Cryptocurrencies attract traders as an asset on a par with foreign currencies, securities, and commodities. This fact is seen from growing trade volumes ($150 billion daily) and all cryptocurrencies’ capitalization ($200 billion). Though cryptocurrencies are not documented in ISO 10962, traders view (and treat) them on equal terms with conventional financial instruments.
Let’s make a more detailed comparison of both financial instruments and markets they are traded in. Why do this if the world of cryptocurrencies has always been considered a standalone realm with its unique regulations? In March 2020 it became more than obvious that the crypto market is not as independent as it had seemed. In fact, the crypto market did experience the consequences of the stock market crash (though the effect reached this market with a two-week delay), while coins and tokens receded in the same way as stocks, gold, and crude oil.
We should start our series with Forex as cryptocurrencies are pretty similar to conventional currencies. We say ‘similar’ relying on the etymology of the word ‘cryptocurrency’ (cryptographic currency) and purpose of first cryptocurrencies whose names ended with ‘-coin.’
Similarities of cryptocurrencies and fiat currencies
In the beginning was the Word, and the Word was not ‘cryptocurrency.’ It was only introduced in April 2011 by journalist Andy Greenberg in his article ‘Crypto Currency’ published by Forbes. Satoshi Nakamoto, who came up with Bitcoin in October 2008, called his work a peer-to-peer electronic cash system. He relied on the developments of cryptographer Nick Szabo, who in 1998, designed an algorithm for decentralized digital currency titled ‘bit gold’ and the concept of smart contracts. However, before those developments saw the light of the day, the terms ‘electronic cash’ and ‘digital cash’ had been spread by David Chaum. Chaum designed his cryptographic protocols, anonymous payment system, and three types of electronic signatures in 1983 and accomplished them in 1989. At that time, Chaum founded a business named DigiCash and registered trademark eCash.
However, it wasn’t etymology that established the affinity. Enthusiasts started to draw parallels because of the purpose of first cryptocurrencies. Then, the world only knew Bitcoin and its first-begotten alternatives — Namecoin, Litecoin, Peercoin, Primecoin, Gridcoin, and Dogecoin. Every project was a peer-to-peer coin-based payment system powered by its own blockchain, protocol, and distributed network. On the other hand, blockchain platforms allowing creating new tokens, decentralized apps and services — with the help of smart contracts and VMs — emerged in November 2013 with NXT as the trailblazer. Functions of complex crypto projects were not limited to payments though their coins were used for the intended purpose.
Having only discerned the main function and being affected by mass media, people started to compare cryptocurrencies to fiat money. In some countries, people even decided to use the term ‘rate’ (against USD) to measure changes in cryptocurrency prices. It’s more advisable to use the term ‘price’ as there are precisely the prices on exchanges — ask, bid, open, high, low, close, usually indicated in US dollars. Meanwhile, rates relate to foreign currencies and are usually set by the central bank (as an official rate of a foreign currency against the national currency) or by commercial banks and exchange offices at their own discretion (in this case it’s called an exchange rate, buying rate and selling rate). In this context, cryptocurrencies are more similar to exchange commodities that are subject to prices (there is no gold rate or oil rate).
If you still want to regard cryptocurrencies as an analogue of fiat money, it should be noted that not every cryptocurrency type can be a versatile mode of payment and possess properties of quasi-money (or near money). Coins (Bitcoin and altcoins) and stablecoins (considered asset tokens) can be reckoned among ‘currencies’ of the ‘reference instruments’ category per ISO 10962. Here, the ending ‘-coin’ in the cryptocurrency type name suggests whether we need to consider it a currency at all.
Emergence of crypto market and Forex
Satoshi Nakamoto introduced a peer-to-peer payment system to let people mine coins and pay each other by means of electronic cash. Even if he supposed that bitcoins could be traded as a commodity or exchanged for fiat money, he hoped it was the users who would establish the market. It took people almost a year, but they eventually formed the market:
in May 2009, the first marketplace (not an exchange), titled New Liberty Standard, was founded and published the first-ever crypto-to-fiat exchange rate — 1309.03 BTC for 1 USD;
in October 2009, the first seller (Martti ‘Sirius’ Malmi) sent 5050 BTC to the marketplace’s admin (NewLibertyStandard) and received 5 USD to his PayPal account in return;
in March 2010, the first crypto exchange, named Bitcoin Market, was opened, on which bitcoin’s first price — 0.003 USD — was formed;
in July 2010, the second crypto exchange, sadly remembered MtGox, was established.
