Could Forex Be TradFi's First Official Foray Into DeFi?

With all the chaos that was 2022, it was easy to miss some of the trends occurring in TradFi and DeFi. The crypto market's reputation took a hit in the eyes of many mainstream audiences: We saw that NFT drops of poor taste and ill intent are bad for customers and tarnish the more valuable NFT use cases by grouping all NFTs together in a negative light; we saw that CeFi with low transparency can cost users billions and we also saw that global events can strongly affect crypto and TradFi alike.

However, from this, we also saw that DeFi's biggest strengths are exactly what is needed to prevent scandals like FTX. While Ethereum is still the DeFi juggernaut, Polkadot continues to grow as a major player in the crypto ecosystem, with more and more platforms winning parachain auctions with lucrative offers. And we saw that well-built DeFi use cases for global finance can be much more stable, cost-effective, borderless and accessible than the Wild West of TradFi Forex. Not for nothing Forex "won" this unflattering term; issues with Forex have been well established — namely, the exorbitant fees, complicated network and many different platforms varying significantly in quality.

DeFi's growth has slowed since 2020's "DeFi Summer," and it seems that the next spike will occur when there is a strong, mainstream use case that can solicit global attention. It is often easier to gain traction on use cases that replace something existing since users already understand the benefits. With this combination of elements, it seems likely that building a strong foundation for DeFi Forex could be the tipping point toward mainstream adoption.

A recent paper from Circle and Uniswap Labs, which are pursuing DeFi Forex, suggested that remittance costs using DeFi protocols could be reduced by up to 80%. In order to achieve these lower costs, DeFi Forex platforms will need to be focused not just on exchange-related features but on the critical integration with traditional finance networks. Pendulum, one of the decentralized-Forex torch bearers, has been pursuing Forex development with a focus on efficiency, tying in other chains via bridges and creating on/off-ramp standards for integrations into local banking networks.

TradFi Forex: Popular, Lucrative, but Imperfect

The current Forex system is made up of traders, brokers, networks and financial institutions. It covers the globe and facilitates the conversion of one currency to another, using various methods from bank drafts, foreign currency bills and phone and computer transactions. While this system works and has been a lucrative profession for many (reaching a market cup of $753.2 Billion in 2022), there are cracks that are starting to show that make the system difficult for users.

The most often discussed are the significant fees and delays that can hit customers when executing a trade. This can affect the ability of the system as a whole to run smoothly and reduces the amount of trade that can happen as people have to factor in the high costs, not to mention the inability to rely completely on how long a transaction can take. In addition to high costs, there can be risks under the surface of the Forex system rising from a global market spread across many different countries (and laws).

Customers who find a strong, trustworthy platform to use can do well, especially if the firm has reasonable rates. Lower-quality providers may negatively affect their customers' trades if there are delays in transactions, which is especially a risk in Forex, as small changes can swing the market and currencies can be highly volatile. Further, much of the software for systems like Forex is devastatingly out of date, with parts of the system still relying on programming languages like COBOL that were developed over 60 years ago but did not have a clear plan to update the system without risking it completely falling apart. This is not a comfort to anyone exchanging money, and as recent airline problems have shown, infrastructure software that isn't updated properly can cause ripples affecting millions.

Still, despite these risks, the Forex market remains highly popular with retail investors, with an expected 7% growth annually over the next five years. This means the system has the potential to benefit many players. The challenge will be finding a way to eliminate some of these underlying risks (transfer times, outdated infrastructure) while maintaining the value that Forex provides.

Can DeFi Reduce Forex Risk?

Enter DeFi. The system was designed to be strong through distribution, updated continuously and transparent in its actions. Two of the key TradFi Forex risks (transaction delays and infrastructure code) will continue to grow over time. The challenge is well known and has been for decades, but there is a valid fear that updating the system — especially changing the software to something better suited to managing a global financial system — could cause untold damage if it doesn't go smoothly.

TradFi is in between a rock and a hard place because it offers so much but can't be modernized without essentially starting over. This was considered unthinkable, but as DeFi is continuing to be developed, it could potentially act as a parallel system for Forex. This would remove the infrastructure risks of TradFi while maintaining its value.

As mentioned above, some DeFi platforms are focused strongly on creating a DeFi-Forex environment that can draw in the TradFi community with something they are already doing, albeit with a flawed TradFi system. These platforms, whether Circle/Uniswap or Pendulum, have the ability to realize this pairing of DeFi and Forex benefits. Pendulum, in particular, is focused on infrastructure connectivity between DeFi and the existing banking system and has a strong following of players who want to see DeFi-Forex built in a way that maintains the value and reduces the risks (they gained the fastest crowdfund ever for a Polkadot parachain slot). With several bridges built or in development, Polkadot and the larger crypto ecosystem can connect. By adding a user-led governing body, the platform will, by default, continue to make decisions that are focused on the well-being of the community.

Looking Ahead

The TradFi Forex model is incredible but aging. We have a chance to fix the system by leveraging what DeFi is capable of doing best: fast transactions, low fees and transparency. This is a long, long way from how TradFi Forex operates and sets up a value proposition that today's Forex users will easily recognize. It will be exciting to see 2023 unfold with the hope of watching Forex become the standard bearer for DeFi mass adoption. If the crypto community can make this happen, DeFi may very well hit its next renaissance very soon.

(Bridgit Murphy is a blockchain technology engineer specializing in integrated online services, smart contracts, fork development, and quality assurance.)