There are three most crucial trading terminologies that every new trader should be acquainted with. One is Foreign Exchange swap – and the other two are forward swap and spot exchange. Interestingly, spot and forward swap are parts of Foreign Exchange swap; in trading jargon, the two parts are addressed as “legs”.
Let’s decode the three terminologies for better understanding of the trading market. The discussion below will also help you to gather a clear idea on the differences between forward swap, spot exchange, and Foreign Exchange Swap. Read more about Multibank.io.
Overview of Foreign Exchange swap
FX swap agreement involves two main procedures that happen simultaneously- borrowing and lending. Put simply, in FX swap, parties involved in the swap both lend and borrow funds (identical amounts). There is one major condition though- both the parties here must require the currency the other party owns as well as own the currency the other party needs.
The FX swap trade happens in two parts. In the first part, the parties borrow and lend at a fixed initial date. In the final part, the parties exchange the amounts upon maturity. The second part of the trade can take place anytime after the initial date, ranging from 1 month to even after 6 months.
Let’s discuss the situation with an example.
Let’s say, our two parties in the FX swap are American (X) and European (Y). X requires EUR while Y needs USD. Both of them decide to participate in a FX swap. They decide to start swapping today and fix the second half of the date after 3 months. According to their agreement, 1,500,000 USD and 1,000,000 EUR will be swapped today at 1.5 EUR/USD spot exchange rate. For forward rate, both the parties agree to 1.6 EUR/USD. We will discuss spot exchange and forward in detail in the latter half of the article.
On the initial date, X receives the specified amount of Euros as well as lends the stipulated amount of US Dollars to Y. After 3 months, X returns the borrowed Euros as well as receives 1,600,000 USD (1,000,000 EUR multiplied by 1.6 EUR/USD). And, thus, FX swap reaches completion.
Overview of Spot and forward
As discussed above, a FX swap agreement comprises two legs or parts- spot and forward.
In spot exchange trade, one asset is traded with another based on immediate or current real-time market rate. The spot trades happen immediately and the payment is delivered upfront. However, it might take 3 days to receive the fund or asset after purchase. But if a trading market is open 24/7, such as a crypto market, the buyer gets the funds on the same day only.
Based on the example mentioned above, the phase of initial borrowing and lending between the swap parties signifies spot exchange- and the rate (1.5 EUR/USD) at which the swap agreement took place was the rate of spot exchange.
Also dubbed as deferred swap, forward swap is the exact opposite of spot exchange.
In forward swap, parties involved in the swap decide to exchange (assets or currencies) at a specific date in future. The future date might vary based on the specific needs and interests of the parties involved. It could be anywhere ranging between 1 week to 1 month to 6 months or even more.
If we look at the example mentioned above, the second phase of the FX swap constitutes the phase of forward swap.
It’s to stress here that forward swaps generally focus on swapping on interest rates. In this case, an exchange of swap of interest rate is scheduled for a specific future date.
Spot and forward exchange in crypto
Spot exchange in crypto
Interestingly, spot exchange and forward swap are not limited to the FX industry only. These two universal trading concepts cover newer trading markets too, such as cryptocurrency.
In crypto trading, spot exchange implies exchange of two crypto assets based on immediate on-the-spot rate. However, spot exchange in crypto also covers exchange of crypto assets with fiat, such as spot trading of BTC and USD. Much like FX swap spot exchange, in crypto too, the payment is always made upfront.
There are various platforms to conduct spot exchange in crypto space. The most popular one is surely crypto exchange. Both centralized and decentralized crypto exchanges allow spot exchange trading. Then, you can also execute crypto spot exchange trading on OTC platforms if you want lesser fees and a more flexible environment than exchanges, especially CEXs. The other option to conduct spot exchange trading in crypto is through P2P crypto trading platforms.
Just one thing to remember, all platforms might not accept fiat payment. So, if you want to use fiat for spot exchange, make sure beforehand that your chosen platform allows crypto exchange with fiat.
Forward exchange in crypto
Forward exchange in crypto implies exchange of two crypto assets based on a scheduled rate- but on a future date. The date of trade will be scheduled on the very day the swap parties form the agreement.
While in spot exchange, the trading parties settle the trade with live market rate- in forward exchange, the rate is based on speculation. It’s because you cannot know beforehand the exact market rate and you have to rely on calculated guesswork and speculation here.
Unlike spot exchange, forward trade is not carried out in crypto exchanges. You mostly have to rely on OTC and P2P trading platforms.
Forward trade and spot exchanges are two of the most crucial pillars of the trading scene- be it the FX market or the crypto trading zone. Both have their own sets of advantages and cons.
When it comes to spot exchange, the process is rather breezy and simple as you don’t need to conduct in-depth technical and fundamental analysis. But, on the other hand, spot exchange does not let you take the advantage of higher gains if the market surges in future.
Forward exchange allows room for speculation and enables the parties to make the most of the market surge in the near future. But, in comparison to spot exchange, it’s a complicated process.