In this article we will discuss about advantages and risks of trading forex with bitcoin. The forex market is the world’s largest and most liquid market. It is a truly global currency market, open 24 hours a day, seven days a week, and from anywhere in the world.
As if forex wasn’t already exciting, cryptocurrencies such as bitcoin have added an intriguing new dimension to currency trading. Many forex brokers have begun to accept bitcoins for currency trading in recent years, with some also accepting a variety of other digital currencies.
Should you invest your hard-earned bitcoins in the forex markets? First, determine the risks and benefits.
A Typical Forex Transaction
Before deciding whether to trade forex with bitcoin, it’s a good idea to understand how a traditional forex trade works.
A Trading Forex with Bitcoin is simply the exchange of one currency for another at the current exchange rate. Unlike tourists who exchange their home currency for local spending money, forex traders try to profit from the constant fluctuations in the real value of one currency versus another.
Trading a ‘Pair’
Assume you are an American trader who believes the British pound will lose value in relation to the US dollar. Trading on the British pound/US dollar currency pair (GBP/USD) is what this is called.
You make a $100 deposit with a forex broker. Assuming a $1 = £0.5 exchange rate, you will receive £50 for your $100. If the GBP/USD exchange rate falls to 0.45, you will close the position at 50/0.45 = $111.11. That is, you profit 11.11% on your initial $100 deposit.
The majority of forex trading is done decentralised through over-the-counter markets. However, just because the forex market is decentralised and bitcoin is a decentralised digital currency does not imply that the two are equivalent.
Decentralization’s Impact
The key distinction is that, while forex exchanges are decentralised, currencies are backed by central banks in the countries that issue them. It is the responsibility of those banks to stabilise and maintain the value of their currencies.
Bitcoin and the majority of other cryptocurrencies lack this support.
Trading Forex with Bitcoin
Consider the following example of a Trading Forex with Bitcoin. First, you open a forex trading account with a bitcoin-accepting broker. AvaTrade, eToro, and LiteForex are a few examples. You then transfer two bitcoins from your digital wallet to the digital wallet of the forex broker.
If the current bitcoin to US dollar exchange rate is $7,500, your deposit of two bitcoins is worth $15,000. Assume you want to open a position in British pounds. You will receive £7,500 if the exchange rate is £0.5 = $1. After a while, the GBP/USD rate falls to 0.45, and you close your position to receive $1,666.65 in your trading account. You’ve earned a nice 11.11% profit and are ready to cash out.
The Bitcoin Impact
Assume, however, that the bitcoin to US dollar exchange rate has changed during this time period to 1 bitcoin = $8,500. You receive ($16,666.65/$8,500) = 1.961 bitcoins when you withdraw your money in bitcoins.
Despite the fact that your bet on British pounds yielded an 11.11% profit (from $15,000 to $16,666.65), the fluctuation in the bitcoin to US dollar rate results in a loss of 0.039 bitcoin, or approximately -2.0%. (Initial deposit of two bitcoins minus 1.961 bitcoins equals.039 bitcoin.)
If the bitcoin to US dollar exchange rate was changed to 1 bitcoin = $7,000, you would profit from both the forex trade and the bitcoin exchange. You would have received 2.381 bitcoins ($16,666.65/$7,000), a 19.1% profit.
Increased Unpredictability
This hypothetical example highlights a major reason to exercise caution when Trading Forex with Bitcoin. Even bitcoin, the most popular and widely used cryptocurrency, is highly volatile in comparison to most traditional currencies.
The value of a bitcoin ranged from $5,532 to $11,982 in the fiscal year ending July 24, 2020.
Because of this unpredictability, the risks associated with trading forex with bitcoin are significantly increased.
Aside from the impact of exchange rate fluctuations on profit and loss, there are other advantages and disadvantages to consider before trading forex with bitcoin.
The Advantages of Trading Forex with Bitcoin
Valuation Decentralization:
One significant advantage of trading forex with bitcoin is that it is not tied to a central bank. Digital currencies are not influenced by central geopolitics or macroeconomic issues such as country-specific inflation or interest rates.
High Impact:
Leverage is available from many forex brokers for bitcoin trades. Experienced traders can take advantage of this. However, such high margins should be approached with extreme caution because they magnify the possibility of loss.
Minimum Deposit:
Some bitcoin forex trading firms allow traders to start with as little as $25. A few forex trading firms have even offered promotions such as deposit matching. Traders should make certain that the broker is legitimate and properly regulated.
Trading at a Low Cost:
To attract new clients, most forex brokers that accept cryptocurrency keep brokerage costs very low.
Security:
To Trading Forex with Bitcoin, you do not need to reveal your bank account or credit card information. This is a significant cost and financial security benefit.
There Are No Global Boundaries:
Bitcoin transactions have no geographical limitations. A South African trader can trade forex through a broker in the United Kingdom. Regulatory issues may persist, but there are no geographical boundaries if both traders and brokers are willing to transact.
The Risk in Trading Forex with Bitcoin
Various Exchange Rates:
Bitcoin is traded on several exchanges, and exchange rates fluctuate. Traders must ensure that they understand which bitcoin exchange rates will be used by the forex broker.
Risk to the US Dollar:
When clients make bitcoin deposits, almost all brokers immediately sell the bitcoins and hold the funds in US dollars. Even if a trader does not immediately enter a forex trade position after depositing, they are still exposed to the bitcoin-to-US-dollar rate risk from deposit to withdrawal.
Volatility is a risk.
Bitcoin prices have historically been highly volatile. Volatility can be used to the advantage of unregulated brokers and to the disadvantage of traders in the absence of regulations. Assume the intraday bitcoin rate fluctuates between $5,000 and $5,300 USD per bitcoin. The unregulated broker may credit the trader $10,000 (2 bitcoins * $5,000 = $10,000) for an incoming deposit of two bitcoins. However, once the trader is ready to withdraw funds, the broker may use the lowest available exchange rate. The trader receives 1.88679 bitcoins instead of the original two bitcoins deposited ($10,000/$5,300 = 1.88679 bitcoins). The unregulated broker could be exchanging bitcoins and dollars for, say, $5,150 and pocketing the difference at the client’s expense.
Security Risks Inherent to Bitcoin:
Bitcoin deposits are vulnerable to hacking, even from a broker’s digital wallet. To mitigate this risk, look for a broker who is insured against theft.
Leverage Risk:
Leverage is risky for new traders because they may not understand the exposure. This risk is not limited to cryptocurrency forex trading; it also exists in traditional forex transactions.
Asset Class Mixing:
Cryptocurrency is a distinct asset class with its own valuation mechanism. Trading forex with bitcoin essentially introduces a new intermediate currency that can have an unexpected impact on profit and loss. Any money not locked up in a trader’s base currency poses a risk.
Conclusion
Although cryptocurrencies such as bitcoin are gaining popularity, there are still numerous risks associated with them. Dealing in a decentralised currency that allows for global transactions with no fees is advantageous in forex trading. However, the tradeoff is effectively adding a third currency to what was previously a trading pair.
Traders who are willing to take that risk should only use a locally regulated forex brokerage.
FAQ
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Reference
Bitcoin Trading | Cryptocurrency Trading | FOREX.com
Disclaimer: Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is extremely dangerous and speculative, and this article is not a recommendation by shonali18.com or the author to do so. Because every person’s circumstance is different, a knowledgeable specialist should always be consulted before making any financial decisions. shonali18.com makes no representations or warranties about the accuracy or timeliness of the material provided on this website.
