The forex market is the largest and most liquid market in the world. It runs 24 hours a day, 7 days a week, all over the world. As if forex is not dynamic enough, cryptocurrencies (like Bitcoin) have added a fascinating new dimension to currency trading. In recent years, many forex brokers have begun to accept bitcoins for currency trading, with some also accepting a larger variety of other digital currencies as well. Should you jump in and begin using your hard-mined bitcoins in the forex markets? In this article, we’ll cover the risks and benefits of trading forex using bitcoin.
- Forex trading involves the exchange of global currencies in the largest and most liquid market around the world.
- In recent years, many forex brokers have incorporated bitcoin and other cryptocurrencies into their offerings.
- While bitcoin forex trades benefit from anonymity and decentralized valuation systems, these can also prove to be downsides as well.
- The single biggest disadvantage to utilizing bitcoin in forex trades may be its high volatility, increasing risk and making results even more unpredictable than normal.
A Standard Forex Trade
Before you consider whether to trade forex using bitcoin, it's helpful to understand how a standard forex trade works. Put simply, a forex trade facilitates the exchange of one currency for another. Imagine you are an American trader betting on the British pound/U.S. dollar currency pair (GBP/USD). You deposit $100 with your forex broker. Assuming the rate of $1 = £0.5, you will receive £50 for your $100. If the GBP/USD rate changes to 0.45, you close the position to 50/0.45 = $111.11. That is, you make an 11.11% profit over your initial $100 deposit.
Most forex trading is done in a decentralized fashion through over-the-counter markets. However, the fact that the forex market is decentralized and bitcoin is considered to be a decentralized digital currency does not mean that the two are equivalent. Indeed, the key distinction is that, though forex exchanges might be done in a decentralized fashion, the currencies themselves are still backed up by central banks around the world. Bitcoin and most other cryptocurrencies do not have that support.
A Forex Trade Using Bitcoin
Now, let’s move on to an example of a forex trade using bitcoin. First, you open a forex trading account with a broker who accepts bitcoins such AvaTrade, eToro or LiteForex. You then transfer 2 bitcoins from your digital wallet to the forex broker’s digital wallet. Assuming the current bitcoin to U.S. dollar rate is 1 bitcoin = $7,500, your deposit of 2 bitcoins is equal to $15,000. Now, assume that you want to take a position in British pounds. If the exchange rate is £0.5 = $1, you will receive £7,500. After some time, the GBP/USD rate changes to 0.45, and you square off your position to get $1,666.65 in your trading account. You have made a tidy 11.11% profit and you are ready to cash out. However, suppose by this time the bitcoin to U.S. dollar rate has changed to 1 bitcoin = $8,500. When you withdraw your money in bitcoins, you receive ($16,666.65/$8,500) = 1.961 bitcoins.
Despite the fact that your bet on British pounds earned you an 11.11% profit (from $15,000 to $16,666.65), the fluctuation in the bitcoin to U.S. dollar rate means that you still sustain a loss of 0.039 bitcoin or about -2.0%. (Initial deposit of 2 bitcoins — 1.961 bitcoins = .039 bitcoin). However, had the bitcoin to U.S. dollar exchange rate changed to 1 bitcoin = $7,000, you would realize a profit from both the forex trade and the bitcoin exchange. In other words, you would have received ($16,666.65/$7,000) = 2.381 bitcoins, a profit of 19.1%.
This hypothetical example illustrates one of the major reasons to exercise caution when considering utilizing digital currencies for forex trading. Even as the most popular and widely used cryptocurrency, bitcoin remains highly volatile relative to most fiat money. This unpredictability means that the risks associated with trading forex using bitcoin are that much greater.
Beyond the exchange rate fluctuations impacting profit and loss, there are other benefits and risks to consider before trading forex with bitcoin.
Benefits of Trading Forex With Bitcoin
- Decentralized Valuations: One major advantage of trading forex with bitcoin is that there is no central bank to randomly change bitcoin valuations. Due to its decentralized nature, the bitcoin rates are free from central geopolitical influence as well from macroeconomic issues like country-specific inflation or interest rates.
- High Leverage: Many forex brokers offer leverage for bitcoin trades. Experienced traders can use this to their benefit. However, such high margins should also be approached with great caution as they also magnify the loss potential.
- Low Deposit Amount: One can start with as little as $25 with some bitcoin forex trading firms. As promotional offers, a few forex trading firms have even offered new members a matching deposit amount through prior special promotions. Traders should take care to check that all brokers are appropriately regulated.
- Low Cost of Trading: Most forex brokers that accept cryptocurrency are keeping brokerage costs very low to attract new bitcoin-trading clients.
- Security: With bitcoin transactions, you don’t need to reveal your bank account or credit card details to deposit or withdraw money. Especially when dealing with foreign brokers, this is a huge advantage in terms of cost and financial security.
- No Global Boundaries: Bitcoin transactions have eliminated global boundaries. Using bitcoin, a trader based in Africa can trade forex through a broker based in the United Kingdom. Regulatory challenges may remain a concern, but if both traders and brokers are willing to transact, then all geographical boundaries are eliminated.
Risks of Trading Forex with Bitcoin
- Different Exchange Rates: Bitcoin trades on multiple exchanges, and exchange rates vary. Traders must ensure they understand which bitcoin exchange rates the forex broker will be using.
- U.S. Dollar Rate Risk: While receiving bitcoin deposits from clients, almost all brokers instantly sell the bitcoins and hold the amount in U.S. dollars. Even if a trader does not take a forex trade position immediately after the deposit, he or she is still exposed to the bitcoin to U.S. dollar rate risk from deposit to withdrawal.
- Danger of Volatility: Historically, bitcoin prices have exhibited high volatility. In the absence of regulations, volatility can be used by the unregulated brokers to their advantage and to a trader’s disadvantage. For example, assume the intraday bitcoin rate fluctuates from $5,000 to $5,300 U.S. dollars per bitcoin. For an incoming deposit of 2 bitcoins, the unregulated broker may apply the lowest rates to credit the trader $10,000 (2 bitcoins * $5,000 = $10,000). However, once the trader is ready to make a withdrawal, the broker may use the lowest exchange rate and instead of the original 2 bitcoins deposited, the trader only receives 1.88679 bitcoins ($10,000/$5,300 = 1.88679 bitcoins). In reality, the unregulated broker may be exchanging bitcoins and dollars at, say, $5,150, and pocketing the difference at the expense of the client.
- Security Risks Inherent to Bitcoin: Deposited bitcoins are prone to theft by hacking, even from the broker’s digital wallet. To cut down on this risk, look for brokers who have insurance protection against theft.
- Risk of Leverage: High leverage is risky for newbie traders who may not understand the exposure. However, this risk is not unique to cryptocurrency forex trading and comes into play in traditional forex transactions employing leverage as well.
- Asset Class Mixing: Cryptocurrency is a different asset class altogether and has its own valuation mechanism. Trading forex with bitcoins essentially introduces a new intermediate currency which can impact profit and loss in unexpected ways. Any money that is not locked down in a trader’s base currency is a risk.
Although cryptocurrencies, like bitcoin, are gaining popularity, there are still many associated risks. In forex trading, dealing in a decentralized currency that offers global transactions with no fees is an advantage. But the tradeoff is essentially adding a third currency to what was a trading pair. Traders who want to take on that risk should use only locally regulated forex brokerages.