Is there something significant between the US dollar and cryptocurrencies? Although the distinctions seem complex, the main point is cryptocurrencies have more value than fiat currencies. This relationship alone is one that investors should look to observe and capitalize on where necessary.
Are cryptocurrencies the digital gold that analysts claim they are? Although many detractors strongly disagree with this notion, plenty of examples suggest it could be more of the case in the future.
The correlation between fiat currencies and cryptocurrencies goes far beyond trading charts, having a far-reaching influence in all financial markets. For investors, it presents an opportunity to consider investing in cryptocurrencies immediately due to the changing economic landscape.
Despite the numerous US dollar references forthcoming in the article being the world’s reserve currency, the impact of cryptocurrencies applies to all conventional currencies globally.
The nature of fiat currencies and cryptocurrencies
Ultimately, the dollar and cryptocurrencies are two versions of a currency, a transactable medium of exchange, and a storage of value. Governments issue fiat currencies through legal tender.
This power has often been abused by many central banks worldwide to the point that some currencies have experienced hyperinflation. On the other hand, a vast number of cryptocurrencies operate through a decentralized structure where no central authority can make decisions willy-nilly.
The process of creating digital currencies is intensive, giving them particular scarcity. Another reason why cryptocurrencies are inherently more valuable is that some, most notably Bitcoin, experience halving that naturally decreases supply and increases demand.
The line in the sand between forex and cryptocurrencies
The forex market has been publically available since the mid-90s, a stark contrast to the ‘new kid on the block’ that only became mainstream arguably in the mid-2010s. Forex, for the most part, is a ranging market, while cryptocurrencies are more of a trending one, specifically a bull market.
Although some currency pairs enjoy extensive rallies lasting for several months, this pales in comparison to cryptocurrencies that are inherently bullish for the long-term. This concept may partly be because they are still a reasonably new market with highly keen speculative interest and investments.
The disadvantage of a new market is the volatility in prices. Although most financial markets are innately volatile, in digital currencies, this is more emphasized, whereas forex currencies are much more ‘stable.’
With all these considerations in mind, some traders may consider looking into cryptocurrencies for their more ‘trend-heavy’ behavior. As forex markets range considerably, it can be challenging to remain profitable without a trend.
The fundamental correlation between forex and cryptocurrencies
Looking at the technical differences between the two may encourage some to diversify. Another motivation for doing so is probably the more significant: the fundamental aspect. Cryptocurrencies are genuinely more valuable than fiat currencies because they are deflationary.
Some analysts suggest cryptocurrencies like Bitcoin as the ‘new age gold.’ Like the elusive precious metal, most cryptocurrencies are naturally scarce, and we cannot create them without any real work and value attached.
On the other hand, fiat currencies are inherently inflationary, mostly due to monetary policies set by governments and central banks. Arguably, the main argument between forex and cryptocurrencies is that the former is inflationary, making the latter a truly desirable proposition.
The inflation argument
As previously established, by design, currencies lose value over time. To illustrate this point, imagine keeping $1 in 2010. Using current US inflation rates, the same $1 would only be worth $0.80 today.
If we compare the performance of Bitcoin over the past decade, we see a totally different picture. Towards the end of 2010, one BTC was under $1. For simplicity’s sake, let’s assume the price was precisely $1.
After ten years, Bitcoin has increased by approximately 1 822 000% if accounting for its current price of $18 220 (as of 09 December 2020). While the rise of the likes of BTC is unprecedented and astonishingly rare, statistics back up that fiat currencies will always lose value in the long run.
On the other hand, due to the limited supply of cryptocurrencies, we should expect them to increase in price.
Could cryptocurrencies be the new ‘hedge against inflation’?
It’s historically been a recurring suggestion gold is a hedge against inflation, that in times of economic hardships, investors prepare to buy the precious metal. A prime example of this belief is gold reaching its highest-ever recorded price of $2000 in 2020 amidst a global recession.
The charts below clearly demonstrate the inverse correlation between gold and the DXY (dollar index). DXY is a trade-weighted index comprised of six currencies that correspond to America’s prominent trading partners: the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona.
The gold rally began around mid-March when most of the global economy officially fell into a recession. We can observe that as it gradually increased in value, the index went into a strong bear market alongside it.
Now, have cryptocurrencies also exhibited similar behavior? Indeed. At around the same time in mid-March, Bitcoin also experienced a massive rally for several months, taking it back to the near $20 000 peak reminiscent of late 2017.
How to take advantage of this relationship
Most experienced Forex traders do admit to trading another or several other markets aside from their primary. The increasingly growing cryptocurrency market may be a good reason for forex traders to invest in these coins.
Analysts predict that many of these digital currencies will likely experience several bull runs, again driving the value of many established fiat currencies down. It may be in the best interest of forex traders to look for such opportunities and observe that when cryptocurrencies are in demand, the value of ordinary currencies takes a hit (and vice versa).
Traders can decide to trade cryptocurrencies through a broker or buy them directly from an exchange. The latter option may be a better option for more cash-strapped investors since they can trade on margin.
Regularly observing the strengths of fiat and cryptocurrencies may give us clues over where the values of each respective financial instrument could go over a defined period.
Although traders who strictly trade forex are not known to diversify into other financial instruments, there is an evident relationship between currencies and crypto.
While other markets like commodities and indices have always had a historical influence on the movement of forex prices, the effect of cryptocurrencies is as significant and easier to see based on the evolving economic landscape.