Fed Cuts, Crypto Surges: What You Need to Know Now

Key takeaways

• Fed Rate Cut & CPI Data
• Crypto regulation is advancing, with U.S. regulators regretting the confusion around "cryptoasset securities."
• Multiple new approaches are being adopted to simplify crypto’s fragmented user experience:some text
  • Socket network: offers an auction orderflow marketplaces that allows existing stakeholders to fulfill users desires, disregarding the targeted networks, rather than solving for native interoperability.
  • Rabby Wallet: New Update allows one of the leading EVM-wallet users to pay with USDC as a gas currency.

The decision is in: the Fed has cut rates by 50 basis points (bps), a move we haven't seen since the COVID-19 pandemic. Beyond the emergency cuts of 2020, this kind of aggressive action hadn't been taken since the 2008 financial crisis. While this rate reduction may create immediate uncertainty and volatility, particularly in the crypto markets, it also opens the door to new opportunities. Investors across both traditional and digital markets are bracing for the impact, with Bitcoin poised to react sharply as sentiment shifts.

Historically, Bitcoin and other digital assets have performed well in low-interest-rate environments. If the market perceives this cut as a signal of returning liquidity, it could ignite a risk-on sentiment, driving a rally in Bitcoin as investors seek higher returns further up the risk curve. A deeper rate cut is also likely to accelerate U.S. dollar depreciation, increasing demand for Bitcoin as an alternative asset and store of value. Additionally, with over $6 trillion currently sitting in money market funds, a 50 bps cut may push investors to move out of these low-yielding instruments and into riskier assets like Bitcoin and Ethereum.

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Figure 1: Fed Funds Rate vs. Bitcoin Price

Source: 21Shares and Data from Yahoo Finance and The Federal Reserve

While short-term volatility is almost inevitable as the market digests this larger cut, Bitcoin may emerge as a preferred asset in this low-rate environment. The 50 bps reduction could also reignite inflation concerns, reinforcing Bitcoin’s narrative as an inflation hedge, which could boost demand over time. Historically, Bitcoin has thrived under similar conditions, and the current setup may present another opportunity for strong performance.

However, with a 55-60% chance of a 50 bps cut already priced in, there’s a risk that this move could spark anxiety over the broader economic outlook, amplifying concerns about deeper challenges and leading to increased market volatility. Last week’s CPI data, along with the nonfarm payroll report from two weeks ago, signaled the possibility of upcoming rate cuts.

Recent CPI data showed inflation cooling to 2.5% year-over-year, the lowest in three years, while core inflation eased to 3.2%. Meanwhile, weaker hiring in the latest nonfarm payroll report underscores the need for more accommodative monetary policy to sustain economic growth. Following the CPI report, risk assets rallied, with Bitcoin and Ethereum gaining 4% and 3%, respectively. Traditional markets also responded positively, with the S&P 500 and Nasdaq rising over 4% and 6%, reflecting growing optimism around looser monetary policy.

Following the 50 bps rate cut, Bitcoin has continued to rise, surging more than 4.5% from Monday’s low of $57,700. In contrast, traditional markets have shown signs of uncertainty, with the S&P 500 fluctuating between its opening price of $5,630 and session highs of $5,700.

Key inflation drivers in August, such as rising shelter costs, stable food prices, and declining energy prices, contributed to over 70% of the increase in core inflation. These pressures likely influenced the Fed’s decision to raise rates by 50 bps. Now, as the Federal Reserve nears the end of its tightening cycle, confidence in risk assets like Bitcoin is growing, given their tendency to thrive in more liquid environments.

Bitcoin’s performance is closely linked to liquidity and interest rate movements. The 50 bps rate cut will boost liquidity by lowering borrowing costs, making high-risk assets like Bitcoin more appealing. Historically, Bitcoin has thrived in low-rate environments, where a weaker U.S. dollar further enhances its appeal as a store of value. Investors, anticipating a weaker dollar, have already driven Bitcoin’s price higher.

As inflation cools and expectations of further rate cuts grow, demand for risk assets continues to rise. Bitcoin, known for its volatility and potential for outsized returns, is benefiting from this shift, attracting both institutional and retail investors.

Data from 2019 to 2024 highlights the sensitivity of both Bitcoin and the Nasdaq-100 (QQQ) to shifts in monetary policy. During periods of low interest rates, such as 2020-2021, Bitcoin surged from $6,589 to over $59,000, while QQQ climbed from $182 to $387, fueled by abundant liquidity and increased risk appetite. However, as the Fed raised rates in 2022 to combat inflation, both assets faced sharp declines. Despite elevated rates in 2024, both Bitcoin and QQQ have rebounded, driven by optimism around future rate cuts.

