What happened

Shares of many crypto-related stocks were struggling today, along with the broader market. As of 12:45 p.m. ET today, the Dow Jones Industrial Average traded more than 900 points down, while the Nasdaq Composite had fallen nearly 4%.

At the same time, shares of the large cryptocurrency exchange Coinbase Global (NASDAQ:COIN) had fallen more than 11%, while shares of the Bitcoin (CRYPTO:BTC)-mining company Riot Blockchain (NASDAQ:RIOT) and the crypto bank Silvergate Capital (NYSE:SI) traded more than 8% and roughly 5% lower, respectively.

So what

All of these companies trade in a correlated fashion to the broader cryptocurrency market and Bitcoin, the world’s largest cryptocurrency. Now below $34,000, Bitcoin has been getting absolutely hammered, down nearly 100% from early November.

There’s a lot going on in the crypto world right now. Russia is thinking about banning crypto trading and mining in the country, and the Federal Reserve has discussed the possible creation of a central bank digital currency, which some see as competition.

Investor looking at falling stock charts.

Image source: Getty Images.

But I think the main culprit behind the sharp sell-off is the same thing crushing the U.S. stock market right now: the Federal Reserve. Several months ago, the chances of the Fed raising its overnight benchmark lending rate in March seemed unlikely. Now, there seems like a very good chance it happens.

Not only that, but the Fed has been tapering the tens of billions of additional monthly bond purchases it started doing at the beginning of the pandemic in order to support the economy in the face of a severe downturn. On top of all of this, the Fed has spoken about reducing its balance sheet once it ends its additional bond purchases and starts hiking rates. In doing so, it would effectively be removing liquidity from the economy, a sharp reversal from the massive amount it has been pumping in.

On Wednesday, the Fed’s rate-setting Federal Open Market Committee will release a new statement that may provide hints about how it is thinking about interest rate hikes and shrinking the Fed’s balance sheet, which the market will be watching very closely. The last time the Fed tried to shrink its balance sheet in 2019 did not exactly end well, leading to an abrupt rise in short-term interest rates. However, the economy is in a much different place than in 2019 and the Fed now has that experience in its pocket.

“The Fed is definitely sensitive to the equity market, but I don’t think it changes anything for the meeting,” Peter Cramer, head of insurance portfolio management at SLC Management, recently told Reuters. 

Cramer added, “If the sell-off leaks to the broader economy and starts to impact the energy, banking, consumer cyclical type names, then I think the Fed would question their path a little bit.”

Now what

There is a lot of debate over whether or not Bitcoin can hedge inflation. So far, it has acted like the other tech and growth stocks currently getting hammered. But ultimately, while it will probably continue to stay volatile, I think Bitcoin is certainly here to stay.

Furthermore, I do see this recent dip as a buying opportunity for stocks like Silvergate and Coinbase. Silvergate is actually positioned to benefit from rising interest rates, and Coinbase is diversifying revenue so it is not as heavily correlated to the movement of Bitcoin.

Riot is heavily tethered to the price of Bitcoin but is based in the U.S., which I think removes some of the regulatory uncertainty it would face if it were in a foreign country.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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