Theforexmarket is the largest and most liquid market in the world. It's a truly global currency market that is open 24 hours a day, seven days a week.
As ifforexwere not dynamic enough,cryptocurrencieslikebitcoin have added a fascinating new dimension to currency trading. Many forexbrokers accept bitcoin, with some accepting a variety of other digital currencies.
Should you jump in and begin using your hard-minedbitcoinsin theforexmarkets? Find out the risks and nuances first.
Key Takeaways
- The forex market is dedicated to trading in the world's currencies.
- Many forex brokers now accept bitcoin and other cryptocurrencies.
- Bitcoin trades benefit from the anonymity and decentralized valuation system the currency represents.
- They add a new layer of risk to forex trading, exacerbated by the extreme volatility of cryptocurrencies.
A StandardForexTrade
Before you consider whether to trade forex using bitcoin (BTC), it's helpful to learn more about conventional forextrades. A forex trade is simply exchanging one currency for another at its current rate. Traveling to another country and exchanging your currency for local spending money is the same thing, but forex traders are trying to make money off the continual fluctuations in the real value of one currency against another.
Trading a "Pair"
Trading a pair is the term for trading a pair of currencies. For instance, you would be trading a pair if you traded on the British pound/U.S. dollar currency pair (GBP/USD). Here's how a scenario might work.
You deposit $100 with aforexbroker. Assuming the rate of $1 = £0.5, you will receive £50 for your $100. If the GBP/USD rate were to change to 0.45, you could close the position at 50/0.45 = $111.11. So, you've made an 11% profit just by exchanging dollars for pounds.
AForexTrade UsingBitcoin
Now consider an example of aforextrade usingbitcoin. First, you open aforextrading account with a broker who provides crypto/fiat pair trading. These includeCoinbase, eToro, andGemini.You then transfer your BTCfrom yourdigital walletto theforexbroker’s.
Assuming the currentBTCto U.S. dollar rate is 1BTC= $7,500, you deposit 2 BTC, worth $15,000. Now, imagine 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 and receive $16,666.67 in your trading account. You have made a tidy 11.11% profit from your 2 BTC, and you are ready to cash out.
If you want to trade using bitcoin, it's best to use only a locally regulatedforexbrokerage. Also, avoid using leverage until you know what you're doing.
Recognizing Profits and Losses
One key difference between trading only currency pairs and using cryptocurrency to trade forex is realizing profits and losses. Bitcoin is traded as an asset, so its market and realized values can differ depending on the circ*mstances.
Market Value After Reconverting to Bitcoin
So, using the previous example with the end result of $16,666.67, suppose that thebitcointo U.S. dollar rate changed to 1BTC= $8,500. When youwithdraw and convert your funds to bitcoin, youreceive ($16,666.67/$8,500) = 1.96078 bitcoins.
Despite the fact that your bet on British pounds earned you an 11.11% profit (from $15,000 to $16,666.67), the fluctuation in thebitcointo U.S. dollar rate means that you sustain a loss of 0.039 BTC(initial deposit of 2BTC— 1.96078 BTC= .039 BTC). However, it's important to note that you haven't lost any fiat value yet.
Next, imagine thebitcointo U.S. dollar exchange rate instead changed to 1BTC= $7,000. You would have received ($16,666.67/$7,000) = 2.381 bitcoins. As misleading as this seems, you haven't gained monetarily from the exchange.
This is because when you make the conversion to BTC, you have lost or gained bitcoin compared to your previous transactions, but your profit (in dollars) remains the same, $1,666.67:
- 2 BTC x $7,500 = $15,000
- Profit from GBP to USD = $1,666.67
- Total = $16,666.67
If BTC climbs to $8,500 and you exchange your money for bitcoin:
- 1 BTC = $8,500
- $16,667.67 ÷ $8,500 = 1.96078 BTC
- 1.96078 BTC x $8,500 = $16,666.67
If BTC dropped to $7,000 and you exchange your money for bitcoin:
- 1 BTC = $7,000
- 2.381 BTC x $7,000 = $16,666.67
So, no value is lost. However, the situation changes if you hold your bitcoin.
Market Value Change While Holding
Only when you exchange your BTC for dollars again can you actually calculate your profit or loss.
Using the above scenario, you repurchase bitcoin after making the initial profit of $1,666.67 at a market price of $7,500. You would have 2.222 BTC. You decide to hold it and sell it later, and the market price increases:
- $16,666.67 ÷ $7,500 = 2.222
- Market value increase to $8,000
- 2.222 BTC x $8,000 = $17,777.78
Now you have a profit because you've realized (converted BTC to money) a gain of $1,111.11.
