Understanding the Differences Between Forex and Crypto Trading

Understanding the Differences Between Forex and Crypto Trading

Reading time: 17 minutes

To the untrained eye, the forex and crypto markets might seem similar. However, there are some considerable differences between the two that make them quite distinct. In this article, we’ll explain what forex and crypto trading is, discuss their key participants, market structure, and size, and explore the pros and cons of trading each market.

What is Forex Trading?

Forex trading, short for foreign exchange trading, is the act of buying and selling currencies in financial markets. It plays a crucial role in the world economy, facilitating international trade, investment, and tourism by enabling the exchange of one currency for another. According to the Bank for International Settlements, the forex market is the world's largest and most liquid financial market, with daily trading volumes of approximately $7.5 trillion.

Forex trading involves buying one currency and selling another, based around forex pairs, such as the EUR/USD (euro/US dollar) or USD/JPY (US dollar/Japanese yen). The fluctuations in exchange rates between currency pairs are driven by various factors, most notably interest rates, economic releases, and geopolitical events.

The forex market operates on an over-the-counter (OTC) basis, which means that transactions are conducted electronically between participants, including financial institutions, corporations, governments, and individual forex traders. Unlike centralised stock market exchanges, the forex market is decentralised and operates 24 hours a day, five days a week.

Forex traders aim to profit from price movements in currency pairs by speculating on their future direction. Since it’s rare for a currency pair to move more than a couple of per cent each day, trading on margin (using leverage) is typical. Traders often employ technical analysis or fundamental analysis, or a combination of both, to inform their decisions.

What is Cryptocurrency Trading?

Cryptocurrency trading is the buying and selling of digital assets, such as Bitcoin, Ethereum, and other altcoins, on online platforms known as cryptocurrency exchanges. These digital assets, or cryptocurrencies, are decentralised and rely on blockchain technology.

Blockchain refers to a distributed ledger system that allows for secure and transparent transactions without the need for oversight from a central authority like a bank or government. Daily total crypto market volume varies significantly due to cryptocurrencies' hype-driven and highly speculative nature. Daily volumes also differ between sources, although CoinGecko has reported fluctuations between $30 billion and $150 billion in 2023.

Like forex trading, cryptocurrency trading involves placing directional trades on the price movements of these digital assets. Pairs are typically quoted against fiat currencies like the British pound (e.g., BTC/GBP) or other cryptocurrencies (e.g., ETH/BTC). Factors like speculative demand, technological advancements, investor sentiment, regulatory changes, and media coverage often drive the price fluctuations of cryptocurrencies.

Cryptocurrency trading takes place on a 24/7 basis, meaning the market never closes. Traders commonly participate in the crypto market through spot trading (buying and selling cryptocurrencies on the spot [immediately]) and use margin (leveraging positions).

The cryptocurrency market is relatively new and constantly evolving. Consequently, it often exhibits higher levels of volatility compared to traditional financial markets like forex. It’s not uncommon for cryptocurrencies to rise or fall 10%, 25%, or even 50% in a single day. This can lead to both significant potential returns and increased risks for crypto traders.

Comparing Market Participants in Forex and Crypto

Various participants, including retail traders, institutional investors, and large corporations, engage in the forex and crypto markets. However, the specific types of participants and their roles within each market differ.

In the forex market, major players include:

• Central Banks: Central banks not only set monetary policy that influences the forex market but also use it to manage their foreign currency reserves - especially if their currency is pegged.
• Commercial Banks and Securities Dealers: Big banks serve as intermediaries between buyers and sellers, providing liquidity and facilitating trades as broker-dealers. They may also trade currencies for profit.
• Hedge Funds and Institutional Investors: These entities, including mutual and pension funds, engage in forex trading to diversify their portfolios, capitalise on market opportunities, or produce returns for investors.
• Multinational Corporations: Corporations may participate in forex trading to manage their exposure to currency risks related to international trade and investment.
• Retail Traders: Individual traders speculate on currency movements for profit or to hedge their personal investments.

This isn’t a complete list; other participants include money transfer firms, market makers, retail brokers, proprietary trading firms and sovereign wealth funds.

In the crypto market, you’ll find participants like:

• Retail Investors: Individuals trade cryptocurrencies for speculative purposes, long-term investments, or as a form of payment.
• Institutional Investors: Organisations like hedge funds and asset management firms invest in cryptocurrencies to diversify their portfolios, take advantage of market opportunities, or trade on behalf of clients.
• Miners: Miners validate transactions and secure the blockchain network in return for newly minted cryptocurrencies.
• Crypto Exchanges: These online platforms facilitate the buying and selling of cryptocurrencies and provide liquidity to the market.
• Corporations: Some corporations have invested in cryptocurrency as a way to diversify their assets. Notable examples include MicroStrategy and Tesla.
• Governments: Governments participate in the crypto market in different ways. For example, the U.S. government has auctioned off crypto seized from illegal activity; El Salvador also holds Bitcoin and accepts it as legal tender.

The crypto market sees a much larger proportion of retail interest compared to forex, with retail investors holding 17% of the total Bitcoin supply (BeInCrypto). In contrast, retail traders account for 2.55% of the forex market’s volume, according to the Bank for International Settlements.

Market Size: Which Market is Bigger?

To truly comprehend the differences between the forex and crypto markets, it’s important to look at two key measures: daily trading volumes and overall market capitalisation.

Daily Trading Volumes

Daily trading volumes refer to the total value of an instrument bought and sold within a single trading day. Higher trading volumes typically indicate a more active and liquid market with a larger number of participants and transactions.

