Understanding Price Formation: Forex and Crypto Markets

Financial markets are usually discussed in terms of what happened: a breakout, a crash or a sudden spike in volatility. But focusing solely on the outcome ignores the "engine" that drove it. Behind every price tick lies a complex machinery of market structure, liquidity and the rapid absorption of information.

As trading grows more interconnected and tech-driven, understanding how a price is formed is now as vital as knowing why it moved. This is nowhere more apparent than in the contrast between Foreign Exchange (Forex) market and the digital frontier of Cryptocurrency. While both react to the same macro forces, the "pipes" through which information flows are fundamentally different.

This article peels back the curtain on the mechanics of price formation, exploring how liquidity, information flow and market structure interact in each market and where those processes converge, we can better understand why prices sometimes move without obvious news, why volatility clusters across asset classes and why similar events can produce very different market reactions.

What is Price Formation?

Price formation is the process through which financial markets determine the price of an asset at any given moment. It is the continuous outcome of supply and demand interacting through market structure, liquidity and information flow. In both the Forex and Crypto markets, this isn't a static number. It is a living, breathing consensus that changes every time a new piece of information enters the world.

In both markets, prices emerge from the aggregation of countless buy and sell decisions made by different market participants. These decisions are influenced by a combination of factors, including economic data, monetary policy, geopolitical developments, risk sentiment and expectations about future conditions. The price seen on a chart is the point at which opposing interests temporarily agree.

A key distinction in understanding price formation is the difference between price discovery and price movement. Price discovery refers to how markets incorporate new information and establish a fair value, while price movement reflects how that value adjusts as liquidity, order flow and participation change. Rapid price moves often occur not because new information is dramatic, but because the market’s ability to absorb orders is limited at a given moment.

Importantly, price formation is shaped by market structure. In highly liquid markets such as major forex pairs, deep pools of liquidity tend to smooth price changes, allowing markets to absorb large volumes with relatively modest moves. In contrast, markets with fragmented or thinner liquidity (more common in parts of the crypto ecosystem) can experience sharper price adjustments in response to the same type of information.

Understanding price formation helps explain why markets sometimes move without obvious news, why similar headlines can produce different reactions across assets and why volatility tends to increase during periods of uncertainty.

The Forex Price Formation Engine

Price formation in the foreign exchange market takes place within a decentralized, two-tiered structure dominated by professional dealers. Unlike exchange-traded markets, forex pricing emerges through the interaction between dealers and their customers and through dealers trading risk among themselves.

At the first level, dealers quote prices to customers based on their current inventories, risk limits and expectations. Customer order flow does not simply reflect demand for a currency; it introduces inventory imbalances that dealers must manage. These imbalances influence how aggressively prices are quoted, directly affecting observed market prices.

At the second level, dealers redistribute this risk through interdealer trading. Prices in the broader market adjust as dealers seek to offload excess exposure and rebalance inventories. In this way, price formation in forex is not driven by customer trades alone, but by how those trades propagate through the dealer network.

Liquidity plays a central role in this process. While major currency pairs benefit from deep and continuous liquidity, it is not unlimited. When dealer balance sheets are constrained or risk tolerance declines, prices can move even in the absence of major news. This helps explain why exchange rates sometimes shift rapidly during periods of uncertainty or stress, despite the market’s size.

Central banks influence this engine primarily through expectations. Policy guidance, interest rate signaling and communication strategies shape dealer positioning well before decisions are implemented. As a result, forex prices often move in anticipation of policy actions rather than in reaction to them.

Taken together, the forex price formation engine reflects a continuous negotiation between information, liquidity, and risk management. Prices adjust not because markets are inefficient, but because they must constantly reconcile new information with the practical limits of liquidity provision.

The Crypto Price Formation Engine

Price formation in cryptocurrency markets takes place primarily through exchange-based limit order books, where prices emerge from the continuous interaction of submitted orders rather than from a centralized dealer network. Unlike the foreign exchange market, crypto prices are formed almost entirely within trading venues, each operating its own matching rules, liquidity pools and order priorities.

A defining feature of crypto price formation is the dominant role of limit orders. Much of the price discovery process occurs not through executed trades, but through the submission, modification and cancellation of limit orders. These actions shape the available liquidity at different price levels and influence market prices even when transaction volume is relatively low. As a result, prices can adjust meaningfully without a large number of trades taking place.

Crypto markets are also highly fragmented. The same asset can trade simultaneously across multiple centralized exchanges, each functioning independently. While arbitrage activity generally keeps prices aligned over time, short-term dislocations can and do occur, particularly at high frequencies or during periods of heightened volatility. In these moments, price integration across venues weakens, allowing discrepancies to persist before being corrected.

Liquidity conditions play a critical role in this process. Compared to traditional financial markets, crypto liquidity is less stable and more sensitive to changes in market participation. When liquidity thins, whether due to time-of-day effects, market stress or rapid order cancellations, prices can move sharply as the order book adjusts to new conditions.

The absence of unified execution standards across exchanges further amplifies these dynamics. Without cross-venue order priority or best execution requirements, price formation depends heavily on where trading activity concentrates at a given moment. This structural characteristic helps explain why crypto markets can experience rapid repricing and abrupt regime shifts, even in response to relatively modest information shocks.

Overall, the crypto price formation engine is driven by order-book dynamics, fragmented liquidity and rapid information absorption. Prices reflect not only changes in expectations or sentiment, but also the structural constraints of decentralized trading venues, producing a market environment that is highly responsive but prone to sudden and pronounced price movements.

Where Forex and Crypto Price Formation Collide

Despite their structural differences, forex and crypto markets often respond to the same underlying forces. Price formation in both markets is ultimately shaped by how information, liquidity, and risk interact in real time. The distinction lies in how those pressures are transmitted through market structure. In both forex and crypto, prices tend to move in anticipation rather than reaction.

