Turn in US Fed interest rate cycle could drive Bitcoin rally forward

Investors with high risk appetite may take 2-5% exposure in their portfolios to this volatile, unregulated asset

Bitcoin, the premier cryptocurrency, is once again attracting investor interest. After a dramatic plunge in value last year — from $66,935 on November 10, 2021 to $16,652 on November 21, 2022 — this digital asset is now witnessing a resurgence, with its price rallying to around $ 29,000 currently.

Expectation of change in Fed policy driving rally

The US Federal Reserve (Fed) is close to the end of its rate hike cycle. Several regional banks in the US have failed, commercial real estate is struggling, and homebuyers are having a hard time paying their mortgages. “Due to all these factors, market participants expect the Fed to pause and then start cutting interest rates, perhaps even do quantitative easing. Such a scenario will be positive for Bitcoin,” says Arjun Vijay, chief operating officer, Giottus Crypto Platform.

Bitcoin halving, which occurs approximately once every four years, reduces the amount of Bitcoin released from each block by half. The next halving on April 27, 2024 will reduce it from the current 6.25 to 3.125. “The supply of Bitcoin will get reduced. If demand for it keeps increasing, its price will rise,” says Parth Chaturvedi, lead-crypto ecosystem, Coinswitch.

Regulatory risks remain

Risks arising from regulations, especially in the US, could hamper the rally. “The US Securities and Exchange Commission (SEC) has taken a strict stance due to which market liquidity has reduced,” says Chaturvedi.

According to Abhishek Kumar, a Securities and Exchange Board of India or Sebi-registered investment advisor (RIA) and founder, SahajMoney, “As long as cryptocurrency as an asset is not brought under regulatory oversight, uncertainty on this count will linger.” He adds that in the extreme event of a crackdown by the major economies, the entire investment could get wiped out.

Vijay, however, believes the US government is unlikely to act strongly against cryptocurrencies, given that the SEC gave its approval for crypto exchange Coinbase’s initial public offering (IPO), and a large number of customers in the US own cryptocurrencies.

Kumar adds that cryptocurrencies are like illiquid stocks with low float and low volumes. “Investors are at risk of falling prey to pump and dump frauds,” he says.   

The rally in Bitcoin could also stall if inflation doesn’t moderate, forcing the Fed to keep interest rates high even in the latter half of 2023.

Is this a good time to enter?

One oft-repeated advice in investing is to avoid catching a falling knife. When Bitcoin fell from $60,000 plus to $30,000, many people bought it. However, several such buyers panicked and sold their holdings when it fell below $20,000. However, now that the price has bottomed out and is on an uptrend, investors may consider entering it.

Limited, staggered exposure

Even though Bitcoin is more expensive than other cryptocurrencies, it is the safest. “Bitcoin should constitute the bulk of your cryptocurrency portfolio. Buy a fraction of a Bitcoin rather than go for a lower-priced meme coin, which would be much riskier,” says Vijay.

He also suggests limiting exposure to cryptocurrencies to 2-5 per cent of the total investment portfolio. Investing only a small portion of your total portfolio in cryptocurrencies will enable you to avoid panic selling amid extreme volatility.

Invest in tranches to average out the purchase price. “Doing so will also give you an opportunity to correct any investment mistakes you may have made,” says Vijay.  

The bulk of your crypto portfolio should be in the form of long-term investments of at least five years. Avoid trading as it adds to risk.

Older investors who held onto their cryptos during the crash should continue to do so. “However, clean up your portfolio by enhancing the allocation to fundamentally sound cryptos,” says Vijay.

A March 7 notification of the Finance Ministry declared entities dealing with virtual digital assets to be ‘reporting entities’ under the Prevention of Money Laundering Act (PMLA). Such entities must maintain KYC (know your customer) details of clients. This has made it all the more important for investors to stick to exchanges that carry out KYC meticulously.

Chaturvedi suggests going with an exchange that makes tax deduction at source (TDS) and tax filing easier for investors.

Cryptocurrency Tax Primer
 

• Under Section 194S of the I-T Act, 1961, a person paying a sum to a resident as consideration for the transfer of a virtual digital asset (VDA) must deduct tax at the rate of 1%
• Profits from trading, selling or swapping cryptos will be taxed at 30% (plus 4% cess), irrespective of whether they are business income or capital gain
• Certain transactions will be taxed at applicable slab rates: receiving cryptocurrency as gift or drawing a salary in cryptocurrency
• The new ITR forms (2 and 3) have a dedicated section named “Schedule VDA – Income from transfer of Virtual Digital Assets” for reporting gains from VDAs

(Source: RSM India)