New ways of managing, transacting and investing our money continue to emerge as the financial world around us evolves. One major change seen in the last decade has come from the rise of cryptocurrencies (or “crypto,” if you prefer brevity) – digital currencies that lack centralized control but enable frictionless transacting and serve as a unit of account in a democratized financial system.
This compares to the traditional fiat financial system, which relies on central banks and governments to issue and regulate the money supply while also facilitating transactions through an orderly payments system, among other responsibilities. Most countries have their own fiat currency or one pegged to an international reserve currency like the U.S. dollar or euro. When you exchange the fiat currency of one country for that of another on decentralized, over-the-counter markets, you call this a foreign exchange (or “forex”).
There are clear differences and similarities as it pertains to using these currencies for buying and selling goods and services. The same goes for investing: forex trading shares some of the same traits as crypto trading, but there’s also plenty that makes each unique.
This article walks through the market structures and exchanges used in forex versus those used in crypto, as well as the differences in regulatory treatment and other aspects of trading.
The Nature of Crypto vs. Forex
First, it’s vital to understand the nature of these assets.
Both rely on laws of supply and demand to determine their price. But both have different risk profiles due to how they derive value.
“Fiat currencies have a measurable value, [while] cryptocurrencies are purely speculative,” opines Justin Grossbard, founder of CompareForexBrokers.com. A currency has broad-based acceptance as legal tender and use as a common medium. Further, it comes with the backing of a government able to control its supply.
A cryptocurrency doesn’t provide these same functions in that, with precious few exceptions, it fails to qualify as legal tender, doesn’t come with backing from a government, nor comes with control of supply by a central bank. Cryptocurrencies rely solely on shared belief in their value between two parties.
Market Participants
But the nature of these assets isn’t the only difference between cryptocurrency and forex. Who participates in these markets varies as well.
Not only do individual investors engage in trading activity in forex markets, but so too do major governmental and institutional participants:
- Governments play a role, as they need to ensure markets have the right liquidity to achieve their economic goals. Conversely, at present, governments represent minor players in the crypto market, though interest has risen for state-controlled cryptocurrencies.
- Banks and credit suppliers provide much of the liquidity to the market. Grossbard says these participants often play the role of liquidity providers in forex markets because of the need to exchange money on behalf of clients traveling or doing business overseas or individuals investing in foreign securities markets.
- Investment funds can use their excess funds or leverage to speculate or invest in forex.
- Corporations who operate in multiple geographic markets can use forex to hedge against currency fluctuations to protect profits from expected changes in forex valuations.
Crypto markets tend to have smaller players and less institutional or governmental presence.
According to data from Bitcoin Treasuries, a much smaller share of the bitcoin market has holders from governments, banks, investment funds and corporations than forex markets. While bitcoin isn’t perfectly representative of the entire cryptocurrency asset class, by looking at the breakout between market participants who hold bitcoin – the largest cryptocurrency by market capitalization – and those who don’t, we can at least get an idea of how little institutional or governmental organizations are involved compared to forex.
It’s a small number. Less than 8% of all mined bitcoin is held by these investors.
To be fair, this only reflects bitcoin held on balance sheets of publicly traded companies, private firms, institutional investors, banks and governments. More could be held in inaccessible bitcoin, or bitcoin that’s been lost or trapped in inaccessible cryptowallets. But while this indicates a higher percentage of bitcoins possibly held by other non-retail investors, the data still shows an overwhelming skew toward individual investors.
Market Size
Forex markets experience the highest volume of any market in the world. According to the Bank of International Settlements’ most recent triennial central bank survey, as of 2019, well more than $6 trillion traded each day in these over-the-counter markets.
Cryptocurrency markets have exploded in popularity over the past few years, but at the moment, they still enjoy far less volume and activity than forex markets. Total combined daily crypto market volume was $1.3 trillion as of September 2021.
Hours of Operation
Forex markets see daily trading 24 hours per day, 5 days per week. Crypto markets not only see the same type of nonstop weekday activity – that action extends to weekends as well.
Crypto markets remain open 24/7/365; they never close.
- SEE MORE Stock Market Holidays in 2021
Both compare favorably to stock market exchanges, which have predefined hours on weekdays and close on weekends and national holidays.
Market Structure
Where crypto vs. forex trading converges is on how these assets trade: over-the-counter, directly between parties, through a broker or exchange. This means traders negotiate pricing based on supply and demand without governing oversight.
Stocks, on the other hand, trade on organized exchanges like the New York Stock Exchange, Nasdaq or other national bourses, and carry stricter issuance and disclosure rules and guidelines.
Accessibility of Assets
Because these assets all reside in different markets, you might need different brokerage accounts and systems to access them. Some services provide access to one, two or all three.
For example, Coinbase is limited to crypto offerings, while TradeStation and Interactive Brokers allow you to invest in cryptocurrencies, forex and stocks.
If you decide to use an investing app to trade crypto, you might not have the ability to withdraw your cryptocurrencies to cryptowallets, or a secure place to store your private keys tied to your unique coins. If you wish to withdraw your virtual currency to a cryptowallet, dedicated cryptocurrency exchanges such as Binance and Coinbase allow you to do this.
