Understanding the Impact of DeFi on the Forex Market


The Impact of DeFi on the Forex Market

Decentralized finance, or DeFi, grew in popularity with the public when it was formally released in 2020, as an ambitious alternative to the cryptocurrency market, with a promise to revolutionize the world of finance as we know it.

Many users have been able to utilize DeFi to trade, but it hasn’t quite panned out as initially expected. DeFi has been used by many to trade, borrow, invest, and lend. These activities were traditionally reserved for the standard banking systems available.

Although DeFI hasn’t quite achieved the strong goals of its inception, financial protocols leveraging blockchain technology have opened more possibilities for those investors with a bit savvier, along with day traders, new business creators, VCs, and many more.

At its peak, the total value secured by decentralized finance protocols exceeded $245 billion, which does not include the competition against particular sections of the traditional financial market for DeFi to maximize its worth. One of these traditional sections was forex trading.

But are we expected to see a change in 2023?

Forex: A $6 Trillion Market That Could Be More Sufficient

DeFi, which has fallen significantly from its bull-market peak, is one of the newest and most liquid markets in the world. Forex, on the other hand, operates entirely differently from DeFi.

Over $6 trillion is traded daily in the forex exchange market, which is ten times larger than bonds and surpasses stock markets.

As the rise of online trading platforms has opened up opportunities for retail traders, just as the rise of DeFi has made investing easier for everyday investors, foreign exchange trading has historically been dominated by central banks and commercial banks, as well as other institutional investors (hedge funds, asset managers).

The inordinate influence wielded by major financial institutions may explain why many still see forex as something of a closed shop.

Even though the forex market is flooded with liquidity, serious inefficiencies exist, giving rise to speculation that DeFi might assist. There are a few powerful players who control the vast majority of trade activity on the forex market.

In this oligopolistic structure, banks, multinational corporations, governments, hedge fund managers, and so on, price movements can easily be manipulated, and even small changes in supply and demand can make a big difference.

Unlike DeFi, the forex market relies on many intermediaries (counterparties, dealers, brokers) who all require end users to trust them. In addition to these unpredictable fees, end users also have to deal with market forces.

Furthermore, no central exchange is used to conduct and report FX trades, which impedes transparency in the market. In this highly fragmented market, prices are discovered in multiple time zones around the world, 24 hours a day, 5 days a week.

While new regulations have been introduced to ensure greater transparency in forex, these regulations are primarily designed to ensure brokers have sufficient capital to cover losses and strengthen reporting requirements.

Could DeFi and Forex Help Each Other? 

It remains hopeful that DeFi will eventually catch on with the mainstream, despite the stagnation since the heady days of 2022. Its case hasn’t exactly suffered from recent events.

Its resilience and decentralized credentials were clearly demonstrated in Q4 of 2022 after FTX collapsed and chaos engulfed centralized exchanges.

As peer-to-peer finance enabled by smart contracts is becoming a mainstream financial instrument, DeFi has emerged as the most active sector in the blockchain sector, reversing centralized financial systems. Because it is largely unregulated and there have been many hacks and exploits in the industry, it has been dubbed the Wild West in its own right. 

Are DeFi’s efforts going to be enough to tackle Forex’s inefficiencies? Many argue forex trading needs real-time exchanges without intermediaries – which DeFi protocols facilitate.

On top of this, there are many DeFi protocols that offer features that could be of great use for traders in the forex market, such as flash loan insurance and automated market making.

Due to the transparent characteristics of blockchain and its display of all public records, it could allow for much more accurate prices and reduce corruption and fraud opportunities.