This trend underscores the close relationship between Fed funds rates and the prices of both Bitcoin and QQQ. Following the COVID-19 pandemic, when the Fed slashed rates and initiated quantitative easing, both assets rallied due to increased liquidity. However, as monetary policy tightened, Bitcoin and QQQ saw steep declines, highlighting their sensitivity to liquidity and borrowing costs.

It’s important to note that while data is normalized for comparison, Bitcoin’s price actually increased more than 10x during this period, compared to QQQ’s roughly 3x gain. The normalization suggests similar growth, but in absolute terms, Bitcoin significantly outperformed QQQ over the same timeframe. For more insights, check out our weekly blog!

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Figure 2: Fed Funds Rate vs. Normalized Prices of BTC and QQQ

Source: 21Shares and Data from Yahoo Finance

Looking ahead, as the fed dot plot shows below, 17 Federal Reserve officials now anticipate further easing in 2024, while just two project rates to hold steady for the rest of the year. Of those expecting cuts, seven forecast one more rate reduction, while nine foresee two additional cuts. One official predicts as many as three more rate cuts before the year ends. 

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By 2025, the majority of Fed officials expect the federal funds rate to drop to 3.4%, marking a notable decrease from the 4.1% projected in previous forecasts. This suggests four additional rate cuts next year, with officials projecting the easing cycle to continue into 2026, bringing the rate down to 2.9%. These updated projections signal the beginning of the Federal Reserve’s long-awaited easing cycle, as the central bank aims to achieve a soft landing for the economy—stabilizing inflation while maintaining robust employment growth.

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Figure 3: The Fed Dot Plot

Source: Federal Reserve

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Apart from the widely-used FedWatch Tool, market participants have been increasingly turning to Polymarket, a crypto-native prediction market, for insights on the Fed’s rate decisions. This decentralized platform has gained prominence, allowing users to wager on potential rate cuts and other prediction markets using crypto infrastructure. Beyond rate predictions, Polymarket has also emerged as a leading platform for U.S. election betting. However, its rapid growth has attracted regulatory scrutiny, leading to legal troubles with the SEC…

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Prediction markets receive an initial nod: Polygon-based Polymarket has gained significant momentum as a leading platform for U.S. election betting, boasting over 60,000 monthly active users and more than $900 million wagered on the 2024 Presidential Election. The platform has also exceeded $450 million in monthly trading volume (as illustrated in Figure 4). Despite its growth, prediction markets have raised legal concerns within traditional financial sectors.

The Commodity Futures Trading Commission (CFTC) has raised concerns about prediction markets, citing their susceptibility to manipulation. On September 6, the CFTC filed a motion to shut down Kalshi’s election betting markets, a platform that launched in July 2021. However, on September 12, a DC judge ruled that Kalshi could continue operating, allowing it to remain a competitor to Polymarket. Polymarket, after facing regulatory scrutiny, moved its operations offshore following a $1.2 million fine in 2022.

Figure 4 – Polymarket Monthly Users and Volume

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Source: Dune Analytics

Why does this matter? The ruling could pave the way for a crypto-native protocol to actively participate in the U.S. political landscape, potentially enabling one of the industry’s key applications to expand its influence beyond the confines of Web3. Just as portfolio diversification is critical in investing, broadening blockchain utility is vital for long-term growth. By expanding use cases, the technology can attract a wider audience beyond traditional Web3 enthusiasts. As mentioned in last week’s newsletter, prediction markets, like Polymarkets, are often viewed as one of Ethereum’s "killer" use cases due to their ability to facilitate decentralized forecasting. A prime example is Polymarkets, which has consistently grown its user base since May, defying the overall market downturn. This demonstrates the growing demand for blockchain applications that reach beyond crypto's usual boundaries.

SEC’s change of heart? In a recent settlement with the SEC, crypto exchange eToro agreed to remove all crypto assets from its platform, except for BTC, Bitcoin Cash, and ETH, effectively classifying all other assets as securities. Notably, the SEC announced its “regrets [for] any confusion [the term crypto asset securities] may have invited” in a footnote of another filing attached to the agency’s lawsuit against Binance. 

