The forex market is the largest and most liquid market in the world. It runs 24 hours a day, 7 days a week, all over the world. As if forex is not dynamic enough, cryptocurrencies (like Bitcoin) are adding a fascinating new dimension to currency trading. You see, a few forex brokers are now accepting bitcoins for currency trading. Should you jump in and begin using your hard-mined bitcoins in the forex markets? In this article, we’ll cover the risks and benefits of trading forex using bitcoins. (See related 5 Tips For Selecting A Forex Broker.)
First, here is an example of how a standard forex trade works. Imagine you are an American trader betting on the British pound/U.S. dollar currency pair (GBP/USD). You deposit $100 with your forex broker. Assuming the rate of $1 = £0.5, you will receive £50 for your $100. If the GBP/USD rate changes to 0.45, you close the position to 50/0.45 = $111.11. That is, you make a 11.11% profit over your initial $100 deposit.
Now, let’s move on to an example of a forex trade using bitcoin. First, you open a forex trading account with a broker who accepts bitcoins (like AvaTrade, eToro or Liteforex). You then deposit 2 bitcoins from your digital wallet to the forex broker’s digital wallet. Assuming the current bitcoin to U.S. dollar rate is 1 bitcoin = $500, your deposit of 2 bitcoins is equal to $1,000. Now, assume that you want to take a position in British pounds. If the exchange rate is £0.5 = $1, you will receive £500. After some time, the GBP/USD rate changes to 0.45, and you square off your position to get $1,111.11 in your trading account. You have made a tidy 11.11% profit and you are ready to cash out. However, suppose by this time the bitcoin to U.S. dollar rate has changed to 1 bitcoin = $560. When you withdraw your money in bitcoins, you receive ($1,111.11/$560) = 1.984 bitcoins.
Despite the fact that your bet on British pounds earned you an 11.11% profit (from $1,000 to $1,111.11), the fluctuation in the bitcoin to U.S. dollar rate means that you still sustain a loss of .016 bitcoin, or -0.8%. (initial deposit of 2 bitcoins — 1.984 bitcoins = .016 bitcoin). However, had the bitcoin to U.S. dollar exchange rate changed to 1 bitcoin = $475, you would realize a profit from both the forex trade and the bitcoin exchange. In other words, you would have received ($1,111.11/$475) = 2.339 bitcoins, a profit of 16.95%.
Beyond the exchange rate fluctuations impacting profit and loss, there are other benefits and risks to consider before trading forex with bitcoin.
Decentralized Valuations: One major advantage of trading forex with bitcoin is that there is no central bank to randomly change bitcoin valuations. Due to its decentralized nature, the bitcoin rates are free from geopolitical influence as well from macroeconomic issues like country-specific inflation or interest rates.
High Leverage: Most forex brokers offer high leverage ranging up to 1:1000 for bitcoin trades. Experienced traders can use this to their benefit. However, such high margins should also be approached with great caution as they also magnify the loss potential.
No Transaction Costs: All bitcoin transactions are digitally recorded on public networks without any involvement from banks or clearing agencies. Hence, there are usually no transaction costs involved in bitcoin, even for global transfers. Brokers pass these benefits to the clients by not imposing any deposit or withdrawal fee for bitcoin transactions. This improves trade profits.
Low Deposit Amount: One can start with as little as $25 with some bitcoin forex trading firms. As promotional offers, a few forex trading firms even offer new members a matching deposit amount. Traders should take care to check that all brokers are appropriately regulated.
Low Cost of Trading: Most forex brokers that accept cryptocurrency are keeping brokerage costs very low to attract the new bitcoin-trading clients.
Security: With bitcoin transactions, you don’t need to reveal your bank account or credit card details to deposit or withdraw money. Especially when dealing with foreign brokers, this is a huge advantage in terms of cost and financial security.
No Global Boundaries: Bitcoin transactions have eliminated global boundaries. Using bitcoin, a trader based in Africa can trade forex through a broker based in the United Kingdom. Regulatory challenges may remain a concern, but if both traders and brokers are willing to transact, then all geographical boundaries are eliminated.
Bitcoins trade on multiple exchanges, and exchange rates vary. Traders must ensure they understand which bitcoin exchange rates the forex broker will be using. (See related A Look At The Most Popular Bitcoin Exchanges.)
While receiving bitcoin deposits from clients, almost all brokers instantly sell the bitcoins and hold the amount in U.S. dollars. Even if a trader does not take a forex trade position immediately after the deposit, he or she is still exposed to the bitcoin to U.S. dollar rate risk from deposit to withdrawal.
Historically, bitcoin prices have exhibited high volatility. In absence of regulations, volatility can be used by the unregulated brokers to their advantage and to a trader’s disadvantage. For example, assume the intraday bitcoin rate fluctuates from $500 to $530 U.S. dollars per bitcoin. For an incoming deposit of 2 bitcoins, the unregulated broker may apply lowest rates to credit the trader $1,000 (2 bitcoins * $500 = $1000). However, once the trader is ready to make a withdrawal, the broker may use the lowest exchange rate and instead of the original 2 bitcoins deposited, the trader only receives 1.88679 bitcoins ($1,000/$530 = 1.88679 bitcoins). In reality, the unregulated broker may be exchanging bitcoins and dollars at say $515, and pocketing the difference at the expense of the client. (For more see Why Is Bitcoin's Value So Volatile?)
Deposited bitcoins are prone to theft by hacking, even from the broker’s digital wallet. To cut down on this risk, look for brokers who have insurance protection against theft. (See related Can Bitcoin Be Hacked?)
High leverage is risky for newbie traders who may not understand the exposure.
Cryptocurrency is a different asset class altogether and has its own valuation mechanism. Trading forex with bitcoins essentially introduces a new intermediate currency which can impacts profit and loss in unexpected ways. Any money that is not locked down in a trader’s base currency is a risk.
Although cryptocurrencies, like bitcoin, are gaining popularity, there are still many associated risks. In forex trading, dealing in a decentralized currency that offers global transactions with no fees is an advantage. But the tradeoff is essentially adding a third currency to what was a trading pair. Traders who want to take on that risk should use only locally regulated forex brokerages.
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SOURCE: Investopedia on Facebook