Speaking about Forex requires a history lesson and a minimal understanding of basic financial terms. For example, Forex itself stands for foreign exchange, where interested parties buy and sell world currencies. While not a physical location, such as the Stock Exchanges in New York, London, and Tokyo, the Forex market lies everywhere, all at once.
What allows this market to exist and function 24/7? The internet. Without the internet, no trades could occur after normal banking hours between 9 AM and 5PM unless you trade in each of the physical stock exchanges, one time zone after another.
Historically, each country had its own separate currency, backed by physical goods or simply by a good faith agreement between the government and its citizens and those of a second or third party. In fact, the Dutch East India Company established the first foreign exchange market in Amsterdam in 1602. Face-to-face transactions required delivering and storing physical goods, determining a price, and then agreeing whether each country’s form of currency held the same value. Because countries rarely owned the same types and amounts of the highest-valued goods, their currencies often varied in value, sometimes within a single day.
This variance in value, known as volatility, could bankrupt entire countries. After World War II caused global economic chaos, the Bretton Woods System established the value of each US dollar against a physical amount of gold in reserve. With this value established, other world currencies could compare themselves to the dollar to transact business. Consequently, both the gold standard and the US dollar affect the economies of other countries directly, sometimes to their detriment.
Because that physical gold reserve had to exist, storing, and moving it around took a great deal of time, personnel, and resources. In addition, the speed of modern transactions outstripped the ability to transport physical money and the gold backing it, causing banks and other financial institutions to place limits, known as holds, on each transaction. Holds ensured that the physical money or gold arrived at the bank in time for the next transaction.
Holds slowed transactions and affected liquidity: the availability of money to make transactions and the speed between depositing it and spending it. Foreign exchanges allowed transactions to occur initially via telegraph and telephone, instantaneously over the internet. This increase in the speed at which transactions could occur, coupled with the fact that supply and demand replaced the gold standard, leads to a return to the volatility of the past.
Determining fair exchange rates for each currency depended on the accuracy of the information supplied by the parties involved, making online trading platforms essential. While banks traded in millions of units, retail Forex brokers traded in 1000-unit chunks instead, putting currency trades within individual reach, a boon to small business owners. These retail Forex brokers could set market prices themselves as Market Makers or rely upon an Electronic Communication Network, or ECN, which allowed rapid comparisons of bidding and selling prices between multiple financial institutions.
The creation of digital currencies challenges the tech industry’s ability to secure and regulate financial markets. Digital currencies such as Bitcoin, Ethereum, or Doge exist electronically. However, as a form of fiat money, their value has no relation to any physical commodities or precious metals. Consequently, market forces alone determine these currencies’ value.