The history of Forex is rooted in the Age of Discovery. Primarily, the purpose of currency markets was to enable participants in international trade to exchange national currencies and enhance foreign economic ties. The first local market emerged in the 17th century in Amsterdam; the first international currency exchange was tuned in 1704 by the Kingdom of England and the County of Holland. Back then, currency markets only exercised the only function — facilitating goods trade and import-export activities.
By 1913, half of all currency transactions employed pound sterling. When the First World War broke out, the US dollar became the key currency. With the foundation of the IMF and the Bretton Woods system in 1944, the US dollar reinforced its domination. However, it wasn’t until the 1970s that Forex started looking like we know it today and gained a global scale. It has got through the following stages of evolution:
In 1971, Richard Nixon initiated a series of economic measures in the US, during which he cancelled the convertibility of the dollar to gold, abandoned the gold standard, and repudiated the Bretton Woods agreement.
Later, in 1973, the members of the Jamaican conference reached an agreement to use the floating exchange rate instead of the Bretton Woods system.
During the Kingston conference in 1976, IMF member states concluded a new agreement and adopted a new currency system titled the Jamaica Accords.
This is how the global foreign exchange market emerged, featuring floating prices depending on supply and demand. Currencies turned into commodities, and the market started to fulfil two primary tasks — speculation and hedging. Today, Forex is a round-the-clock global market of interbank and OTC deals for those focusing on making money on foreign currency quotes.
Differences between crypto and Forex markets
The core common point between various financial markets is that the principle ‘one party sells, the other buys, the third throws them together’ works in any of them. It’s way more interesting and helpful to study what makes them different as traders use such factors as determinants when choosing where and what to trade.
Organisers and mediators
Cryptocurrency trading is powered by crypto exchanges of three types: centralized exchanges (CEX), decentralized exchanges (DEX or P2P), and hybrid exchanges (HEX). Also, there are some dedicated marketplaces where over-the-counter deals are closed. Neither crypto exchanges nor OTC marketplaces trade with customers or affect prices. The crypto market encompasses thousands of online exchangers whose owners purchase cryptocurrencies (while exchanges never do that) at comfortable prices and then sell them at better. All market participants communicate and interact over the Internet. If a registered company wants to offer fiat as a mode of depositing or withdrawal or use them in currency pairs, it needs to obtain a licence from a regulatory authority.
There are very few purely-currency exchanges on Forex; more prevailing are versatile exchanges that feature a wide choice of financial instruments. In most countries, there is no profiling under which exchanges are divided into currency, stock, or commodity. Such jurisdictions use just exchanges on which everything can be traded. Banks, investment firms, brokers, and dealers have been operating in that market for long. They can be trade parties, mediators for major investors eager to edge into Forex and other markets. Regardless of the function, all organisers and intermediaries must obtain a licence from a financial authority.
One can refer to monitoring and ranking websites to see the daily trade volume of a specific cryptocurrency. For instance, on 9 April, CoinCap registered the bitcoin trade volume of $30,680,645,645 and ether trade volume of $14,135,240,666. These figures are based on trade data crypto exchanges regularly provide. The crypto market’s total trade volume on that day amounted to $125.8 billion.
It’s impossible to estimate trade volumes on Forex as there is no accountant keeping track of all deals in such a large market. As long as there are few currency-only exchanges and operations are mostly over-the-counter, forex mediators only show traders the tick volume. The latter is not a real or even provisional volume parameter: in fact, it reflects how many times the price changes within a specific period — thus working as an oscillation counter. But, rounded analytical data suggest that in 2010, the daily turnover amounted to some $4 trillion, and it had reached the bar of $10 trillion by 2020.
The crypto market is less liquid as not all cryptocurrencies can be freely exchanged with each other or fiat currencies. Liquid cryptocurrencies will probably only count half a thousand, while the other 5 thousand ‘shitcoins’ and tokens remain unsolicited and burden portfolios.
Forex is the most liquid market as convertible national currencies are being traded on it. Any order in a book is executed almost instantly thanks to limited diversity (180 currencies in 206 states). If every 100-thousand-plus city issued an original currency, only 206 ‘capital’ currencies out of imaginary 4 thousand would be liquid.
The crypto market has become one of the most volatile due to its legal and regulatory uncertainties and price instabilities. All this is a benefit for traders and investors but a problem for users expecting coins to be accepted ubiquitously. Here are the indicators for this year: for 1.5 months since 1 January, BTC price has gained 43.2%, and during the Black Thursday’s market crash (12 March), it fell by 37.2% in just a day. Most tokens occasionally yield 2-4-time profit or loss.