In forex markets, currency prices typically respond to macroeconomic drivers in relatively structured and observable ways. Interest rate decisions, labor market data, and geopolitical developments generate responses that are widely anticipated and monitored. This allows market participants to contextualize price formation around economic calendars, historical behaviour, and established macroeconomic relationships.

Cryptocurrency markets, by contrast, operate under a dual-driver dynamic. While major crypto assets are increasingly influenced by institutional capital flows and global macro trends, large segments of the market remain highly sensitive to narrative-driven forces. Social media sentiment, protocol upgrades, regulatory signals, and concentrated ownership can all introduce sudden shifts in order flow and liquidity.

These differences do not change the underlying process of price formation, but they alter how quickly and unevenly information is translated into price. In crypto markets, high-speed information dissemination and rapid shifts in participation can accelerate price adjustment, particularly when liquidity is thin. As a result, price movements may reflect changes in narrative and positioning as much as changes in economic expectations.

This contrast helps explain why similar macro developments can produce smoother adjustments in forex markets and sharper, more discontinuous moves in crypto markets. In both cases, prices respond to evolving expectations, but the channels through which information enters the market, and the speed at which it is absorbed, differ materially.

Liquidity acts as the common transmission mechanism. When liquidity is abundant, markets in both asset classes can absorb new information with relatively modest price adjustments. When liquidity thins, however, even small imbalances in order flow can produce outsized moves. This dynamic explains why periods of uncertainty often lead to heightened volatility across both forex and crypto markets simultaneously.

Cross-market interactions further reinforce this convergence. Movements in major currencies, interest rate expectations, or global risk benchmarks frequently spill over into crypto markets, shaping pricing behaviour even in the absence of crypto specific news. Conversely, sharp moves in crypto, particularly during periods of stress, can influence broader risk sentiment and positioning across asset classes.

Where the two markets differ most is in how quickly and unevenly these forces are reflected in price. Forex markets tend to adjust through dealer balance sheets and interdealer liquidity, while crypto markets adjust through order-book depth and exchange-level dynamics. Yet in both cases, price formation reflects the same underlying process: the continuous reconciliation of information with available liquidity.

Understanding where forex and crypto price formation collide helps explain why markets often move together during global events, why volatility clusters across asset classes, and why price action cannot be fully understood in isolation. While the engines differ, the forces acting upon them are increasingly shared.

Key Differences in Price Formation: Forex vs Crypto

While forex and crypto markets respond to many of the same global forces, the way prices are formed differs meaningfully due to market structure, liquidity provision, and information transmission.

In the foreign exchange market, price formation is largely shaped by a dealer-driven structure. Liquidity is provided by banks and professional market makers who manage inventory risk and absorb order flow across a two-tiered system. Prices tend to adjust through balance-sheet constraints and interdealer trading, producing relatively smooth transitions as information is incorporated.

In contrast, cryptocurrency price formation is exchange-driven and order-book centric. Prices adjust directly through changes in visible liquidity, driven by limit order placement, cancellation, and execution. Without centralized liquidity provision or unified execution standards, price adjustments can occur unevenly across venues, particularly during periods of stress or rapid information flow.

A further distinction lies in liquidity stability and scale. The foreign exchange market remains the largest and most liquid financial market in the world, processing trillions of dollars in daily trading volume. This depth of liquidity typically results in tight spreads and efficient execution, allowing markets to absorb large transactions with relatively limited price impact under normal conditions.

Cryptocurrency markets, while maturing through increased institutional participation, remain smaller in scale by comparison. Lower aggregate liquidity means that large transactions, particularly those executed by concentrated holders, can exert a disproportionate influence on price. When order books thin, these flows can trigger rapid price adjustments amplifying volatility and accelerating price formation.

These structural differences have important implications for how prices evolve. In highly liquid markets such as forex, price formation often reflects the gradual reconciliation of information across a broad participant base. In crypto markets, price formation is more sensitive to changes in participation and order-book depth, making prices more responsive and also more discontinuous during periods of stress or heightened activity.

Information transmission also differs. Forex markets primarily reflect macroeconomic data, monetary policy expectations, and geopolitical developments that are widely anticipated and scheduled. Crypto markets, while increasingly influenced by these same forces, are also shaped by decentralized and narrative-driven inputs that can alter positioning quickly and without warning.

These differences do not imply that one market is more efficient than the other. Rather, they highlight how the same information can produce different price behaviour depending on the structure through which it is processed. In both cases, price formation remains a dynamic process - one that reflects the constant interaction between expectations, liquidity, and risk.

Bottom Line: Why Price Formation Matters for Traders

Price formation is the process through which financial markets determine the price of an asset at any given moment. It reveals why prices can shift without obvious news, why volatility often appears suddenly and why similar events can produce very different outcomes across asset classes. Understanding this process moves analysis beyond outcomes and toward the mechanisms that drive them.

In both forex and crypto markets, prices are shaped by the interaction of information, liquidity and risk, but the structures through which those forces operate differ materially.

Forex prices adjust through dealer balance sheets and interdealer liquidity, while crypto prices respond more directly to order-book dynamics and fragmented trading venues. These differences influence not just the speed of price adjustment, but the nature of volatility itself.

For traders, the implication is clear: price action cannot be fully understood in isolation from market structure. Recognizing how liquidity conditions, information flow and participation interact provides deeper context for market movements and helps explain why periods of calm can quickly give way to sharp repricing.

As markets become increasingly interconnected, the ability to interpret price behaviour through the lens of formation rather than reaction becomes an essential part of navigating both traditional and digital assets. Understanding how prices are formed does not eliminate uncertainty, but it offers a clearer framework for interpreting it.