy.” This paper explores the connection between monetary policy, equity markets in America, and the volatility witnessed in the crypto market.
Based on the study findings, crypto assets are an inverse of US monetary policy instead of market risk hedging assets. It stresses the need for a multilateral approach in tackling the implications of crypto assets on the fiscal balance, capital flow measures, and monetary relations.
Macroscopic policies involving the use of the cryptographic unit assess how the government’s actions affect this market. Temporary fluctuations in fiscal policy, which may have specific characteristics, can have a direct and indirect impact on cryptocurrencies.
The consequential effects of fiscal policy on cryptocurrencies are described as follows
Direct effects: The same way that fiscal policies can encourage or discourage the increase in demand for cryptocurrency. The government can propose to reduce the tax rate for individuals who voluntarily engage in cryptocurrencies as an investment tool. On the other hand, the use of cryptocurrencies may be considered unlawful or be allowed with hefty taxes imposed on them if the relevant government sets a high tax on them or bans cryptocurrency’ usage. He added that fiscal policy may also influence market development and the innovation of digital assets through the provision of funds.
Indirect effects: The macroeconomic factors and financial structure are influenced by fiscal policy, which may affect the price and risk of Bitcoin. For instance, hedging products such as cryptocurrencies are expected to do well during periods of inflation.
On the other hand, explaining the effect of external shocks on the domestic economy, there could be a surge in demand for safe-haven assets such as government bonds. The demand for those assets may decrease due to reduced investment by individuals. These two factors influence fiscal policy, which is accepted and regulated, among others, through the competitiveness and stability of financial systems.
Cryptocurrency fiscal policy remains vigorously dynamic and easily affected by the market since it touches on different market benefits and demerits. The size of the market, government goals, community perception, and interaction with other forms of policies decisively determine the most appropriate fiscal strategy for cryptocurrencies.
In October 2023, the IMF presented a board paper on the theme “Elements of Effective Policies for Crypto Assets.” This paper fears that tokens create new problems. The paper calls for the development of a ‘one-stop’ policy approach to address these challenges.
It stresses certain issues, like the control of monetary independence and fiscal exposures, improvements in consumer protection and the integrity of the cryptocurrency markets, as well as the facilitation of international cooperation in establishing the digital infrastructures and the innovations of the new forms and means of international payments.
US Treasury Secretary Janet Yellen said in April 2022 that it remains uncertain whether digital assets or cryptocurrencies could be used as hedges. From her comment, it is understood that the U. S. administration has not determined whether cryptocurrency should be partly or fully integrated into portfolios.
Cryptocurrencies have different legal statuses depending on the legislation of different countries and can be either liberal or conservative. Many factors play roles in determining how the government perceives and regulates cryptocurrencies and related instruments. These include:
Cryptocurrency definition and classification: The legal traditions that apply to these virtual currencies differ depending on how each country defines and categorizes cryptocurrencies. These digital currencies are legalized in some countries as property, security, or commoditized, and in others, they are not recognized as money or financial instruments.
Government goals and priorities: Based on the government’s objectives, the legal environment and relative policies regarding cryptocurrencies can serve various purposes. Some of them include facilitating innovation, protecting investors and consumers, maintaining stability in the crypto environment, penalizing unlawful activities, or serving the interests of the specific nation.
Government Coordination: The level of coordination and integration of government policies and laws concerning cryptocurrencies in different regions may differ based on the level of cooperation within the country. Some nations would be able to follow the rules and recommendations of international bodies such as “the FATF or G20”. While other countries will, on the other hand, be able to opt for totally different and divergent options.
In early January 2024, the US Government announced a new set of rules for cryptocurrencies in the United States of America. These policies cover six major areas, such as financial stability problems, consumer and investor problems, and many more. The Cryptocurrency Policy Councils were also formed, whose duty would be to monitor and oversee the implementation of the policies.
The Brazilian law on virtual assets, Law No. 14,478, also known as the ‘Legal Framework for Virtual Assets, ' was passed in June 2023. It provides a sophisticated definition of virtual assets. In December 2021, India launched a National Strategy on Blockchain. It gives a roadmap, directions, and goals for promoting and applying blockchain technology in various industries.
In November 2021, India, as the G20 president, published the Presidency Note as an input for a Roadmap on Establishing a Global Framework for Crypto Assets for the G20 nations to consider. The brief offers a thorough summary of the problems and difficulties surrounding digital assets and makes recommendations for potential areas of international cooperation and coordination.
In February 2021, the Indian House of the People was introduced to the Cryptocurrency and Regulation of Official Digital Currency Bill 2021. It aims to prohibit all forms of virtual currency, excluding its endorsement and promotion of the digital currency to be issued by the RBI. To date, the measure is still under consideration as a bill and has not gone through to becoming a law.