The forex market is the largest financial market, with daily trading volumes of around $7.5 trillion. This massive size can be attributed to foreign currencies' vital role in international trade, investments, and tourism. Major banks, governments, and multinational corporations drive most of the trading volume.

On the other hand, the crypto market sees much less daily trading volume. While estimates can vary wildly between sources (CoinCodex reports $374.57 billion on the 27th of April 2023; CoinGecko puts it at $62.7 billion), the chart above from The Block shows a 7-period average total daily volume across 38 leading crypto exchanges. While these figures are impressive, they are still dwarfed by the sheer size of the forex market.

Market Capitalisation

Market capitalisation, often abbreviated as market cap, is the total value of all outstanding units of a financial asset. It’s calculated by multiplying the current market price of an asset by the total number of outstanding units.

Currencies are distinct from asset classes like stocks and cryptocurrencies in that they don’t have outstanding units; their supply is typically controlled by a central bank. It’s, therefore, impossible to apply the concept of market cap to the forex market.

The closest comparison would be to extrapolate its daily trading volume over a year (~$7.5 trillion x 365), roughly equaling $2,737.5 trillion, or $2.737 quadrillion. Note that this simply reflects annual trading volumes, not the total value of the forex market (as has been claimed).

However, it’s perfectly possible to calculate the market cap for the crypto market. According to CoinGecko, the total crypto market cap currently stands at $1.26 trillion - 16.8% of the forex market’s daily volume and ~0.0004% of its annual volume!

Comparing the Structure of the Forex Market and Crypto Market

The structure of the forex and crypto markets differ significantly due to the nature of the assets being traded and the primary participants in each market.

Forex Market

The forex market is a decentralised market where transactions occur directly between participants instead of through a centralised exchange. Its structure consists of various levels, with the interbank market at the top, where large commercial banks trade with each other, either directly or through electronic systems (primarily EBS and Refinitiv). These rates influence the bid-ask spread for the rest of the chain.

Next in the hierarchy are smaller banks, hedge funds, retail market makers, retail Electronic Communication Networks (ECNs) and corporations. The participants have less favour with the larger banks, and so deal with slightly worse rates. At the bottom of the ladder are retail traders, tourists, and small firms, amongst others.

Crypto Market

The crypto market operates through centralised and decentralised exchanges and OTC desks. Centralised exchanges, like Binance and Coinbase, facilitate transactions and provide liquidity with user-friendly trading platforms.

Meanwhile, decentralised exchanges (DEXs) enable peer-to-peer trading without a central authority, allowing users to connect their crypto wallets and trade directly with each other. OTC desks typically deal with institutional investors that wish to limit their market impact when placing large orders.

The nature of crypto has also led to new firms that mimic traditional financial players but with slight differences. For example, retail and institutional lending firms, stablecoin issuers, and custodial platforms each play a unique role in the crypto market’s day-to-day function.

The Pros and Cons of Trading Forex

So what exactly are the advantages and disadvantages of trading forex?

Pros

• Liquidity: High market volume ensures easy trade execution, typically with tight spreads and low costs.
• Accessibility: The forex market operates 24/5, allowing traders worldwide to participate regardless of their time zone.
• Leverage: Brokerages often provide traders with leverage, enabling them to take larger positions with less capital.
• Diversification: Dozens of currency pairs exist, offering a wide range of opportunities to traders.

Cons

• Leverage Risks: While leverage can help maximise profits, it can also lead to significant losses if risk management is neglected.
• Complex Market: Exchange rates are influenced by myriad factors, meaning staying up-to-date on market news and developing a deep understanding of what moves the market is essential.

The Pros and Cons of Trading Cryptocurrencies

Pros

• High Potential Returns: The cryptocurrency market has experienced significant growth over the past decade, offering traders the potential for substantial returns.
• Wide Range of Assets: There are over 10,000 cryptocurrencies to choose from, each with their own idiosyncrasies, that offer dozens of opportunities every day.
• Control: Crypto traders can choose to trade on DEXs, which gives them much more control over their funds and security.
• Diversification: Crypto assets are, for the most part, uncorrelated to other asset classes. This makes them a strong option for portfolio diversification.

Cons

• High Volatility: The cryptocurrency market is known for its extreme price fluctuations, which can lead to significant losses in a short period and may be challenging to manage.
• Regulatory Uncertainty: The regulatory environment surrounding cryptocurrencies is still developing, and changes in regulations can have an outsized impact on the market.
• Security Risks: Being digital assets, cryptocurrencies are susceptible to cyber-attacks and hacking incidents. This includes targeted individuals, exchanges, and entire crypto projects.
• Correlation Risks: Many altcoins closely follow Bitcoin, which may limit the benefits of trading multiple cryptocurrencies. There have also been periods where Bitcoin correlates with the S&P 500, potentially reducing the diversification benefits of trading crypto.

The Bottom Line

In summary, the forex and crypto markets offer unique opportunities for traders and investors alike. While the forex market is the world's largest and most liquid financial market, playing a vital role in international trade and investment, the crypto market offers a newer, more volatile, and technology-driven alternative for traders seeking potentially higher returns.

Their size and age explain much of their differences; large financial institutions dominate forex, whereas the crypto market is characterised by a greater proportion of retail investors and innovative companies exploring the world of digital currencies. By understanding their fundamental differences, you can now make more informed decisions about which market may be better suited to your trading style and risk tolerance.