Module 18: Forex Trading and Ardana’s Decentralized Foreign Exchange
Module 18 dives further into Danaswap by focusing on forex trading on Ardana's decentralized exchange. This module shows you how forex trading works and compares crypto to forex trading.
What is Foreign Exchange
The last module provided a guide to Danaswap, this module focuses on forex trading on Ardana’s decentralized exchange.
Foreign exchange (or forex) is the conversion of one country's currency into another. The value of a country's currency in a free economy is determined by supply and demand principles. Additionally, the value of a currency may be tied to the currency of another country, such as the U.S. dollar or even a basket of currencies. The government of a country may also set the value of its currency.
However, many countries allow their currencies to float freely against other countries, resulting in a perpetual state of fluctuation.
The U.S. dollar, Euro, Japanese Yen, British pound, and Australian dollar are the most traded currencies globally. The U.S. dollar remains the most significant currency, accounting for more than 87% of all daily transactions.
Foreign exchange is traded between banks worldwide, and the Bank for International Settlements (BIS) oversees all transactions.
What Affects Currency Value?
Market dynamics based on commerce, investment, tourism, and geopolitical risk determine the value of a currency. For example, when a traveler visits another country, they must pay for goods and services in the host country's currency. As a result, a traveler must convert their own country's cash into the local currency. Thus, the demand for currency exchange services such as this will significantly impact the value of a country's currency.
In other instances, an investor from one country may wish to invest outside of their home country, and that investment must be made in the local currency. These factors, and others, all contribute to the vast growth of the foreign exchange markets by creating a demand for foreign currency.
The Impact of Inflation on Foreign Exchange Rates
Inflation can have a significant impact on a country's currency value and exchange rates with other currencies. Inflation is more likely to have a large negative effect on the value of a currency and its exchange rate, even if it is only one factor among many.
A very low inflation rate does not guarantee a favorable exchange rate. However, a very high inflation rate is almost certain to negatively influence an exchange rate.
Inflation is related to interest rates, which have an impact on currency rates. Interest rates and inflation are intricately linked, making it difficult for currency-issuing countries to regulate. Low-interest rates encourage consumer spending and economic growth and have a favorable impact on the currency's value. Inflation can develop when consumer spending rises, and demand exceeds supply.
On the other hand, low-interest rates do not normally attract foreign investment in the same way that higher interest rates do. On the other hand, higher interest rates entice foreign investment, boosting a country's currency demand.
Forex Traders
Forex traders include professional traders and amateur traders who trade either as a hobby or for their own financial gain.
Forex traders use exchange rates to earn from trading foreign currencies. Traders try to predict how currencies will fluctuate in value in relation to one another and buy or sell accordingly.
Foreign exchange trading is riskier than many other types of investing, and it is not recommended for every trader. With the possibility of large gains comes the possibility of large losses. As a result, understanding how this market operates is critical before deciding to become a forex trader.
How Does Forex Trading Work?
The foreign exchange market is the largest financial market globally, where trillions of dollars are traded daily. Moreover, it is the most liquid of all the world's financial markets.
Furthermore, there is no centralized marketplace for currency transactions in the foreign exchange market. Instead, it's an over-the-counter (OTC) market. All major currencies are exchanged at all major financial centers, and the forex market is open 24 hours a day, five days a week.
In the forex market, foreign exchange trading entails the simultaneous purchase and sale of two currencies. The value of a currency (base currency) is determined in this method by comparing it to another currency (counter currency). Thus, the foreign exchange rate is when one currency can be exchanged for another currency.
The most commonly traded currency pairs are EUR/USD, USD/JPY, GBP/USD, and USD/CHF. The euro-US dollar rate (EUR/USD) is the most popular foreign exchange market, where the euro's value is traded in U.S. dollars.
Forex trading is relatively straightforward. If you wish to make a forex trade, you must first sell one currency and buy another. You make a profit if the currency you buy moves up against the currency you sold.
For example, the exchange rate between the euro and the U.S. dollar is 1.40 to 1. If you buy 1,000 euros, you will pay $1,400. If the exchange rate later rises to 1.50 to 1, you can sell those euros for $1,500, making a profit of $100.
What is Leverage?
Leverage is commonly used in the forex trading market. Traders can use leverage to buy multiple times their initial investment. Some forex traders, for example, utilize the leverage of 20:1. This means they can buy $20,000 worth of F.X. for $1,000 and borrow the rest of the money from the brokerage firm.
Leverage magnifies both gains and losses in any investment, including the currency market. For example, if you buy $20,000 worth of foreign exchange and the rate rises 10%, you will benefit $2,000. If you employ a 20:1 leverage and invest $1,000, you will make a 200% profit.
Leverage, of course, works both ways. For example, if your $20,000 falls 10% to $18,000 with the same 20:1 leverage, you will lose your $1,000 investment and have to repay the brokerage business for the loan.
How to Begin Forex Trading
Foreign exchange can be traded in three ways:
On a Commodity Futures Trading Commission-regulated exchange.
On a U.S. Securities and Exchange Commission-regulated exchange
In the off-market market (also known as over-the-counter trades).
You will first need to open a brokerage account before you begin trading. Most major stockbrokers in the United States also offer F.X. trading. It is also possible to start trading F.X. through a stockbroker if you already have a brokerage account.
However, to trade forex, you usually only need to complete out a brief online application.
