Will Countries Switching to Crypto Impact the Forex Market?
The response to cryptocurrencies among governments of the world has been mixed thus far. Many of them have decided to regulate digital tokens as assets or, in the case of the EU, as untaxed commodities. Others have fully or partially banned them. Alongside these decisions, there have also been moves toward digital versions of state-backed currencies designed to share properties with both cryptos and fiat.
To date, however, few countries have gone as far as to put cryptos front and centre of national monetary policy. Most notable is El Salvador, whereas last year, bitcoin was now considered legal tender alongside the U.S. dollar (even though many citizens in El Salvador have little to no sense of what cryptos are). So it is far and away from the biggest instance of a company embracing crypto. But whether this represents the winds of change and what effect any of this will have on the global forex market remains to be seen.
First, it’s important to understand the market for foreign exchange, which is as fickle as the currencies that are traded on it. A forex explainer at FXCM characterises this market as the largest in the world, with a volume of more than $5 trillion USD traded daily on average. Traders aim to buy and sell at competitive but profitable rates, and speculation on the market follows various indicators and news events that might affect currencies. These might include inter-bank lending rates or government policies such as military interventions and major investment programmes. By contrast, speculation on the value of cryptocurrencies –– which a central bank does not back –– is generally a more uncertain prospect.
Given the nature of forex, could this sprawling, massive and thoroughly established market be disrupted by countries switching to crypto? It’s a question worth considering, particularly if you consider the point of view of the bitcoin “true believer” community –– which, according to FT, it anticipates bitcoins or similar tokens becoming the default currencies around the world, replacing current systems.
However, there are certainly obstacles to this happening (or happening in a way that might be expected) that even those true believers acknowledge. The low likelihood of powerful governments surrendering the power their currencies afford them domestically and abroad is notable. After all, central banks were created in a climate of instability largely thanks to thousands of competing private currencies, as Jeffrey Frankel noted on The Guardian.
Before making guesses as to how crypto adoption might impact forex, it’s also reasonable to question whether other countries will follow El Salvador’s lead. The most bullish of predictions might be that of DeVere Group CEO Nigel Green, who believes several countries will soon establish bitcoin as legal tender.
However, the countries considering this move –– which, according to Green, include Panama and Paraguay –– tend to have weaker economies and thus less influence over forex. This reinforces the idea that currencies of major countries and blocs like the dollar and the euro are not under any immediate threat of being disrupted. Because the countries mentioned above-weighing crypto adoption may be trying to break out of either the weakness of their own currencies or the dominance of the dollar (El Salvador has used the dollar as an official currency since 2001 and still uses it alongside bitcoin), though, it’s not impossible that in the long term, crypto could chip away at the incumbents’ influence on the global stage.
As we alluded to briefly above, a number of governments with extensive resources are looking into (or already experimenting with) central bank digital currencies (CBDCs). The furthest along of these is the digital Chinese yuan. Since the value of the digital yuan and all proposed CBDCs are one to one with the standard versions, the only substantive change to them is the metadata around them, which enables better government tracking of the movement of money. The impact on forex from these is unlikely to be significant, therefore, aside from any effect on money used in illicit transactions.
Another possibility is that even if the decentralised cryptocurrencies like bitcoin come to displace fiat ones, eventually, a multilateral system may have to be created to regulate money used in trade –– somewhat similar to the dream of John Maynard Keynes and the ‘bancor.’ We are still a long way from that, however, with more than one reason to be sceptical of such a future. In the meantime, major banks and traditional institutions are now on board with crypto, and the revolving doors of power mean that nation-states might be tempted to influence it rather than stop it.