When folks think about Bitcoin, it’s often in the context of halving cycles, ETFs, on-chain metrics, et cetera.

But behind the scenes of this seemingly autonomous cryptocurrency, the $7.5 trillion per day foreign exchange (forex) market is quietly pulling the levers of price action.

Here’s what the data actually tells us about the intersection of crypto and forex and why we should pay close attention.

The dollar is king. For the most part.

For years, the DXY (US Dollar Index) has had an inverse relationship with Bitcoin . When the dollar strengthened (DXY up) Bitcoin fell and vice-versa (DXY down Bitcoin up) for the reasoning that Bitcoin has been priced in dollars. An increasing DXY strengthens the dollar relative to other fiat, makes it more expensive to buy internationally, thus reducing demand.

The traditional inverse relationship has however deteriorated or even flipped positive in 2024, pointing to the maturation of the crypto markets to being treated like other macro assets subject to liquidity.

The yen-anomaly.

What may come as a surprise, academic research show, however, that it is the Japanese Yen (JPY) (the most traded pair internationally, second only to USD/CAD) that has historically exhibited higher correlations with both Bitcoin and Ethereum.

More specifically, academic work find all crypto cryptocurrencies display stronger cross-market correlations than the Australian dollar and British pound . When looking into jump dynamics we additionally see that we get to see an FX Premium for USD/JPY in the synthetic markets compared to the traditional FX market for USD/JPY - potentially indicating the level of financial infrastructure limitation in crypto.

This suggests to forex traders and crypto traders, that monitoring the Yen may signal something that relates to a move in Bitcoin even faster or more clearly then watching for moves in other currency pairings, for example EUR/USD and GBP/USD.

When is there an influence? What impacts what?

Academic research finds a directional relationship between the crypto and forex markets based on market conditions:

1. Normal market conditions: the FX market has little to no influence on cryptocurrencies and Bitcoin operates independently.
2. Crisis market conditions: as volatility increased in the FX markets, we notice that correlations between cryptocurrencies and currencies increased dramatically and strongly. The greater the volatility increases, so does the magnitude of jump risk and covariability between FX markets and cryptocurrencies.
3. Crypto influences forex: during crisis periods, crypto prices’ influence on foreign exchange prices significantly exceeded the influence of the former. That is to say, during stress and periods of crisis, we find that cryptocurrency price’s impact to FX exchange prices became bigger and Bitcoin and Ethereum fully transmitted positive shocks to currency markets.

Through the foreign exchange rate channel

Through this linear modeling approach we still find a positive relationship, although the impact remains on the foreign exchange rate's influence to Bitcoin. A positive shock on a market to the currency exchange rate (increasing market price, moving closer to parity if the rates moves closer from a number bigger than 1) causes a reduction in value on Bitcoin, whereas a negative shock to the currency market value of cryptocurrency price becomes increasing. The previous result points to dollar depreciation being a positive for cryptocurrency.

The elephant in the room…stablecoins.

In recent research published by Bank for International Settlements on the topic of stablecoins the authors present a fascinating piece of evidence. First, the amount of global fiat to stablecoin converts more than 70 percent originates from non- dollar currency. Every single time a user buys $1 of aUSD with an alt coin or local fiat, that's effectively forex transaction that affects demand for aUSD. The use case that they observe most often is as follows - users converting local currency into $USD pegged stablecoins which are then traded into their target cryptocurrency.

But more importantly, an exogenous 1% increase in stablecoin inflows is predicted to-

-Raise local currency parity deviations by 40 bp;

-Result in the local currency depreciation by approximately 65 bp on the traditional foreign exchange market;

-Cause increased dollar premia in the market for the synthetics dollar transactions, for and beyond existing discrepancies.

Those countries using non-USD peg and with a shallow exchange rate risk tolerance (where the exchange rate deviations have been observed to be the highest and the FX risk hedging costs lowest such as those emerging Asian and LATAM countries, for example Indonesia, Turkey, Philippines, Thailand, Argentina, Colombia …and Mexico too) will thus find those impacts greater and more widespread

What is All Of This Means For you?

The interplay of crypto and forex is going to be increasingly important and given that the Dollar is the key driver of its moves it's worth keeping an eye on The DXY which can function as an ever-present, inversely related indicator for Bitcoin prices; Watch the JPY where we find higher correlations among currencies for potential early signals of market reversals and; Watch stable coin inflows especially those of non dollar users in the emerging markets as they can translate over into impacts in the FX market. This all adds yet another layer of complexity and the need for risk awareness in all markets moving forward, but adds much richer levels of data and information that should be carefully evaluated for making informed decisions for all participants.

What’s your take on the forex-crypto nexus? Let me know in the comments!