Investors "realize" gains or losses when they receive money for their asset. Think of it as making the gain or loss "real." The asset goes from market value to real value when it is sold, so it is realized, or made real.
Increased Unpredictability
This hypothetical example illustrates the big reason to exercise caution when using digital currencies for forex trading. Even the most popular and widely used cryptocurrency, bitcoin, is highly volatile compared to most traditional currencies. For instance, bitcoin spot prices ranged from $35,166.20 on Nov. 14, 2023, to $37,879.93 on Nov. 15, 2023. One day later, it was down to $36,197.39. The quick and wide price variations can mean quick losses but also quick profits.
This unpredictability makes the risks associated with trading forex using bitcoin much greater because the bitcoin-to-fiat currency exchange rate changes so quickly.
Beyond the exchange rate fluctuations impacting profit and loss, there are other benefits and risks to consider before tradingforexwithbitcoin.
Benefits of TradingForexWithBitcoin
- Decentralized Valuations: A major advantage of tradingforexwith bitcoinis that bitcoin is not tied to a central bank. Digital currencies are free from central geopolitical influence and from macroeconomic issues like country-specificinflationorinterest rates.
- High Leverage: Many forexbrokers offerleverageforbitcointrades. Experienced traders can use this to their benefit. However, such highmarginsshould also be approached with great caution as they magnify the potential for losses.
- Low Deposit Amount: A trader can start with as little as $25 with somebitcoinforextrading firms. A fewforextrading firms have even offered promotions like a matching deposit amount.
- Low Trading Costs: Manyforexbrokers that accept cryptocurrency offer low costs to attract new clients.
- Security: You don’t need to reveal your bank account or credit card details to make a bitcoin transaction on decentralized exchanges. This is a big advantage in terms of cost and financial security.
- No Global Boundaries:Bitcointransactions have no global boundaries—a trader based in South Africa can tradeforexthrough a broker based in the United Kingdom. Regulatory challenges may remain a concern, but if both traders and brokers are willing to transact, there are no geographical boundaries.
Risks of TradingForexwithBitcoin
- Different Exchange Rates: Bitcointrades on multiple exchanges and exchange rates vary. Traders must ensure they understand whichbitcoinexchange rates theforexbroker will be using.
- U.S. Dollar Rate Risk: While receivingbitcoindeposits from clients, almost all brokers instantly sell thebitcoinsand hold the amount in U.S. dollars. Even if a trader does not take aforextrade position immediately after the deposit, they are still exposed to thebitcoin-to-U.S. dollar rate risk from deposit to withdrawal.
- Danger of Volatility: Historically,bitcoinprices have exhibited highvolatility. In the absence of regulations, volatility can be used by unregulated brokers to their advantage.
- Security Risks Inherent to Bitcoin: Depositedbitcoinsare prone to theft by hacking, even from a broker’s digital wallet. To reduce this risk, look for a broker who has insurance protection against theft.
- Risk of Leverage: Using leverageis risky for new traders who may not understand the exposure. This risk is not unique to cryptocurrency forex trading.
- Asset Class Mixing: Cryptocurrencyis a different asset class altogether and has its own valuation mechanism. Tradingforexwithbitcoinsessentially introduces a new intermediate currency that can impact profit and loss in unexpected ways. Any money that is not locked down in a trader’s base currency is at risk.
Can You Trade Crypto on Forex?
Some Forex brokers let traders use cryptocurrency and others don't. In many cases, its a matter of the regulations across various jurisdictions.
Is Crypto Forex Trading Legit?
Trading crypto and fiat pairs is a legitimate trading strategy, but there is extra risk involved above and beyond that of forex pair trading.
Can I Trade Crypto in My Forex Fund?
If your broker and country laws allow you to do so, then yes you can. Make sure you check regulations in the jurisdiction you're trading in so that your activities remain legal.
The Bottom Line
Althoughcryptocurrencies likebitcoin are gaining popularity, there are still many associated risks. Inforextrading, dealing in a decentralized currency that offers global transactions with little or no fees is an advantage. But the tradeoff is essentially adding a third currency to what was a trading pair.
So, if you're considering taking on the risks of trading forex with cryptocurrencies, you should use only a locally regulatedforexbrokerage.
The comments, opinions, and analyses expressed on Investopedia are for informational purposes only. Read ourwarranty and liability disclaimerfor more info. As of the date this article was written, the author does not own cryptocurrency.