Further still, you can withdraw your virtual currency and load them onto anonymous prepaid debit cards to withdraw funds from ATMs.
Funding and withdrawing money from forex accounts has a more familiar flow: Traders can make ACH transfers from their bank account, make wire transfers, use online checks, or even use credit cards in many instances.
Trading Pairs
Yet another difference between forex vs. crypto trading is the use of “trading pairs.”
- SEE MORE How Is Cryptocurrency Taxed? Here’s What You Need to Know
When you trade one currency for another – say, U.S. dollars for euros – the exchange will show the value of one currency relative to another. Specifically, you’ll be shown how much it would cost to purchase the second currency (called the quote currency) with a single unit of the first (base currency). When trading forex on a currency pair, you buy the base currency and sell the quote currency.
For example, when looking to trade USD for EUR, you might see a quoted price of $1.20 USD to buy one euro. This means for every euro you buy, it costs you $1.20 USD.
In forex, trading pairs that involve the USD are called “currency pairs.” When pairings don’t involve the USD, these are called “currency crosses.”
In crypto trading, technically the same logic applies. Crypto trading pairs, or cryptocurrency pairs, involve trading one crypto for another, such as Ethereum/Bitcoin Cash (ETH/BCH). (Note: Not every crypto can be traded for another currency, fiat or virtual.)
Trading pairs in crypto matter because some cryptocurrencies can only be bought with other cryptocurrencies, making knowledge of these pairs necessary to expand your crypto holdings. This gives investors a chance to arbitrage between trading pairs as well as compare the relative worth of coins.
How Do Regulators View Crypto vs. Forex Trading?
Depending on how an asset is classified, it falls subject to rules and regulations of certain regulatory bodies within the United States and other countries.
The U.S. does not currently provide for comprehensive oversight of cryptocurrencies; instead, it relies on a hodgepodge of regulatory supervision.
Regulators and investors have traditionally seen cryptocurrencies a bit like a bystander witnessing Superman, asking “Is it a bird? Is it a plane?” says Greg King, founder and CEO of Osprey Funds, which offers multiple cryptocurrency funds.
While this asset class has grown at breakneck speed, regulations around it have lagged. But here are some important cryptocurrency regulatory facts:
- In 2014, the U.S. Commodity Futures Trading Commission (CFTC) classified virtual currencies as a commodity. This decision makes cryptocurrencies subject to regulation by the CFTC when used in the context of a derivatives contract or if evidence of fraud or manipulation occurs in interstate commerce. The CFTC regulates cryptocurrencies through the Commodity Exchange Act (ECA).
- The Internal Revenue Service (IRS) treats taxes on crypto much the way they do other capital assets by levying capital gains and losses taxes.
- The Securities and Exchange Commission (SEC) currently remains focused on taking actions against unregistered initial coin offerings (ICOs).
- The Federal Deposit Insurance Corporation (FDIC) recently issued a request for information on digital assets but doesn’t currently insure cryptocurrency deposits for member banks.
- The Securities Investor Protection Corporation (SIPC) doesn’t protect cryptocurrencies held in investors’ accounts in stock trading brokerages because it doesn’t classify as a “security” under the Securities Investor Protection Act, section 78lll(14).
Forex or traditional currencies, on the other hand, meet a higher regulatory definition by classifying not only as commodities, but also as securities, Grossbard says.
- SEE MORE 5 Things You Should Know About Cryptocurrency Before Investing
“Currencies can function as commodities in the sense that traders buy and sell them to profit from exchange rate fluctuations,” he says. “However, they are a security because they are released by a central authority.”
As a result, currencies are subject to several higher levels of regulatory scrutiny, as well as investor protections through FDIC and SIPC insurance.
Historically, for an asset to qualify as a security, it must meet the requirements established by the Howey Test, King says. This test came from a Supreme Court case which sought to determine whether a transaction qualified as an “investment contract.” Under the 1946 Supreme Court ruling, any transactions that constitute an investment contract are a security and are subject to disclosure and registration requirements.
As of now, the SEC states that crypto fails to meet this definition. However, this might change in the future as the Biden administration investigates matters further.
Trading Crypto vs. Forex: Neither Is for the Faint of Heart
Ten years ago, talk of cryptocurrencies remained relegated largely to internet forums and chatrooms as a possible solution to a host of issues that describe our current fiat currency systems: privacy concerns, centralized command and control, theft and fraud and more.
But while these new cryptocurrencies address many of these items, they still serve primarily as an alternative to fiat currencies in our day-to-day lives.
What we will see unfold in the coming years might change how crypto is regulated, issued and traded. Depending on how governments treat the virtual currency class, we could see fewer differences between forex vs. crypto trading – and perhaps more resemblance.
In either case, neither forex nor crypto trading is for the faint of heart as both carry risks related to trading, volatility and complexity. For now, seasoned traders are the best candidates for trading in these markets, as they can employ more risk mitigation techniques and hedge their trades appropriately.
The post Crypto vs. Forex Trading: appeared first on The Network Journal.