Forex usually doesn’t experience 10-percent drops or jumps — such cases only happen in crises and concern national currencies of developing countries. For instance, over the same 1.5-month period from the beginning of the year, the GBP/EUR quote has increased by 1.9% but then lost 6.0% during the 10-day downturn from 9 to 19 March.
Considering high volatility, crypto exchanges provide traders with a short leverage, usually 3x or 5x. Also, many exchanges started to introduce a P2P loan service where users can provide a leverage to each other.
Forex doesn’t offer such a feature, and only intermediaries can help their customers there. But, middlemen can offer larger leverages, lending for margin trading 20 or even 200 times more funds than the amount of collateral on the balance. However, such generosity may turn into an account blow-up due to a margin call.
The main difference between the crypto market and other markets lies in the following principle. In ordinary trading with spot deals, a seller going to sell some coins must use their own coins to deposit to their account on a crypto exchange, i.e. send them to the exchange’s wallet (crypto address). When a counter order emerges, after its execution the exchange will immediately transfer those coins to the buyer’s balance. Later, the buyer will be able to withdraw them to their address by request — cryptocurrency will be supplied. We don’t concern cryptocurrency derivatives in this context. They constitute a submarket that is only in infancy so far.
Let’s clarify one important technical thing. In fact, coins are not transferred anywhere from the blockchain. They appear when a block is generated and added to the chain, and stay there forever. After that, the information on a coin right handover is sent to all network participants. People are just more used to saying ‘send coins’ and ‘receive coins’ (again the analogy with money). Remaining in the same place — in previous chain blocks, coins only change their owners (not always in a whole but in small portions). In this context, cryptocurrencies resemble real estate property, as if it could be sold and bought by square inch. Almost like owner data are updated in cadastres, new entries appear in blockchain, saying that the balance of the sender’s address decreased, for example, by 0.5001 BTC, and the balance of the recipient’s address increased by 0.5 BTC (and the address of the miner who confirmed the transaction increased by 0.0001 BTC).
The point is not in the blockchain’s specifics but in the fact that coins purchased on the crypto exchange instantly become the buyer’s property. Though they are temporarily stored on the exchange’s wallets (with the respective amount displayed in the account), the buyer has the right to dispose of coins as they like, for example, withdraw them from the exchange. To do so, they need to click Withdraw; after that, the exchange would send the specified number of coins (minus withdrawal fee) to the user’s wallet. Technically, in this cryptocurrency’s blockchain there would appear an entry informing that the balance of the exchange’s address decreased and the balance of the user’s (new coin owner’s) address increased.
Virtual foreign currencies
On Forex, it’s only banks that really exchange foreign currencies, but also transnational corporations concerned with importing and exporting goods buy and sell foreign currencies through exchanges for hedging. They are direct trade parties. Such operations always include interim conversion into hard currencies (USD, EUR, GBP, JPY, CHF, CAD, AUD) or CLS’s clearing currencies (they have 18 kinds including hard currencies).
Also, exchanges handling real currencies engage accredited investors (not directly though but through brokerage firms and investment funds). Mediators, in their turn, should be regarded as accredited institutional investors. They just manage their clients’ assets for a commission rather than sell them the currency purchased on exchanges. They all come to Forex not to speculate on currency quotes but to diversify the risks occurring in the stock and commodity markets. No need to jump from exchange to exchange: everything can be handled on one — versatile — exchange.
Those millions of private forex traders speculating in standard ways, by bid-ask spread, and by scalping, work with contracts for difference through dealers and dealing desks. Such trading doesn’t concern any supply as neither of the parts concludes spot deals — thus nobody contacts with the currency. This is a parallel or virtual submarket inside the market, that is, a market of derivatives inside the foreign exchange market. However, ISO 10962 suggests that derivative financial instruments are grouped in different categories by specifics rather than affiliation to a particular financial market.
Thus, private forex traders play against a dealer and each other, without entering the exchange. Closing deals, for example, with the SGD/HKD pair, they gain profit or suffer losses, but Singapore or Hong Kong dollars are not transferred to the accounts (of traders or dealers). Instead, the accounts are opened and kept in the US dollar, euro, or local currency. With that, not all dealers buy that real currency — that private clients virtually trade — from brokers. There are very few market makers, and usually orders only make various currencies even more liquid.
It’s worth noting that individuals, who trade through broker terminals in the stock and commodity markets, don’t get stocks or gold in hand. They feel comfortable with earning on derivatives. It’s only the crypto market where participants trade ‘real commodities’ (not physical but digital) that can be brought in and withdrawn in another form. Such accessibility and simplicity relieve cryptocurrency traders and investors from resorting to brokers and dealers. The gate (website) of any crypto exchange is always open for everyone.