DeFi in Forex

Over $7 trillion is traded on the Forex market daily. One-third of this amount (or $2.2 trillion) is at settlement risk daily.

Settlement risk in forex is a risk that occurs when two parties in a currency exchange transaction don’t follow through on their agreed-upon exchange of money.

Imagine you’re trading stickers with a friend, and you give them a sticker you promised, but they don’t give you the sticker they promised in return. That’s kind of like settlement risk. It’s when one party doesn’t do what they said they would do in a trade.

To avoid this risk, parties use various agreements and systems, although, in most cases, they are impractical or too expensive.

What is the solution?

Decentralized Finance

A research paper by Circle and Uniswap talks about how DeFi can address the settlement issue of Forex.

One of the many arguments was that blockchain could enable atomic transactions. Since one trade cannot occur without the other, it eliminates credit risk in the settlement process.

They propose a cross-border payment system that relies on two layers – tokenized cash (USDC, I assume, is the stablecoin in this case) issuer (Circle) and DEX (Uniswap).

USDC will be backed by full reserves to meet on-demand liquidity, which will ensure that users can redeem the USDC token for the fiat counterpart. 

Uniswap will facilitate price discovery, risk exchange, and USDC settlement in one currency versus another.

Moving Forex to on-chain can have benefits like 24\*7 market hours, instant settlements, minimum (or no) settlement risk, transaction data visibility, privacy-preserving transactions, and deep liquidity.

The idea looks interesting and innovative, and if the risks are weighed in properly, we could see the Forex market shifting to blockchain for its benefit.

What do you think?

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