Cryptocurrencies and Forex: How Digital Currency is Changing the Foreign Exchange Market

If you are a forex trader or understand some of its tidbits, you already know this field is exciting, diversified, and rewarding. But do you know how this landscape is changing? Cryptocurrencies are adding a new perspective and opportunity.

Forex simply means foreign exchange. It involves exchanging one currency for another. Essentially, forex is the oldest financial market. Nonetheless, today's forex market is miles apart from what it used to be. New instruments, assets, technologies, and methods of conducting it have emerged. This has helped the sector grow, witnessing over $5 trillion daily trading volumes.

Cryptocurrencies are a nascent sector whose existence came into being after Bitcoin was invented in 2009. Cryptocurrencies are a form of digital currency that run on public ledgers called blockchain. Since the invention of Bitcoin, several other cryptocurrencies have emerged, taking the total market cap to over $1.1 trillion, according to CoinGecko.

Despite being a new asset class, cryptocurrencies have attracted considerable attention. Their decentralized nature, liquidity, and security features have made the digital asset class popular. Undoubtedly, cryptocurrencies are revolutionizing forex markets, opening up new opportunities for traders. Do you want to learn more about crypto forex reading? This excerpt is for you.

Cryptocurrency Pairs

Before delving into the most popular cryptocurrency pairs in the forex markets, it is crucial to note that digital assets can be paired via a fiat currency, a stablecoin, or another crypto. An example of a crypto versus crypto pairing is BTC/ETH, while a crypto-fiat pairing is BTC/USD. However, you will notice that many cryptocurrencies are paired with a crypto equivalent of fiat like BTC/USDT. In this case, USDT is the stablecoin pegged 1:1 to the dollar. Thus, USD and USDT will technically mean the same thing in crypto trading.

Having noted the above, the following are the popular cryptocurrency pairs you will find in forex markets:

BTC/USDT or BTC/USD

The US dollar is the most popular currency in and beyond the forex market. Bitcoin (BTC) is, similarly, the most popular cryptocurrency. Thus, Bitcoin and the US dollar are the kings in their respective markets.

Pairing Bitcoin and the dollar gives a very high liquidity asset due to their popularity. In this case, liquidity refers to how active traders are on a particular asset. A highly liquid asset opens up trading opportunities and has low spreads and slippages, hence, increases profit opportunities.,

Bitcoin pairing with another fiat would also be a popular trading asset like BTC/EUR, BTC/AUD, and BTC/GBP. However, as you will notice, many exchanges will lack some fiat pairings, especially for exotic currencies. Since the US dollar is commonly used and has stablecoin options for pairing with Bitcoin, BTC/USD has become the most popular for traders.

Trading BTC/USD is also advantageous because the two assets are inversely correlated. When the value of the dollar rises, Bitcoin drops, although not always. The inverse relationship becomes pronounced when macro events change market sentiment.

For example, the US Federal Reserve has recently embarked on economic tightening by raising rates to combat inflation. Anticipations of rate hikes boost the dollar since it is a contractionary move that lowers its supply. Conversely, rate hikes reduce the appetite for risky assets such as Bitcoin, causing their price to fall. With the inverse relationships, it is easy for traders to catch huge and predictable moves when trading BTC/USD.

ETH/USDT or ETH/USD

Like Bitcoin, Ethereum (ETH) is a major cryptocurrency ranked second by market value. Ethereum powers smart contracts and decentralized applications. Over time, Ethereum's use has grown exponentially, with increasing applications in decentralized finance, non-fungible tokens, and the metaverse. ETH, the native currency, powers these applications, making Ethereum a popular pairing in forex.

While Ethereum is less affected by macro events like Bitcoin, both move in tandem. As such, Ethereum is inversely correlated to the dollar, opening up opportunities for trading. Ethereum also carries high liquidity owing to its use cases. Thus, it can be bought or sold effortlessly on demand.

Furthermore, you will find Ethereum listed on most exchanges. This makes ETH/USD worthy of attention for a forex trader with an eye on digital assets. There are also numerous other fiat and stablecoin pairings for ETH simply because many people would want to transact with it.

LTC/USDT or LTC/USD

Litecoin (LTC) is ranked at #15 by market cap. While there are superior peers, Litecoin is very popular in forex markets. That's partly due to its similarities to Bitcoin.

Litecoin is the second-oldest digital asset, created from a fork of the Bitcoin protocol in 2011. The longevity of existence has made Litecoin quite a popular cryptocurrency pair. 

The protocol was created due to the inefficiencies of the Bitcoin network of cost, speed, and transaction throughput. Litecoin is faster, less costly, and processes up to 56 transactions per second compared to Bitcoin's 7 TPS.

