Getting Forex Onchain
Learn the barriers to getting trillions of dollars of forex liquidity into DeFi and how we can overcome them
Forex is the biggest financial market in existence. However, DeFi needs further infrastructure development to be ready to bring forex on-chain. On average, $6.6 trillion is traded daily on foreign exchange markets. Many opportunities for traditional finance integration with the blockchain space would arise after a sizable chunk of forex liquidity found its way into DeFi. So it is no surprise that much work is being done to bridge this liquidity to DeFi.
Barriers to Getting Forex Onchain
On-chain forex still doesn’t play any meaningful role in crypto, despite it being a perfect and straightforward use case for DeFi. There are several reasons for this including:
- On/off ramping friction
- Legal and compliance questions
- Limited stable token availability
- High cost of Forex trading via AMMs
Much work is being done in the crypto industry alongside regulators to address compliance, stable tokens, and on/off ramps. For example, Pendulum are building a fiat-optimized blockchain that addresses all three. But the high cost of trading forex on AMMs needs to be addressed by technical innovation.
We currently see a minuscule fraction of Forex trading happening in DeFi. Let’s look at the EUROC<->USDC trading pair volume data on DeFi to see how limited onchain forex spot trading is. EUROC (Euro Coin) is the biggest 1:1 redeemable non-USD stable token. The data below was recorded on the 19th of October, 2022.
$688k daily trading volume
$45k daily trading volume
$5k daily trading volume
As we can see, DeFi has barely begun tip-toeing into the 6.6 trillion dollars of daily forex trading volume. One significant barrier is that on-chain forex via AMMs (automated market makers) is still expensive.
Trading Forex on AMMs is Expensive
Off-chain forex trading has very low costs. With trades on major pairs like USD and EUR costing less on average than exotic pairs like USD and BRL. Again, let’s crunch the trading fees for forex on DeFi with data from 19th October. This data is for $100k of transactions between EUROC and USDC (trades in both directions) with a price oracle of 98,124 USD / 101,912 EUR.
98,066 USDC / 101,338 EUROC*
$1.7m pool TVL (Total Locked Value)
Average swap costs = (98,124–98,066) + (101,912–101,338) /2 = $316 = 0.32%
*This means that if you swap 100k EUROC into USDC, you would receive 98,066 USDC. And if you swap 100k USDC into EUROC, you would receive 101,338 EUROC.
97,971 USDC / 90,683 EUROC
$420k pool TVL
Average swap costs = $5691 = 5.69%
97,647 USDC / 97,267 EUROC
$3.2m pool TVL
Average swap costs = $2561 = 2.56%
Fundamental AMM design reasons prevent these costs from significantly lowering further. Unlike off-chain forex exchanges, AMM liquidity providers (LPs) provide the liquidity in a (mostly) passive fashion, which means that each directional price move results in a loss for the LPs. This is referred to as the ‘impermanent loss’. This impermanent loss has to get offset with trading fees in order to attract and hold liquidity. This is a systemic issue with AMMs because price changes on AMMs happen through trades, not through proactive price adjustments by the LPs. Learn more about how AMMs work and impermanent loss in this article:
What is an Automated Market Maker (AMM)?
How AMMs work, how they differ from traditional order books and why they are one of most important crypto innovations…
The AMM passive mechanism is perfect for price finding of longtail assets. However, it introduces unnecessary costs for LPs (and in turn traders) for assets where price finding is dominated by off-chain action, as is the forex case. So to offer competitive forex costs, we need a different type of specialized Market Making protocol.
Enter Amber, the hyper-efficient new PMM (Proactive Market Maker) designed to give forex liquidity on DeFi the green light. Amber’s architecture offers automated market-making with low-risk single-sided liquidity provision. Amber aims to bring down the costs for a $100k trade with similar swap liquidity to the example above to 0.05%-0.10%. This enables Amber to tap new sources of liquidity (like forex) and operate with significantly lower slippage and fees compared to other AMM designs. Learn more in the Amber whitepaper here:
Amber is the next generation proactive AMM in DeFi, enabling single-token liquidity provision without impermanent loss
It is likely not a question of if forex liquidity enters DeFi at scale but a question of when. Mainstream decentralized forex trading would carry many benefits for fintechs, businesses, and traders. These benefits include self-custody and access to the efficiencies and opportunities of DeFi 24/7. Projects like Amber aim to build forex infrastructure for this fiat DeFi future. Amber will be one of the first dApps built on Pendulum chain. Pendulum is on a mission to pioneer the internet of fiat with a blockchain optimized for traditional finance. Finally, allowing fintechs to integrate with DeFi applications such as specialized forex AMMs, lending protocols, or yield farming opportunities. Everyone is welcome to join the Pendulum Telegram Community and Discord community in swinging traditional finance into DeFi.
Automated Market Making without Impermanent Loss. For real.
Building the missing link between fiat and DeFi through a fiat-optimized smart contract blockchain based on Polkadot’s Substrate. Allowing traditional finance fiat services to integrate with DeFi applications such as specialized forex AMMs, lending protocols, or yield farming opportunities. Developed by SatoshiPay.