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R-star: Is Bitcoin Price Feeling Heat of a Rising Real Neutral Rate of Interest?

Last Updated October 12, 2023 2:15 PM
Josh Adams
Last Updated October 12, 2023 2:15 PM
Key Takeaways
  • The Federal Reserve left interest rates unchanged in September as the U.S. grappled with inflation.
  • Despite inflation slowing, could interest rates remain higher than we expect?
  • A key economic indicator puts big, flashing question marks above Bitcoin’s future trajectory.

U.S. Federal Reserve interest rates have been on a wild run since the financial crisis of 2008, with big implications for Bitcoin. The central bank had them near zero between 2008 and 2015, then gradually raised rates to around 2.5% by 2018 before cutting them back down to near zero again in 2020 due to the Covid-19 recession.

Then from 2022, the Fed raised rates ten consecutive times, a pace not seen since the 1980s. But with economic headwinds buffeting the U.S. and global economy, experts are speculating whether the R-star, the “natural” interest rate, may remain elevated for some time. A picture that might not look great for bitcoin.

What Is the R-Star? And What About Bitcoin?

The so-called R-star is used to determine the appropriate level of interest rates to achieve economic stability. Generally, higher interest rates tend to have a negative impact on Bitcoin prices.

Therefore a higher R-star—the theoretical benchmark that, when achieved, should result in full employment, stable prices, and sustainable growth—should be bad for Bitcoin. But how do we know where to look?

Economists are forever trying to gauge this R-star figure—the “natural” interest rate that keeps inflation steady and the economy humming. Arguably, it’s more art than science, with some trial, and error, and educated guesses mixed in.

Two graphs illustrating the historical R-star for the United States.
Two estimates for the R-star in the United States. Source: Federal Reserve Bank of New York

R-star fluctuates based on economic conditions. When growth booms, R-star often rises since demand for loans and investments grows, pushing up equilibrium rates. If people expect high inflation, R-star may climb, too, as lenders want higher rates to offset eroding purchasing power. Productivity gains and potential growth can also boost the figure.

Central banks try to match policy rates to R-star to balance stable prices and full employment. If inflation drops too low, they may cut rates below R-star to stimulate spending.

Conversely, high rates restrain the economy and can lower inflation. So policymakers aim to estimate and track R-star, adjusting rates when needed to meet their mandates.

What Does the R-Star Have to Do With Bitcoin?

However, an analysis  out this month from RSM suggests this key economic indicator may be tilting upwards. According to their estimation, R-star has risen to between 1.75% and 2%. The Federal Reserve Bank of Richmond puts the figure higher at 2.2%. A lot higher than the 0.5% it sat around for much of the past 15 years.

But why does this matter?

A rising “real neutral rate” or R-star means that risk-free interest rates are expected to stay significantly above the rate of inflation over time. This is problematic for Bitcoin for several reasons. 

First, it makes holding U.S. dollars in safe assets like Treasury bills more attractive, as they offer a real positive return. This provides unwanted competition with Bitcoin’s appeal as a store of value. Why rely on Bitcoin when low-risk, traditional investments can compete?

Second, Bitcoin’s security over the long term likely depends on generating sizable transaction fees. But with high real interest rates, the incentive to hold dollars rather than transact in Bitcoin increases. 

That could starve Bitcoin of the fee revenue needed to sustain its network security as block rewards decline with each halving. Dan Smith of Blockworks Research has estimated  that for fee generation to fully replace the current level of block rewards, Bitcoin would have to trade at $750,000. (It is currently trading at $21,800—so a little way to go yet.)

A Question Mark Over Bitcoin’s Price

In economics, there is generally an inverse relationship between interest rates and inflation. When interest rates are high, borrowing becomes more expensive, and people and businesses tend to spend less. So, positive real rates suggest that damaging hyperinflation is less imminent. 

Could a rising R-Star put negative pressure on bitcoin's price?
Annual expenditure of the United States government from 2009 to 2023, by quarter(in trillion U.S. dollars). Source: Statistica

So while profligate U.S. spending may seem bullish for Bitcoin at first glance, the likely policy response of higher real interest rates curbs Bitcoin’s upside potential. At least for now, a rising R-star dims Bitcoin’s trajectory by making the competition – holding dollars – more compelling.

At least, that’s the theory of Byron Gilliam  in Blockworks. With the Fed pumping $6 trillion into the economy for the pandemic, and the U.S government spending rising to 9.45 trillion  in Q2, the stars looked aligned for bitcoin’s price. But with another star—the natural interest rate—ticking upward, Bitcoin’s future potential may well be in question.

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