To understand the importance of currency exchange and the cryptocurrency revolution as it currently stands, we must begin with a deep dive into the origins of currency.
What is a Currency?
Money has been said to serve three basic functions: a unit of account, a medium of exchange, and a store of value.
A currency, more specifically, is money in any form when utilised in circulation, as a medium of exchange. This means that it can be used in financial transactions, including the buying of goods and services.
Looking beyond the world currencies we recognise today, notable examples are the metal coins and polymer banknotes that we handle frequently in our everyday transactions - or are hidden, to the best of our knowledge, down the back of the sofa.
Before the existence of money, commodities considered to hold intrinsic value were deemed as money. Interestingly, ancient China elected to trade with the cowry shell in the 11th century, whereas the Aztec empire pronounced the copper tajadero (or chopping knife) as their preferred currency.
In the modern world, the United Nations (UN) now recognises 180 world currencies as legal tender, which circulate on the foreign exchange market (Forex), leveraging a daily turnover of at least $5 trillion dollars.
Consequently, Forex is a major source of revenue and speculation for central banks, institutions and investors, as they seek to observe the projected success or failure of global currencies. By adding cryptocurrency to the mix with El Salvador’s consolidation of Bitcoin as legal tender, it is important to understand the future of currencies, and more so, cryptocurrencies.
What are the Major World Currencies?
The major world currencies can be defined by the height and frequency of their trading volume. Those with the highest average trade volume are widely accepted as the major world currencies.
According to the foreign exchange market (Forex), the US dollar has the highest trading volume of all currencies and is involved in over 80% of all foreign exchange transactions. In 2020, the Euro and Japanese Yen ranked behind the dollar in their foreign transaction volume, contributing to at least 33% (JPY) and 23% (EUR) of Forex transactions.
The foreign exchange market indicated the world’s major currencies are the:
- US dollar (USD)
- Euro (EUR)
- British Pound (GBP)
- Japanese Yen (JPY)
- Swiss Franc (CHF)
- Canadian Dollar (CAD)
- Australian and New Zealand Dollar (AUD), (NZD)
What are Major Currency Pairs?
While there are at least 8 major currencies in the world, there are only 7 major currency pairings that are traded on the foreign exchange market. This is because a major currency must involve the dollar as the base, or counter currency, in the trade - and of course, the dollar cannot be traded with itself (USD/USD).
There is some debate about which pairings should be considered as major currency pairs since the concept can be understood both from an economic (trading volume) and speculative standpoint.
As it currently stands, the major pairs are displayed on the table below:
What are Minors and Exotics?
Minor trading pairs occur when a major currency is traded with another, such as the Swiss Franc and the Euro. Without the appearance of the US dollar, the currency pair in question is defined as a minor currency pair.
Popular examples of Forex minor currency pairs are displayed in the table below:
An exotic currency pair is a term used to describe the trading of a developing economy’s currency - as either the base/counter currency - with another major currency.
Often when trading with exotic currencies, traders must be diligent and experienced in the field and account for destabilising factors that affect currency value. In the case of exotic currencies, these factors can be the political or economic agenda of the country that increase volatility and trigger extreme movements or wild swings within the exotic trading pairs.
Why is the US Dollar so important?
The prevalence of the US dollar in the foreign exchange market can be attributed to a pivotal point in history: The Bretton Woods Agreement of 1944. The intention was to create an efficient foreign exchange system that would promote economic growth on an international scale, and utilise economic competition to safeguard against the extreme devaluation of currencies.
Despite the eventual fall of the Bretton Woods system in 1971, the value of the US dollar continues to prevail. As of the agreement, participating countries concurred that their respective currency would be pegged to the fluctuating value of the dollar. However, at the time of the system, the currency valuation of the US dollar had a basis in allocated gold, due to the abundant stores of the American reserves. Now, this is no longer the case.
In 1971, when the US gold supply was considered insufficient to cover the number of dollars in circulation, president Nixon famously devalued the USD when he suspended the ability for citizens to convert their dollars into gold. With gold quite literally out of the trading equation, countries that participated in the agreement suddenly had more autonomy over their currency exchange agreements, making them free-floating.
The Future of Currency
When considering the volatility of exotic currencies, it is significant to witness nations such as El Salvador shaking up the financial market by making Bitcoin legal tender. As an emerging market economy (EME), reliance on Bitcoin, and further broadening country-wide use of cryptocurrency, has produced a considerable response from Salvadorians.
As the first country to utilise virtual currency as legal tender, many have opposed the introduction of Bitcoin due to fears surrounding its instability. This anxiety was coincidentally proven to be true on the first day Bitcoin was introduced as legal tender when the cryptocurrency fell by 20% of its value.
It seems that currency, or more widely money, must act as a medium of exchange in addition to a store of value. Currencies exchanged on the Forex market are known as fiat currencies and, even in the case of the US dollar, have depreciated in value over time.
El Salvador is just one example of a country adopting alternatives to fiat currency. More widely, emerging economies are desperately seeking new currencies that are not susceptible to the depleting effect of inflation. In light of this, we should question whether Bitcoin and other cryptocurrencies more generally, are the right option for emerging markets? The recent crash seen for Bitcoin in the past week suggests otherwise, with its inherent volatility now taking its toll.
Could the implementation of gold as currency once again, perhaps, be the solution for countries looking to elevate the stability and prosperity of their economy? What if this gold was digitalised, made portable through a mobile phone and underpinned by the efficient, peer-to-peer, blockchain technology, much the same as Bitcoin operates on?
Kinesis has already rolled out public-private partnership projects in Indonesia, to create a stable foundation for emerging economies, bringing forward a system that enables the spending, trading and storing of gold as currency. By making KAU - Kinesis’ native gold-backed currency - legal tender, could developing nations establish a new monetary path that introduces, anew, the enduring value of gold seen in the Bretton Woods era?
It seems that only time will tell.
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