The recent history of the foreign exchange (forex) space offers insight into the developing digital asset economy.
Unlike traditional stocks, which typically trade on centralised marketplaces, foreign exchange trading happens electronically over decentralised networks that span the globe. Although the underlying mechanisms and technologies are different, there are clear parallels between the decentralised and international structure of forex trading and the emerging cryptocurrency and digital asset markets.
The arrival of the internet fundamentally changed forex trading by opening up the markets in the late 1990s and early 2000s to the general public. At the time, the ability for individuals to trade from their own computers was a novel opportunity. In addition to big banks, a legion of smaller retail brokers cropped up alongside this developing industry to provide interfaces, tools, and services to facilitate the growing forex trading landscape.
Nonetheless, when forex trading first went online, it had elements of the lawless, “Wild West” culture that has also characterised the early stages of cryptocurrency. The parallels between the digital infancy of both is just one reason why the two are natural allies in a combined trading space, and why the evolution of regulation in one has wide-ranging implications for the other.
The evolution of national forex regulation
To appreciate the current conditions that traders operate in now for both traditional forex as well as for crypto currency trading, we need to appreciate the regulatory developments in the established forex space that current markets are built on.
Within the forex space, the theoretical basis for regulatory policies and institutional standards have always centred around protection for individual investors and market stability. To become licensed as a forex broker, an entity must often meet minimum capital requirements, adhere to bookkeeping, reporting, and audit requirements, offer limited leverage, and meet a number other criteria depending on their national jurisdiction. By creating the current rigorous licensing process, regulators aim to prevent fraudulent brokers from entering the marketplace and exploiting clients.
In the US, the Commodity Exchange Act (CEA), requires forex brokers to register with the Commodity Futures Trading Commission (CFTC). The CFTC has largely delegated the registration process to the National Futures Association (NFA). The standards put in place by the CEA are designed to protect customers, particularly investors who are “individuals with assets of less than $10 million and most small businesses.”
The Australian Securities and Investments Commission (ASIC) moved to regulate over-the-counter (OTC) derivatives trading in 2009, following the G20 Summit, which served as the impetus for other countries to reform forex regulations, as well. Australia began to implement legislation in this regard back in 2013, aligning ASIC’s main objectives with those espoused by the G20 Summit: “[to] enhance the transparency of transaction information available to relevant authorities and the public, promote financial stability, and support the detection and prevention of market abuse.”
After suffering the consequences of deregulation in the 80s and 90s, Australia’s regulatory environment today is considered to be one of the most robust and effective. Today, forex brokers are required to maintain an ASIC license, which demands they hold, “at least the sum of $50,000; plus five per cent of adjusted liabilities between $1 million and $100 million; plus 0.5 per cent of adjusted liabilities for any amount of adjusted liabilities exceeding $100 million.”
Australia is not the only nation to institute minimum capital requirements as licensing requirements for forex brokers. Japan’s Financial Services Agency (FSA) has updated its policies a few times since its 2005 amendment of the Financial Futures Trading Act to include forex. Highly leveraged transactions became problematic in 2007-2008, and regulators moved to institute a four per cent margin requirement ratio for certain types of forex transactions.
In 2016, Japanese regulators updated the margin requirement policy to apply to all forex transaction types. The Monetary Authority of Singapore (MAS), similarly, updated its criteria for issuing licensed to forex brokers. Applicants today must meet minimum capital requirements as well as education requirements, and the somewhat more abstract qualifications of “fitness and propriety.”
Shaping crypto trading
Perhaps one of the biggest challenges the digital asset economy will face is legacy regulation creating barriers to entry for companies attempting to enter the crypto space, such as exchanges, leading to the kind of consolidation and centralisation that has occurred within forex. Scale can make the complex and expensive administrative and liquidity overhead easier to cope with, but with the price that it shuts smaller and start-up players out of the market altogether by pricing compliance out of their reach.
Take the US, home to some of the biggest forex brokers in the world. Trading there remains highly regulated and regimented. The high costs associated with getting approved to offer services make the market very hard to break into. Europe has remained more diverse, but the recent moves to impose “variation margins” into MiFID regulatory policies threaten to create an atmosphere in which compliance is too expensive for smaller companies.
As cryptocurrencies have gained momentum and solidified as a new asset class, the question of regulation has becoming more pressing. For investors and innovators, the developing regulatory landscape surrounding digital assets carries enormous weight, and regulatory steps by one country can have a significant impact the global market. While many within the cryptocurrency space are opposed to regulation from a philosophical standpoint, it is clear that numerous governments are pushing to regulate digital assets, using traditional forex as a model.
Blockchain technology is developing rapidly, and enforcement of encryption-based services can be difficult. How regulations will ultimately impact this space remains to be seen, but we can look to history the forex landscape of 20 to 30 years ago for insight into how regulatory bodies enter a largely unregulated, decentralised, international marketplace.