Litecoin also undergoes halving events like Bitcoin. Every 4 years, rewards are halved to control the tokens in supply and protect the token's value. The last halving event occurred on August 2, 2023.

The tokenomics of Litecoin, market trust, and relationship to Bitcoin have made the LTC/USD pair very popular in forex. In fact, many traders view Litecoin as the closest thing to Bitcoin and are willing to experiment with it. Traders that want a cheaper alternative to Bitcoin consider Litecoin. This increases demand and unlocks liquidity for its trading pairs, led by LTC/USDT.

DOGE/USDT or DOGE/USD

This could be an unpopular choice here. After all, Dogecoin (DOGE) only ranks #9 by market cap and is often considered a joke cryptocurrency. The sentiments are valid, given that Dogecoin is a meme token mostly driven by hype and speculation.

But investors know this token can unlock value and generate supernormal returns within hours or minutes. This occurs during wild price events, such as announcements or online chatter. Doge has reacted to the slightest news, including a sneeze by its godfather Elon Musk.

In other words, DOGE/USD pairing is popular in forex. However, investors should be aware of wild price changes and volatility that can lead to significant losses when trading this pair.

ETH/BTC

You don't have to trade a cryptocurrency-fiat/stablecoin pairing. A crypto versus crypto pairing could also be ideal, with ETH/BTC the most popular option. These are crypto titans and why many investors will rush to pick one against the other.

But as you will notice, the two cryptocurrencies may exhibit similar price trends. So where is the opportunity? Historically, the pair oscillates, although ETH is growing in value faster than Bitcoin. Traders can spot and capture value fluctuations and profit from trading between them.

The advantage of trading ETH/BTC is that being the most popular cryptocurrencies, liquidity is high, and opportunities are limitless. These opportunities open up in bear and bull market scenarios, so there is no dull day if you master trading them.

Trading Strategies

There are numerous trading strategies in the forex markets. However, not every strategy may be ideal for crypto pairs. Some of the popular strategies for trading cryptocurrencies in the forex market are discussed below:

Trend following

Cryptocurrencies, like forex, move up, down, or range depending on the market sentiment. The movement leaves behind money trails in the form of a trend.

Trend followers take advantage of movements, up or down, to profit from forex and crypto markets. By following the trend, traders buy on market dips and sell on market tops during a bull market. In a bear market, traders enter short trades and exit on market bottoms.

To benefit from a trend-following strategy, a trader bases their decisions on indicators such as trend lines and moving averages. These indicators show when trends are starting or shifting to enter and exit trades appropriately.

Holding or buy-and-hold strategy

Just imagine this; Bitcoin was valued at nearly $0 when it was invented in 2009. The value has grown exponentially, withering dips and turns to claim a record above $68,000 in November 2021. Other cryptocurrencies have exhibited similar patterns. What does this mean?

Someone who bought the cryptocurrency in its early days was in supernormal profits at the record price. Even at today's price of around $28,000, the holding would still be in massive profits. Hodlers are crypto buyers who accumulate and hold it for a prolonged period, mostly years. The traders benefit from a near-assured increase in value, unbothered by short-term volatilities.

Hodling has become quite popular with big crypto investors known as whales and corporations. An example of this is MicroStrategy, which has consistently been buying Bitcoin since August 2020. By investing huge amounts of resources, the investors profit from their holding when these cryptos are eventually sold higher in the future.

Nonetheless, when using the buy-and-hold strategy, an investor must select an asset capable of sustaining gains. This protects value for their investments and earns them money for their disciplined trading approach.

Range trading

Crypto markets range quite often depending on market conditions and trading pairs. The market oscillates between trends and consolidation zones in a ranging market.

Range trading can be popular for some crypto pairs, such as ETH/BTC, which move within narrow ranges against each other. If you are buying ETH/BTC, it means you will acquire ETH and sell BTC.

Under most circumstances, ETH and BTC exhibit similar trends. So, in such a trade, you don't expect ETH to move at significantly higher margins against BTC. Rather, you are taking short-term opportunities in range trading between the two.

In range trading, investors must be aware of support and resistance zones to enter and exit trades. The general practice is to buy an asset at a support zone and sell it at a resistance level.

Arbitrage method

Arbitrages are rare opportunities in crypto markets. The trading method involves taking advantage of price differences in crypto assets between exchanges. Arbitrage opportunities exist because exchanges value cryptocurrencies differently.

For example, you will find the value of Bitcoin at $28,000 in exchange A and $27,500 in B. To profit from such a difference, arbitrageurs will buy Bitcoin at exchange B and immediately sell it at a higher value at exchange A.

Despite being one of the most popular crypto trading strategies, investors' speed is needed as prices can change quickly. Investors must also ensure the profits from the arbitrage trading match or exceed the exchange fees and other costs.

