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Forex vs Crypto Assets

14  October 2020 | ZebPay Trade-Desk

While the Forex market has been around, and operational for decades on end, the Crypto markets are incredibly young, and deal with only digital assets.

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Understanding the Forex Market: 

The Foreign Exchange (FX) market transacts in government issues currencies. It is operational 24 hours a day (excluding CFD FX market), five days a week.

It is undoubtedly, the largest trading market in the world, with average daily trade volumes upward of $5 trillion USD. There are a range of participants in the FX market, such as Banks, FI’s,  businesses and retail investors. These players main aim is to exchange national currencies either as a means of business, or to book short term profits to arbitrage and trading. It was in the late 1970s, though, that institutional investing and retail investors saw an opportunity to make good ROI’s in this space, and came to dominate this market. Then, the advent of internet trading in the ’90s has made Forex more accessible and more automated than ever, and this allowed the FX market to surge and become as large as it is today. 

A peculiar aspect, as well as an USP of this market is that most of the Forex market is OTC, unlike stocks which are primarily traded on exchanges.  This allows traders to negotiate amongst one another, without any governing authority over them that guarantees the trades. Once terms and conditions are established, a broker facilitates the trade, on behalf of the client. 

The nature of the FX marketplace has attracted traders for many years. The FX market is known to be volatile, and very fast paced. More often than not, this volatility provides opportunities for a lot of money to be made. The degree of volatility is derived from political and economic news, as the strength of a nation’s economy, as well as its international relationships, weigh heavily on the value of its currency against others. Hence, it is fair to say that macro factors impact these markets to a large extent. For this reason, both technical analysis, through charts and complex models, but also fundamental research play a key role in the minds of traders and investors, as this market is both complex but uncertain.

Understanding the Crypto Market: 

As mentioned above, the Crypto market is quite young, but has seen a lot of traction over the past decade. It exclusively deals with digital assets. It operates 24 hours a day, seven days a week. In this case, much of the trade is done through exchanges, though OTC is fast developing.

Crypto assets and token’s started trading with Bitcoin (BTC), in early 2009. The first few exchanges opened a few years later. Soon, with the advent of different altcoins, a vast ecosystem of trading different digital assets quickly blossomed, as the number of exchanges boomed. Today, the crypto market witnesses daily volumes upward of approximately $100 billion, and a majority of that chunk flows through exchanges. These exchanges are open 365 days a year, however, trading regulations on many of these platforms can vary wildly due to different parts of the world having different rules and attitudes concerning digital assets and how they are governed. 

The digital assets market place is known for its volatility, and the scope it entails for manipulation. However, just like the Forex market, the volatility is seen as an opportunity by many. While the market is susceptible to industry news and scams, in general, cryptocurrency markets are less affected by global events or traditional financial markets. Traders are less likely to be scanning headlines and more likely to be paying attention to charts and technical analysis, as presently, crypto assets are largely seen as a trading tool not an investment avenue. This however, has been fast changing, as these markets develop further, awareness improves, regulations set in place, and infrastructure around it is built. 

How do the Forex and Crypto Markets Pit Against Each Other?

Key Differences:

  • Forex trades happen primarily through the mean of OTC, while majority of Crypto trades happen through exchanges. OTC trading offers global liquidity, but trades usually are facilitated by a broker. The exchange however acts as the singular authority over buying and selling and usually has a fixed rate (or rate structure) that will always apply to trades. Hence, no negotiating takes place on exchanges.
  • External, macroeconomic factors tend to bear a more significant impact on forex pairs, that on crypto pairs.
  • Traditional currencies (fiat) can be pegged to an asset, other currencies or nothing at all, but they are highly regulated by governments and central banks. Systems are defined, and interactions are well established. For digital assets, virtually none of them are well regulated, and the future of how legislation will develop is uncertain.
  • Cryptocurrencies however are relatively new, hence to some extent undefined. None of them are tied to a particular nation or bank. Some of them are pegged to other assets, most of them are not, and they rely on their own utility to derive value. The intrinsic usefulness of a digital asset can vary, and in a competitive market multiple projects strive to serve the same niche.