Once the account is opened, you can start trading by selecting the currencies you wish to trade. The currencies of the foreign exchange market are always sold in pairs. When one of the currency pairs increases in value, the other decreases in value.
It is always best for beginner traders to only trade the most widely traded currencies, such as the U.S. dollar, British pound, or euro, because they are the most liquid and have the smallest spreads. In forex, the spread is a fee included into the buy (bid) and sell (ask) prices of each currency pair. When you look at a currency pair's price, you will see a difference between the purchase and sell prices — this is the spread, also known as the bid/ask spread. In short, the forex spread is the price that the trading specialist, who acts as a middleman between the buyer and the seller, charges for managing the trade.
One way to start forex trading without any real consequences is to open a forex trading practice account. Babypips.com, for example, offers a trading course plus a demo account, and thinkorswim provides a simulated trading tool.
Typically, practice accounts are funded with a considerable sum of virtual money. You may learn how to trade forex without risking any actual money in this method. If you discover that you can trade profitably after a lot of practice, you can consider opening an actual forex trading account.
Cryptocurrency vs. Forex Trading
In recent years, cryptocurrencies have become quite mainstream, and many traders are debating whether to focus on crypto markets instead of forex or try to combine the two.
Although crypto trading appears to be quite similar to forex trading at first glance, there are some key differences between the two that we will address below.
Let's get into it!
Number of Instruments Available
The major currency pairs (EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD /USD, NZD/USD) usually are the focus of forex traders. In addition, some traders choose to trade exotic currency pairs, such as those involving a major currency and a currency from a developing country, such as South Africa or Mexico.
In comparison, there are many instruments to choose from in the crypto markets, while forex markets can occasionally see quiet trading hours for days or even weeks at a time.
Liquidity
Because the F.X. market is one of the most liquid in the world, you can purchase or sell your selected instrument without suffering substantial price changes, regardless of the size of your position. This is a significant benefit since you will always be able to exit a deal at a price equal to or very near to the one displayed on the screen.
With most cryptocurrencies, this is not the case. Trading is not nearly as lively for other cryptocurrencies as it is for Bitcoin, making it difficult for traders to exit trades at a targeted price.
Volatility
Cryptocurrencies are highly volatile, whereas forex markets are less so. In the currency markets, such fluctuations are uncommon and mainly occur in exotic pairs. With this in mind, it is easier to manage risk in the forex market, but the profit potential in the crypto markets is larger.
Profit Potential
Crypto markets have grown in popularity as a means of generating higher-than-average earnings. Risk rises in tandem with profit possibilities when trading; therefore, traders should expect to incur larger risks when trading cryptocurrency.
The value of many coins can eventually drop to zero if a project does not perform well or the capital flows into more established coins, which is the norm for developing markets in advanced stages.
It's worth noting that traders can continually improve their potential in forex trading by utilizing leverage, albeit this is a double-edged sword that comes with risks involved, as outlined above.
Deciding Between Crypto and Forex Trading
When deciding between crypto and forex markets, traders should consider their financial goals, available capital, trading style, etc.
The easiest method to make an informed decision is to experiment with small accounts in both crypto and F.X. trading. After a few months, you will be able to determine which market is best for you.
Remember, you do not have to pick between crypto and forex trading and can take advantage of both markets' advantages.
Ardana's Decentralized Exchange
Ardana is seeking to introduce forex trading into a stablecoin ecosystem through a decentralized foreign exchange on the Cardano blockchain. Cryptocurrencies are a vehicle that have the potential to surpass traditional banking products by being more efficient, less bureaucratic, and transparent. In today's increasingly digitized business environment, banks and financial institutions who choose to adopt cryptocurrencies will gain a significant edge over their competitors. For example, JPMorgan Chase launched its own cryptocurrency, JPM Coin, which is primarily used for money transfers and faster transaction processing between customers. Morgan Stanley began offering blockchain-based investment products in 2018. In addition, more than 100 banks have tested instant payments using the cryptocurrency Ripple.
According to Ardana's roadmap, Q4 of 2022 will be the release date for the decentralized foreign exchange on Danaswap. The protocol will include popular trading currencies such as the United States Dollar (USD), Great Britain Pound (GBP), and the Euro (EUR), which will all be generated as stablecoins on the platform.
Currently, there are few ways to mint on-chain-backed stablecoins other than those pegged to the U.S. Dollar. This means that a potentially large international user base will have to use a stablecoin in a foreign currency. Stablecoins for currencies other than the U.S. dollar do exist, but they are not decentralized, instead relying on a trusted custodian to back these assets with its reserves.
Users will be able to mint stablecoins of different currencies and exchange between them on Danaswap, allowing for a fast, low-cost, and accessible international currency system for all.
Conclusion
For those new to trading, in the beginning, it may seem like forex and crypto trading are very similar. And while there are certainly some undeniable similarities between the two, there are many significant differences.
Forex trading is a market like any other, driven by supply and demand. In other words: When demand for a particular currency is high, its price usually goes up, which is also one of the fundamentals of cryptocurrency trading.
However, unlike forex, you can trade on any cryptocurrency trading platform 24/7. However, the cryptocurrency market is also much more volatile and has much less liquidity.
In order to decide which market is best for you, you first need to consider your financial goals, risk tolerance, and preferred trading style. However, you do not have to choose between forex or crypto, and it is possible to reap benefits from both markets if you are willing to put in the time and effort to become proficient in forex and crypto trading.