Scalping

Scalping is as popular in the forex market as in crypto. It is a high-frequency, short-term, but high-risk trading method. Scalping targets tiny price movements in crypto markets to generate small and multiple profits.

Since markets are always on the move, scalping opportunities emerge daily. Thus, the trading method is popular for skillful day traders seeking to add some bucks to their balance sheet every day. This is common during periods of economic data release and market events that generate rapid price movements.

However, scalping could be very risky in the crypto market due to the unpredictable nature of markets. Frequent price changes can cause an asset's price to go against the trend and generate huge losses.

Regulation and Security

Crypto forex trading is still in its infant stage, and regulation in the sector is underdeveloped. Traders may need to be aware of various regulatory and security issues:

Tax issues

The tax implications of cryptocurrencies vary from one jurisdiction to another. In the US, crypto holders are required to pay capital gains taxes on profits realized from the sale of the assets. The capital gains are paid irrespective of whether a trader bought the cryptocurrency in the US or not.

Crypto investors are also bound by the US federal income tax provisions. In this case, cryptocurrencies are regarded as property and not currencies. Investors must report crypto transactions on their annual tax returns. This means they must keep a record of the purchase price, which they can use to determine the fair market value of the cryptocurrencies.

Legality of crypto trading

Unfortunately, cryptocurrencies are yet to gain universal acceptance. Countries such as China, Nepal, and others have banned crypto trading. This means traders in such markets cannot benefit from the digital asset sector.

Even for other countries, such as the US, which have not banned crypto, their legal status remains in limbo. The lagging of legal protection exposes investors to uncertainty should laws emerge quickly. It also means investors are on their own when dealing with digital assets.

Money laundering

The decentralized nature of blockchain technology and crypto makes the sector vulnerable to financial crimes. Essentially, the main blockchain promise is anonymity. That allows criminals to take advantage and commit crimes. As such, news of compromised crypto exchanges, entities, and wallets is not new.

According to Chainalysis data, criminals have laundered more than $33 billion worth of cryptocurrencies since 2017. The Chainalysis report highlights theft and scamming as the common methods criminals use to launder crypto money.

Meanwhile, as a crypto forex trader, you can protect yourself by carefully selecting trading platforms and protecting yourself against the simple tricks of criminals. These include unsolicited messages promising airdrops, tokens, and grants from unconfirmed sources. Even on legitimate sites, most crypto trading is not overseen by regulators meaning any losses sustained are borne personally by the users.

Consumer protection and data theft

Crypto forex traders are exposed to security issues that expose their funds and data. Crypto firms, exchanges, and wallet providers are loosely protected or may lack regulation at all. As we have seen in the past, high-profile collapses such as FTX in late 2022 expose crypto investors to significant losses.

Similarly, there is a lack of sector-specific data protection rules in the crypto sector. The decentralized and peer-to-peer nature of blockchain networks makes it difficult for the existing data protection laws to apply. This increases the potential for abuse of one's private data should it land in the hands of criminals or be used apart from the intended purpose.

Luckily, this area is evolving, and countries are seeking ways to bring crypto firms into the regulatory net to protect investors. Europe recently enforced the Markets in Crypto Assets Regulation (MiCA) governing the issuance of crypto assets and provision of related services. The US is pondering similar laws, with more countries expected to follow suit.

Conclusion

The world of crypto has inevitably arrived. Arguably, cryptocurrencies add on to forex trading by diversifying assets and increasing liquidity. Trading both markets requires knowledge of how prices move and the price behavior of different instruments. Luckily, knowledge of the forex markets makes it easier to enter the crypto world since they share certain attributes. Also, some forex trading strategies may apply to the crypto assets. Investors must tailor their strategies to market situations and assets to benefit from crypto trading.

Nonetheless, crypto-forex traders must be aware of tax implications, data protection issues, money laundering, and the legality of crypto trading in their jurisdiction. As the world of cryptocurrencies expands, these issues will likely be ironed out, especially legal clarity. At this point, it is important to guard against risks by carefully selecting the trading platform and not falling for scamming attractions. Predictably, crypto trading will grow bigger and better as more assets enter trading platforms and security issues are addressed.

Disclaimer: Any information presented is for general education and informational purposes hence, not intended to be and does not constitute investment or trading or tax advice or recommendation. No opinion given in the material constitutes a recommendation by M4Markets that any particular investment, security, transaction or investment strategy is suitable for any specific person.

It does not take into account your personal circumstances or objectives. Any information relating to past performance of an investment does not necessarily guarantee future performance.

Trinota Markets (Global) Limited does not give warranty as to the accuracy and completeness of this information.

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