Introduction
What is FX market? Inefficiencies and how blockchain can solve them?
Foreign exchange, or Forex is the most liquid market in the world. Most of the FX or currency trading is done not on exchanges but over the counter. According to the BIS (Bank for International Settlements), the daily turnover in OTC FX markets reached $7.5 trillion in April 2022.
That FX market is mostly an OTC market implies that it’s not transparent. It also results in the market being fragmented and prone to price manipulation by large banks.
Financing costs can be excessively high for many firms because they depend on prime brokers to access FX markets. Since the number of financial institutes providing prime brokerage services are low, it usually takes a big deposit to access these services. Furthermore, the title of ownership of funds is typically transferred to a prime broker.
Advantages of blockchain in FX trading
In legacy currency markets, settlements are measured in days, such as T + 1 or T + 2 days. Blockchain technology will accelerate the process by settling the trades in seconds rather than days. The time interval between the execution of a trade and its settlement will shorten drastically.
Due to its decentralized nature, blockchain doesn’t depend on a single entity which for FX trading means that retail traders will own their capital. Even in the case of insolvency or default of a Prime Broker, traders’ funds will be safe.
Protocols
Handle.fi
One of most notable protocols building in the space is handle.fi, a decentralized multi-currency stablecoin protocol. Stablecoins supported by the protocols are collateral backed and are called fxTokens. These stablecoins are soft pegged to a wide range of currencies, such as Swiss franc, Japanese yen, pound sterling, US Dollar, Euro, Chinese renminbi among others.
By providing collateral users can borrow fxTokens in your local currency mitigating your currency risk. You can also leverage trade, and invest or farm in your local currency. In all these cases, handle.fi makes it possible to decrease currency risk.
Users can also mint fxTokens if they deposit collateral to a fxToken vault. Though only ETH is accepted as a collateral in the initial phase, over time other ERC20 tokens, and platform’s own $FOREX token will be added to the list of eligible collaterals.
It will be possible to earn yield by providing liquidity in either fxTokens or $FOREX tokens. The handle liquidity pool (hLP) is a basket of currencies which provides liquidity for protocol users. Traders can use the pool for leverage trading, or for swapping any FX assets. Also, you can think of hLP as a market maker since it acts as a counterparty to all trades. Once participants deposit an approved asset to hLP, they’ll receive shLP (staked hLP). shLP holders will receive trading, funding, and swap fees. They’ll also get funds from trader losses and liquidations.
DeFinity
How DeFinity solves “liquidity conundrum”?
The availability of liquidity makes it hard to develop a trading platform; it’s the situation which DeFinity whitepaper calls “liquidity conundrum”. The conundrum here is that price takes are not interested in platforms lacking liquidity; and price makers tend to be apathetic to provide liquidity in ecosystems with the dearth of price takers.
So, how does DeFinity break “liquidity circle”? We already mentioned that prime brokers are intermediaries who get and provide liquidity to market participants. Since liquidity is vital for the functioning of the platform, DeFinity will keep the supply of liquidity by prime brokers. Nothing new here. But it has the potential to eliminate the use of prime brokers as an intermediary because price takers don’t have to have a relationship with price makers. Market participants will be able to access global liquidity either via prime brokers / custodians or through other channels that will be added to the DeFinity platform later.
DFX
Another protocol building in the decentralized FX space is DFX Finance. Its main use will be in trading fiat-backed foreign currencies. Currently, most stablecoins are pegged to US dollar which is hardly conducive to the development of decentralized currency trading. As its website claims, DFX is keen to build “stablecoins for the world”. At the time of writing this, fiat-backed currencies available on the platform are USDC, CADC, EUROC, among others.
To facilitate the trading and swap of currency pairs, the platform enables liquidity mining. Participants can earn yield by providing liquidity on the platform.
