Forex on blockchain is mirroring the real world markets, research finds

New research finds blockchain currency markets already track real foreign exchange markets but blockchain fees remain a barrier to it taking over from banks.

Foreign exchange is the world's deepest financial market, with roughly $9.6 trillion traded each day, according to the latest Bank for International Settlements Triennial Central Bank Survey, yet its underlying infrastructure has changed surprisingly little in a generation.

A small group of dealer banks still oversee most trades, settlement still relies heavily on Continuous Linked Settlement (CLS), the dominant global FX settlement system, and pricing for many end users ultimately depends on the balance-sheet capacity of global banks.

That architecture is now being challenged by the rise of fiat-backed stablecoins on public blockchains, central bank work on wholesale digital currencies, and the tokenisation of bank deposits and money-market funds by major financial institutions.

New evidence on how blockchain-based currency trading functions in practice comes from a recent study in the Journal of Financial and Quantitative Analysis, “Blockchain Currency Markets,” co-authored by Associate Professor of Finance, Ganesh Viswanath-Natraj, of Warwick Business School in collaboration with Angelo Ranaldo (University of Basel) and Junxuan Wang (HKUST Guangzhou).

The paper provides the first transaction-level analysis of stablecoin foreign exchange trading on decentralised exchanges (DEXs).

A new layer in currency markets

The study focuses on stablecoins — digital tokens pegged to fiat currencies such as the US dollar and euro — traded on Uniswap V3, the dominant decentralised venue for this activity.

By matching transaction-level blockchain data to interbank EUR/USD benchmark prices reported by CLS, the authors measure how closely on-chain exchange rates track traditional FX markets.

On average, the EURC/USDC exchange rate stays very close, within about 24 basis points to the real-world EUR/USD rate used by banks. When small differences do occur, they are mostly caused by blockchain factors like transaction fees and network volatility, rather than the financial constraints that typically influence prices in traditional currency markets.

“Decentralised currency markets respond to the same macroeconomic forces as traditional FX, and arbitrage keeps prices in the two venues closely aligned,” says Dr Viswanath-Natraj. “The differences are mostly in the form that frictions take, not in whether the market functions as an FX market.”

A familiar dealer structure

A common claim about decentralised finance is that it eliminates intermediaries, but using wallet-level information, the researchers identify a hierarchy of participants that closely resembles traditional FX markets.

A small number of highly active, experienced traders, specifically the top ten wallets by trading volume, carry out about half of all trades and play the biggest role in setting prices. Another group, known as “primary dealers,” can create and redeem stablecoins directly with issuers and step in when prices drift from their intended value, bringing them back into line. The rest of the market is made up of passive participants who provide liquidity but mainly adjust their positions automatically in response to price changes, rather than trading on new information.

The economic roles performed by these participants closely resemble those of dealers, arbitrageurs, and liquidity providers in conventional FX markets. What differs is the infrastructure through which they operate.

The new frictions in currency trading

If blockchain-based FX markets are closely linked to interbank markets, why have they not displaced more of the existing system?

The paper argues that trading frictions have changed form rather than disappeared. On the blockchain, dealer spreads and correspondent banking costs are replaced by gas fees, the transaction fees required to execute trades on blockchain networks, and slippage against pool liquidity. Gas fees dominate the cost of small trades, while slippage becomes the main constraint for institutional-sized transactions.

For larger trades, total execution costs are broadly comparable to those faced by mid-tier corporate clients in over-the-counter FX markets today.

Implications for adoption

The study suggests that blockchain-based currency markets are evolving into a parallel layer of FX infrastructure rather than a complete replacement for existing systems. Stablecoin pools remain much smaller than traditional FX markets, transaction costs remain sensitive to network congestion, and the system still depends heavily on a small number of stablecoin issuers.

“Several structural frictions would still need to be resolved before stablecoin-based FX markets could operate at the scale of traditional FX infrastructure,” says Dr Viswanath-Natraj.

“The more likely near-term outcome is that stablecoin markets complement existing over-the counter infrastructure rather than replace it.”

Further reading:

How stablecoins will impact foreign exchange markets

Regulatory transition could be 'impossible' for some stablecoins

How do we keep stablecoins stable?

How are interest rates set on DeFi platforms?

Ganesh Viswanath-Natraj is Assistant Professor of Finance at Warwick Business School and a member of the Gillmore Centre for Financial Technology. He teaches Financial Markets on BSc Accounting & Finance and Fintech: Digital Currencies and Decentralised Finance on the MSc Finance and MSc Business and Finance.

This article is based on the following research:"Blockchain Currency Markets" by Ranaldo, A.; Viswanath-Natraj, G. and Wang, J. It is published in the Journal of Financial and Quantitative Analysis. Doi:https://doi.org/10.1017/S0022109026102841