Market Wrap: Cryptos Recover From Drop After Fed Rate Hike; Expect Higher Volatility

Most cryptocurrencies traded higher over the past 24 hours, albeit with large price swings after the U.S. Federal Reserve raised interest rates for the first time since 2018.

The Fed also boosted its inflation forecasts and signaled plans to raise interest rates in similar increments six more times this year. Low rates and central bank stimulus have contributed to rallies across speculative assets, including cryptocurrencies.

Bitcoin (BTC) fell about 3% immediately following the Fed announcement, but quickly pared losses toward the end of the New York trading day. Similar price moves were seen in the S&P 500, while Treasury yields and the U.S. dollar pared earlier gains.

The central bank also announced that it will reduce its balance sheet of bond holdings "at a coming meeting," not specifying whether it will happen at the next meeting in May. Over time, analysts expect higher volatility and lower market returns as a result of tighter monetary policy.

Meanwhile, on Wednesday, Ukrainian President Volodymyr Zelenskyy legalized crypto in the country. The law determines the legal status, classification, ownership and regulators of virtual assets. Ukraine has received at least $100 million in crypto donations over the past three weeks from people who want to support its defense and help fund humanitarian efforts.

In crypto markets, many alternative cryptocurrencies (altcoins) outperformed on Wednesday, suggesting a greater appetite for risk among traders. Chainlink's LINK was up 5% over the past 24 hours, compared with a 10% rise in SAND and a 2% gain in BTC.

The chart below shows elevated BTC implied volatility versus realized volatility, which means bitcoin traders have positioned themselves for an increase in price swings over the past week.

Lately, there has been large demand for longer-dated options toward June-December, coupled with increased activity in ETH put options, according to QCP Capital, a Singapore-based crypto trading firm. QCP expects BTC's volatility curve to steepen after the Fed decision as traders discount short-term price price swings.

The options market has placed a 52% probability that BTC will trade above $38,000 in April, according to Skew data.

Bitcoin's 90-day correlation with the overall crypto market is near all-time highs, which makes it difficult for investors who want to diversify across tokens.

Generally, altcoins outperform during bull markets because they have a greater risk profile relative to bitcoin. And during down markets, bitcoin outperforms as investors reduce their exposure to risk. So, when correlations are high, there is less opportunity to reduce volatility in a crypto portfolio, which is why some traders have remained on the sidelines.

Rising correlations "paint a picture of an overall risk-averse sentiment in the market," Arcane Research wrote in a recent report. "In the summer of 2020, the correlation was headed downwards, caused by bitcoin's strength compared to altcoins. The correlation bottomed in Jan. 2021, before it grew as altcoins began moving more inline with bitcoin."

Since cryptos have moved in the same direction over the past year, there is less desire among traders to rotate into altcoins, according to Arcane Research. That could enhance bitcoin's outperformance relative to altcoins.

Digital assets in the CoinDesk 20 ended the day higher.

There are no losers in CoinDesk 20 today.

Sector classifications are provided via the Digital Asset Classification Standard (DACS), developed by CoinDesk Indices to provide a reliable, comprehensive, and standardized classification system for digital assets. The CoinDesk 20 is a ranking of the largest digital assets by volume on trusted exchanges.