While these actions don't represent a full reversal of the agency's previous stance, they do suggest a willingness to reassess its approach to crypto regulation. This could signal the start of a more tailored regulatory framework for the industry, potentially reducing some of the uncertainty plaguing the market. It may also expedite the passage of pending legislation, such as the Financial Innovation and Technology for the 21st Century Act, which passed the House Financial Services Committee in May 2024 with strong bipartisan support.

For a detailed breakdown of what this act means for the crypto industry—particularly how it replaces the four-pronged Howey Test with five conditions for a decentralized system—check out our May 2024 Monthly Wrap.

Abstracting Crypto’s Complexity

A key barrier to crypto adoption is the lack of a user-friendly experience. With over 380 networks across smart-contract platforms (alternative L1s) and Ethereum-based scaling solutions (L2s), navigating this landscape can be overwhelming for newcomers.

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At the L1 level, fragmentation poses significant challenges. Managing multiple wallets with different seed phrases and transaction methods is cumbersome. The need for crypto forex services (bridging solutions)  across 300+ networks complicates asset transfers even further, and users must juggle various native gas tokens (e.g., ETH, SOL, etc.) to transact across different blockchains.

On the L2 side, interoperability remains the main issue. While Ethereum-based scaling solutions share a common settlement layer, allowing users to utilize the same wallet (e.g., Metamask), each network's unique scaling approach creates obstacles for cross-chain transfers. This diversity impedes the development of a seamless forex system connecting more than 80 L2 networks.

Given the degree of fragmentation, exploring different interoperability strategies is essential. Although chain abstraction is a broad topic deserving deeper analysis, this report will focus on account and wallet abstraction as key strategies to improve the user experience.

Figure 5 – Mapping of the Crypto’s Modularity Industry

Source: OurNetwork

On one side, Account Abstraction refers to the ability to customize blockchain accounts and make them smarter. In this regard, Ethereum’s upcoming Pectra upgrade is a key milestone in enabling this functionality at the network level, paving the way for the creation of smarter wallets. Notably, Coinbase’s smart wallet, the first major adopter of ERC-4337, has seen impressive growth, with a total of around 37,000 users onboarded to date, as shown in Figure 6.

Figure 6 – Weekly New Users of Coinbase Smart Wallets (CSW)

Source: Dune Analytics

We anticipate the adoption of the standard to accelerate significantly following the activation of Ethereum's Pectra upgrade. However, it's important to highlight that this trend is already gaining strong momentum, as shown in Figure 7 below.

Figure 7 – Monthly ERC-4337 (AA) Interactions

Source: Dune Analytics

Alternatively, Socket Network, an interoperability-focused infrastructure provider, offers an innovative solution to cross-chain challenges through its Modular Order Flow Auction (MOFA) protocol. In that, Socket creates a competitive marketplace where execution agents (validators and sequencers) bid to fulfill cross-network user-requests. This system employs chain-abstracted bundles, streamlining multi-network transactions and eliminating the need for users to directly interact with different networks. Socket's approach offers advantages to both users and existing stakeholders, positioning it as a noteworthy alternative to Coinbase's solution in addressing cross-chain interoperability.

1. Users: Enjoy improved execution and a simplified experience across fragmented crypto infrastructure.
2. Stakeholders (sequencers, validators, and market makers): Gain expanded roles and increased fee-earning opportunities within the ecosystem.

While related, wallet abstraction focuses on enhancing the user interface itself, simplifying wallet creation and management through familiar web2 credentials, and streamlining cross-blockchain interactions. In essence, account abstraction implements protocol-level changes, whereas wallet abstraction improves the application-level experience.

Rabby Wallet, one of the leading wallet providers, exemplifies this trend with its new gas abstraction feature. This innovation allows users to deposit USDC or USDT into a dedicated gas account, enabling them to pay transaction fees across multiple supported networks using these stablecoins. While this optimized transaction method may incur slightly higher costs due to multiple asset transfers, the added convenience likely outweighs the premium for most users. 

In conclusion, the ongoing efforts to simplify crypto’s complexities are vital for attracting new users. To achieve mainstream adoption, the crypto experience should mirror the user-friendly nature of Web 2.0, eliminating the need for users to grapple with technical concepts like gas fees, seed phrases, or cross-network transfers. These initiatives aim to transform crypto interactions into a seamless, familiar web experience, paving the way for broader acceptance and usage.

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Market Sentiment Gauge: Fear and Greed Index

A glance at the Fear & Greed Index, a multifactorial tool that analyzes crypto market sentiment, reveals a shift in market sentiment from fear to a more neutral stance, currently reading at 49. This marks a notable improvement from last week’s score of 31, indicating that market conditions have stabilized.

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