By the most reliable estimates, the daily turnover of the foreign exchange (FX) market is on average $6.6 trillion (or ~$2.4 quadrillion per year) with around $2.0 trillion per day being spot volume and roughly $4.5 trillion consisting of derivatives volume (1.BIS), making it the largest and most liquid market on the planet.
Cryptocurrency and more specifically the emergent Decentralised Finance “DeFi” space is comparatively miniscule, though growing rapidly. On an average day in Ethereum for instance, decentralised exchanges produce between $2bn — $4bn in trading volumes (Dune Analytics), and the size of US dollar denominated fiat backed and collateralized synthetic market (“stablecoins”) is around just 50bn USD (Messari Research).
In fact as of writing, the entire market capitalization of cryptocurrencies does not even match the daily spot volume of foreign exchange markets.
Compared to the state of the space twelve months ago however, progress has been enormous . Although still incredibly nascent it is clear the foundational blocks for future growth are now being laid. DeFi now has functioning spot exchanges, derivatives exchanges, debt markets, insurance markets and asset management solutions to name a few.
On the asset and protocol layer more exotic concepts such as NFT financial products and superfluid collateral are incoming, while scalability is being aggressively pursued on “Layer 2” solutions and alternate chains. Capital inflows continue to increase.
Lights are on, but nobody’s home?
Amongst all of this innovation and experimentation, foreign exchange feels conspicuously absent. Why is this? Are US dollar only denominations really adequate for all market participants?
The answer one year ago may have been yes — perhaps due to market size limitations — but given the large non-US demographic participating in cryptoassets (for instance nearly half of all crypto funds as of 2020 were located outside of the US) it is hard to argue that uniquely US dollar denominated stablecoins over the entire space is a viable long term option.
The space is rapidly evolving to a point to where the main purposes of FX can be accommodated on chain (namely speculation, hedging and remittance), giving the idiosyncratic features of Ethereum-like blockchains such as composibility and accessibility a material relevance to FX.
Just as other traditional financial markets are being successfully transplanted onto the blockchain and DeFi, a logical next step would be a move away from solely USD representation — to a broader currency offering.
FX Utility to Defi: Awakening the Beast
As previously mentioned, the main purposes of FX markets can be loosely categorized as: speculation, hedging and remittance.
Foreign currency speculation on DeFi may come in the form of derivatives products such as perpetuals, futures and options, or instruments such as synthetics (collateralized debt positions) which have become staple components of yield generation strategies such as liquidity providing, borrowing and lending.
Users may also use the aforementioned for on chain hedging against their USD exposure, or even the construction of more complex positions such as cash and carry trades.
Virtual remittance would be possible with synthetic or derivative products, although full remittance would require fiat ramp solutions. An example of a more exotic use case may even be the tokenization of a profitable long term cash and carry trade as an NFT, and using it to collateralize a debt position for a completely different yield strategy.
As the FX market in DeFi matures, we are likely to see a similar trajectory of composibility and fluidity which we now see on US dollar products.
The possibilities are endless, and a well developed FX market will undoubtedly be counted as critical DeFi infrastructure sooner rather than later.
Handle.fi is well positioned to deliver this; becoming a one stop shop for all of DeFi’s FX needs, offering synthetic spot, leveraged and derivative products for the world’s most popular non-USD currencies
Join us on our journey to build the global defi FX protocol.
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1. Bank for International Settlements. “Triennial Central Bank Survey Foreign exchange turnover in April 2019.” Monetary and Economic Department, 16 September 2019, https://www.bis.org/statistics/rpfx19_fx.pdf.
2. Dune Analytics
3. Messari Reseach
4. PWC “2020 Crypto Hedge Fund Report