While the American Federal Reserve (Fed) continues its policy of monetary tightening in order to curb inflation, its influence on the cryptocurrency market is increasingly felt. Most notably, the correlation between the Fed funds rate and liquidity in the crypto market appears increasingly evident.
The Fed Rate and Crypto Liquidity, a Close Correlation
The world of crypto seems increasingly linked to the workings of traditional finance. This is according to a recent analysis by Tom Wan, analyst at 21.co, on the impact of the Fed’s rate hike on the liquidity of stablecoins in decentralized finance (DeFi).
In publication on
To further his study, Wan took a close look at blockchain data regarding the liquidity of USDT and USDC on the Aave protocol. He was thus able to highlight a correlation between the fluctuations of these flagship stablecoins and the evolution of the Fed’s key rate.
Specifically, the analyst has observed two dramatic declines in liquidity since the collapse of Terra and FTX. When the Fed raised rates by 75 basis points in September 2022, from 2.33% to 3.08%, the liquidity of USDT and USDC plunged by $1 billion, a drop of 55%.
Then in July 2023, the Fed’s decision to raise rates by 25 basis points, bringing the rate from 5.08% to 5.33%, was followed by a $380 million decrease in liquidity stablecoins, a reduction of 33% compared to its initial value.
The Impact on Decentralized Finance (DeFi)
According to Tom Wan, stablecoin rates in decentralized finance (DeFi) have become less attractive in terms of risk/return since the Fed raised rates, with the two sectors now offering similar returns.
Additionally, the recent rise in bullish sentiment has increased demand for leverage, which could drive up borrowing rates on DeFi lending platforms if supply follows.
Although the Fed appears to want to slow the pace of its rate hikes, it has not ruled out further increases. It will therefore be necessary to closely monitor the evolution of its monetary policy as well as its repercussions on liquidity within the crypto ecosystem.
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