Key Similarities:

  • Ultimately, both these markets deal with currencies, are fast-paced and volatile, and both rely on modern-day communications technology in order to operate.
  • To a large extent, both markets aim to serve  a variety of players ranging from individuals to massive financial institutions, all of whom are either conducting regular business or attempting to earn a profit on volatility and spreads.
  • One other major connection between these two markets is the importance of internet technology. Though Forex started before the internet age, it has exploded as a result, and today, the internet is the primary way that these trades are executed. Cryptocurrency just takes this one step further, as it only exists in the digital realm, and without it, digital assets wouldn’t exist. 

How do they compare – Investment Analysis

Crypto finds a place in trading and investment books both as a medium of exchange or capital and store of value. While a forex pair drives its value from macroeconomics and geopolitical factors, a crypto asset can drive it’s value from few other factors along with these, for ex. USDT (tether) will be affected by factors affecting USD as well as crypto specific factors.

With that said we would like to focus on where traditional crypto assets find a place in trading books or investment books relative to forex. We look at the volatility of crypto currency and forex pairs.

USD/INRDollar IndexBTC/USDETH/USD
1 Month Vol0.26%0.32%2.03%4.47%
1 Year Vol0.38%0.44%5.33%7.10%

We see here as a point of difference that crypto currency showed high volatility historically, which then would lead to question about how much these assets have returned over the past, over the period for which we look at volatilities. We see BTC has gained 36%, ETH has gained 105% vs USD. So, higher volatility makes crypto a fit into a trading book giving tactical opportunity to make profits while high gains makes it an attractive addition to investment books subject to the risk appetite of investment managers.

Next feature we look at is whether crypto inherently provides for some diversification benefit, we test this by looking at correlation of USD/INR, BTC/USD, ETH/USD with the dollar index over recent month, recent year  and recent three years.

USD/INRDollar IndexBTC/USDETH/USD
1 Month Cor25.58%100.00%-52.26%-69.07%
1 Year Cor22.99%100.00%-5.39%-6.27%
3 Year Cor20.04%100.00%-4.60%-5.81%

Though over the recent month both pairs show high negative correlation with dollar index , over longer horizons the correlation with dollar index is a weak negative. This low correlation over longer horizons makes crypto assets an attractive addition as an alternative asset to portfolio. 

This analysis would be incomplete without discussion of stable coins such as USDT (tether) or DAI or PAXG, the crypto assets whose value is more or less pegged with traditional assets(ex. USD), such a coin delivers the exposure to an asset with which it is pegged along with benefits of crypto assets. This adds an avenue combining traditional assets with crypto for investment managers and as an arbitrage opportunity for trading managers in the initial days.

Conclusion

A question that one might ask themselves, is which market is a better place to trade in?

While the Forex market offers more built-in stability, as well as an industry with deeper roots, more infrastructure and clear regulation, the crypto market offers potential for massive returns that would be unlikely to be found by investing in traditional currencies. There is however the element of higher volatility, and unclear regulation that one must take into account in the crypto marketplace. 

Hence it all depends on an individual’s risk appetite, and ultimately boils down to which trading environment suits a trader more. However, many traders choose to be a part of both these markets. The key to being successful is by staying educated in order to make the best trading decisions and hopefully stay ahead of the curve and make the most informed decisions.

References:

https://trading-education.com/
https://cointelegraph.com/
https://news.bitcoin.com/

Disclaimer : This report is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation or needs of any investor. All investors should consider such factors in consultation with a professional advisor of their choosing when deciding if an investment is appropriate. The Company has prepared this report based on information available to it, including information derived from public sources that have not been independently verified. No representation or warranty, express or implied, is provided in relation to the fairness, accuracy, correctness, completeness or reliability of the information, opinions or conclusions expressed herein. This report is preliminary and subject to change; the Company undertakes no obligation to update or revise the reports to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events. Trading & Investments in cryptocurrencies viz. Bitcoin, Bitcoin Cash, Ethereum etc. are very speculative and are subject to market risks. The analysis by Author is for informational purposes only and should not be treated as investment advice.

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