How Can Cryptocurrency Regulation Impact Forex Trading?

Issues within the cryptocurrency market continue to stay in the headlines. The blowup of FTX and the recent Gemini suit for fraud over interest accounts has stained the cryptocurrency market. Former FTX CEO Sam Blankman-Fried has been charged by the U.S. Justice Department, which is likely to usher in additional crypto regulation in the United States. The protection of retail consumers is at the heart of securities regulation in the United States. Unfortunately, this concept flies in the face of the idea that cryptocurrencies should be decentralized. The question for the industry is whether decentralized and oversight can coexist with each other. The idea behind a decentralized blockchain is that the control is left to the users of the distributed network and not a central bank or a government. How can the decentralized organization regulate itself when the process starts to hurt consumers? With more regulation coming for cryptocurrency, with the oversight impact forex trading?

What is the Difference Between Forex and Cryptocurrency

To get a feel for what will occur in the forex market if there is more oversight in cryptocurrency trading, you need to understand the differences between cryptocurrency trading and forex trading. Forex trading, is the exchange of fiat currencies. Fiat currencies are issued by governments and have internal oversight, such as a central bank or a government agency. In the United States, the Federal Reserve oversees forex trading using the Officer of the Controler of the Currency. The Commodity Futures Trading Commission (CFTC) is also in charge of currency trading, a branch of the United States government.

If there is an adverse change in the value of a currency, the government can manipulate the currency for the country's benefit. For example, if a currency rises, the country's exports might become less competitive. In this case, a central bank might intervene in the forex market to lower the value of a currency.

Forex trades can have an interest-bearing component. Suppose you purchase a higher-yielding currency and sell a lower yielding currency for a period in the future. In that case, you can benefit from holding the higher-yielding currency to generate the difference between the higher and lower yields if all exchange rates remain the same. If the spot price moves, you will still gain your interest but might also experience a capital gain or loss. There is no guarantee that you will be able to lock in your gains, since the exchange rate will constantly fluctuate. The currency trading in the carry trade is subject to oversight as a currency pair.

Cryptocurrencies are digital coins that are created on a decentralized system. Coins are made through exchanges each time a new transaction is verified. There is no oversight body except for those who participate in buying and selling the cryptocurrency.

Cryptocurrencies are created through a mining process. There are two common ways to mint a new coin. Proof of work is a standard process used to generate new Bitcoins. When a new transaction on Bitcoin is generated, the transaction must be verified. Minors compete for the right to verify the transaction by solving a complex algorithm. The first to solve the problem verifies the transaction and is awarded Bitcoin. The process is entirely decentralized and run by the member who verifies transactions and participates in the trading process.

Proof of Stake is another process that verifies the transaction. Ethereum is an example of a coin verified by the proof of stake process. This mechanism randomly picks a stakeholder whose currency owns Ethereum to verify the transaction. The verifier is awarded Ethereum. The process is completely decentralized and run by members who hold a stake in Ethereum and participates in the trading process.

Generally, to purchase Bitcoin or Ethereum, you need to exchange it for another cryptocurrency or a fiat currency. Therefore, there is a value between cryptocurrencies and fiat currency. That value can change over time but can be influenced by the supply and demand for cryptocurrency and fiat currency.

FTX Blowup

Some issues can be related to both fiat and cryptocurrencies. For example, George Soros, a hedge fund titan but a considerable amount of money that the value of the British pound would tumble due to fundamental issues with the country's borrowing and debt practices. Soros broke the British pound in 1992, generating more than one billion in profits for his fund.

At the tail end of 2022, FTX, a cryptocurrency currency exchange, filed for bankruptcy. The decline was likely because of the good of fashion fraud, which has yet to be proved by the U.S. Justice Department. What is known is that the CEO of the exchange used customer funds to finance private bets that were taken by a hedge fund that he also managed. Bankman-Fried used customer funds to finance his trading efforts, and when this information was leaked, customers ran for the existence. Bankman-Fried did not have enough money to cover the company's margin, leading to bankruptcy. Many of the customers participated in interest-bearing accounts. FTX was not the only cryptocurrency exchange borrowing cryptocurrency from its customers.

Gemini Sued

In December, the Gemini Trust Company and its founder Tyler and Cameron Winklevoss were sued by investors. The claim was that the interest the company paid on cryptocurrencies was sold as an interest-bearing investment and should have been registered as securities. Investors were promised as much as 8% on interest baring holding to allure investors. Still, in November, the company halted redemptions after a partner of Genesis Global became entangled in the FTX implosion. Gemini refused to honor any redemptions, which wiped out all the funds held in the interest-bearing program. Any time there is an issue where consumers are impacted by programs that should have been registered as securities, there is likely to be a splashback. Consumer complaints are at the crux of the most recent push by regulators to oversee the cryptocurrency industry further.

Does Distrust in Cryptocurrency and Fiat Currency Matter?

Historically, it's hard to regain investors' trust after a currency blows up. A fiat currency, USD/JPY carry trade blew up, and despite the stain on the trade, investors made their way back and used low-interest yen to fund finance. This likely means there is hope for the interest-bearing cryptocurrency stable coins providing investors substantial returns. When government yields are low, investors look for an alternative. There may be a time when cryptocurrency funding trades come back into the marketplace with the trust of cryptocurrency investors.

Will Further Regulation on Cryptocurrencies Impact Forex Trading

Measuring how much the pending regulation will benefit forex trading is hard. Initially, cryptocurrency trading, which saw prices surge and tumbles (see chart), is less attractive as the momentum that led to a quick buy-in by the public that cryptocurrencies were likely to gain mainstream adoption has been paused. While many continue to believe that a decentralized monetary system will eventually have full-scale adoption, there are also reasons to think that some form of oversight might be needed for decentralized tokens to work. The mania surrounding NFT has somewhat vanished, and continued headlines that describe interest baring products not registered as securities will weigh on the adoption of cryptocurrencies. What remains a question is whether trading wants to learn how to trade cryptocurrency.

Cryptocurrency volumes have tumbled since November. In the wake of the bankruptcy of FTX, volumes surged but have since declined and have likely lost a lot of traders to other asset classes. Fiat currency trading is the largest of the capital markets and has probably benefited from the absence of trading in the cryptocurrency market.

The Bottom Line

The upshot is that cryptocurrency needs time to stabilize after experiencing a wild rise where prices surged from very low levels to record highs only to tumble. As prices whipsawed, it became clear that many players in the cryptocurrency game bet wrong and potentially tried to take advantage of customers to fund their trading. In the wake of the blowup of FTX, several companies are trying to describe why they did not register their interest-bearing products.

Nobody ever said that the full-scale adoption of digital coins would come in a straight line. The bumpy road to cryptocurrency use will not include a significant blowup of an exchange and potential oversight by regulators. Consumers must trust cryptocurrency exchanges and the product they produce to force adoption. In the meantime, the volumes in the forex markets should continue to remain robust.