The future of forex trading could be decentralized forex. Using a blockchain or another decentralized mechanism, one would be able to purchase stable coins and cryptocurrencies that provide access to less volatile products like the dollar or the Euro. There are several benefits of using stable coins, and they have been gaining traction with institutional traders looking for cryptocurrency trades with minimal volatility. Decentralized exchanges that provide investors access are starting to see increasing volumes. Decentralized exchanges saw volumes increase by 870% in 2021, year over year.
Institutions no longer have to worry about trading on the spot market. They can use stable coins for carry trades, allowing them to expose themselves to the yield differential without purchasing a currency pair. Decentralized forex trading could be the next evolutionary step in forex trading.
What is a Stable Coin?
A stable coin is a digital currency. It is similar to other digital coins such as Bitcoin and Ether, but it’s pegged to fiat currencies such as the U.S. dollar or the Euro. The volatility of stable coins is generally lower than a digital currency such as Bitcoin or Ether. Bitcoin volatility is approximately eight times as volatile as some of the major currencies, such as the dollar or the Euro. This type of volatility means that you much more exposed to market factors when you purchase Bitcoin as opposed to a Stable coin.
What are the Benefits of a Stable Coin Compared to Trading a Currency Pair?
There are several benefits of trading a stable coin on a blockchain instead of in the currency markets. Stable coins are regulated instruments and are held in segregated accounts. Stable coins are accessible to anyone who has access to the internet. When you purchase a Stable coin you receive automatic access to the fiat currency that the stable coin backs.
For example, if you purchase a USDC Stable Coin in Euros, you do not have to wait for the spot date to receive the dollar currency. The transaction is immediate. You do not have to continue to roll the currency daily beyond the spot date to hold on to the fiat back Stable Coin. The elimination of the role of the currency pair helps reduce some of the commissions that a retail investor might experience.
Stable Coin Trading Strategies
Another way investors can profit from stable coins is to engage in carry trading. This type of trading allows an investor to benefit from the interest rate differential between two currencies. When evaluating the notion of what is forex trading, you need to understand different parts of the forex market, including the forward curve, which is made up of interest rate differentials.
The interest rate differential is the difference between two fiat currency interest rates. For example, when you buy the USD/JPY, you are simultaneously buying the U.S. dollar and shorting the Japanese Yen.
When you short the Yen you need to pay the lender the interest rate for the period in which you are shorting the Yen. During that same period, you will receive the interest rate on the U.S. dollar. If the dollar interest is larger than the yen interest rate, you will be receiving a carry. If you are longing the Yen, you will have a negative carry.
When you purchase a U.S. dollar stable coin, you earn the U.S. dollar interest rate. When you purchase that using a Euro, you are theoretically earning the difference between the Euro interest rate, which you are shorting, and the dollar interest rate on the stable coin. Stable coins will generally earn a higher interest compared to what is offered at a bank.
Practical Uses
If you plan to use cryptocurrency for everyday use, which includes making payments and sending money transfers, You might consider using a digital coin that offers low volatility.
The Bottom Line
The upshot is that stable coins could become the future of forex trading. Stable coins are less volatile and do not provide the same historical volatility as digital coins such as Bitcoin or Ether. The historical volatility of digital coins such as Bitcoin and Ether are more volatile than some of the major currency pairs. The volatility can become challenging if you use a digital coin for payments.
Volumes of stable coins exploded in 2021. More than $1 trillion in volumes were traded in 2021 on decentralized exchanges compared to $115 billion in 2020.
When you trade, you no longer have to worry about forward or spot trading, where the currency you trade is delivered in two business days. Stable coin transactions are immediate. You can also trade stable coins for carrying trades. This type of trading allows you to pick up the yield differential between two different stable coins.
While the concept of digital coins is most well-known when trading Bitcoin or Ether, the practicality of using a volatile product for everyday expenses might not work. There is a use-case for stable coins backed by fiat currencies like the dollar and the Euro. While not a traditionally appealing investment vehicle for many retail investors, there continues to be the likelihood that these products continue to develop as digital assets become more popular.
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