How FX Exchange Rates Are Determined

One of the best ways to understand what OpenFX does, and why it’s important, is to understand the market we operate in. So let’s talk about FX exchange rates.

What is an exchange rate?

An exchange rate is the value of a nation’s currency versus another. They’re usually quoted using an acronym for the currency they represent: USD is the US dollar, EUR is the euro. Between USD/EUR, an exchange rate of 0.86 means that one dollar equals 0.86 euros.

Exchange rates can be:

• Free-floating, meaning they change based on forex supply and demand.

• Fixed, meaning they are pegged to another currency to ensure their stability.

• Restricted, which is when the value is set by the country’s government. These currencies are restricted to exchanges expressly within the country’s borders. Sometimes they will have both an onshore and offshore rate.

So far, so good. But in the world we actually live in, the world of exchange rates is volatile, enigmatic and downright befuddling. Imagine yourself as a secret agent, trying to explore the world of currency flux. If you follow the money, where will it take you?

The FX market trades $7.5 trillion per day—orders of magnitude larger than stock markets—which means small shifts in sentiment can create massive flows. A strong jobs report can send a currency up; political instability sends it down. Sometimes the moves are responses to data; other times, speculation or momentum might be driving.

To understand how weird this can get, you have to step into some spy shoes. Let’s take a trip to a few countries where you can literally get a good (or terrible) exchange rate off the street.

X-ray vision on: Shadow networks

For a lot of people in developing corridors, USD is perceived as more than a transaction currency; it’s a store of value. When times get tough, people in markets like Colombia, Brazil, Argentina or Venezuela want to shore it up. This of course affects the exchange rate.

In Colombia the dynamics get really strange. Street vendors, dubbed “cambistas,” sometimes operate informal FX exchanges that work outside the regulated banking system. Cambistas monitor both the official rate and neighboring countries’ black-market rates to profit from cross-border arbitrage. These social networks are trust-heavy, so it’s useful to have a few cambistas in your pocket while navigating the market.

The thing is the more fragmented and trust-based these networks are, the larger the spread gets between the market’s exchange rate and the price on the street.

On Venezuela’s border, entire communities engage in informal exchange and arbitrage whose dynamics are informed by migration, remittances and informal trade. Often, these networks are run by families and can literally decouple the local black-market rate from the street rate in Bogotà or Medellín.

In situations like this, wider spread doesn’t just come in the form of more fees; it also brings added risk. We’re talking counterfeit currency, police imbroglios and scams.

It’s not your everyday mom-and-pop shop.

Macroeconomic factors are also a big cause of currency flux. Interest rates matter enormously: Higher ones attract foreign capital seeking returns, strengthening the currency. Inflation erodes purchasing power, weakening a currency. GDP growth, employment data, trade balances—all these feed into valuations. Central bank policies can move markets in seconds. When the Fed hints at rate changes, traders react immediately.

Cultivating relative stability is thus crucial, because FX rates impact everybody. They impact trade with other nations, the cost of imports, and tourism—tourists with stronger currencies might prefer visiting countries where their money goes further.

Brazil uses a tax called the IOF to cultivate currency stability. It has a big impact on how Brazilians interact with foreign currencies, and thus on the official exchange rate. For example, the IOF imposes a tax of 1.1% on cash currency exchanges; international credit card purchases or foreign loans can see a 6.38% tax, depending on the nature of the transaction. This exists partly to control demand for USD.

Again, because it’s perceived as a store of value, uncontrolled USD flow can devalue Brazilian currency.

The result on the street is predictable: Black market spreads get wider, but also more popular in order to avoid IOF tax. Some people prefer the so-called “dolar paralelo” (the black market dollar) because it doesn’t come with added fees—apart from the ones their dealers add on, anyway.

All this sounds shadowy and uncommon, but depending on where you are, it really isn’t. Let’s quickly detour to Argentina, where the “dólar blue” (or blue dollar) refers to the black market exchange rate for the US dollar.

For many years, Argentinian currency changed so often that it had multiple exchange rates, exacerbated by inflation and the devaluation of the pesos. Culturally, there isn’t a lot of trust in the pesos, which brings us back to that recurrent point: The dollar as a safe store of value.

Enter the blue dollar, which becomes essential for people looking not only to engage in cross-border transactions but literally to protect their savings. Because of restrictions on buying USD on the official market, the blue dollar has become very popular. Instead of dealing with the controls imposed by Argentinian banks, the blue dollar’s rate is determined by supply and demand. For local people, this rate feels “truer” and less tampered with, even if it is sometimes more expensive. In recent months, the Argentinian government has worked to match the blue dollar rate to the official exchange rate for the Argentine peso.

Now you see that culture and regulation actually interact, constantly, to impact forex rates. All this brings us to a crucial question: What is the forex market, anyway?

The forex market: A primer

The foreign exchange market, also known as the forex market or FX, is a nonstop market where currencies are traded over-the-counter.

It isn’t a place with a door that you can simply enter.

Rather, it's a decentralized global network where major banks—like JPMorgan, Citibank and Deutsche Bank—constantly trade currencies. They are the great oligarchs of this spy tale, controlling everything from impenetrable skyscraper fortresses. The massive volumes of currencies that move between them form the backbone of FX pricing. The rates they negotiate with each other become the reference point for everyone else, trickling down to markets as complex as the ones we just described.

But even at this Olympian level, FX is a labyrinth to navigate, riddled with layers:

• The spot market is for immediate delivery: Trade currency now, settle in two business days.

• The forward market lets you lock in rates for future dates, crucial for businesses hedging risk.

• The futures market offers standardized contracts on exchanges.

• The options market provides the right, but not obligation, to exchange at specified rates. Each serves different needs, from speculators to corporations managing international operations.

From there, there’s the bid/ask spread. Every market maker quotes two prices: the bid (what they'll pay) and the ask (what they'll charge). The difference is their profit margin.

In the interbank market between major currencies, this spread might be a fraction of a penny. By the time it reaches consumers through banks or currency exchanges, that spread has widened considerably.

That gap is where everyone in the chain gets paid.

What you need to know about the mid-market rate

The mid-market rate is the midpoint between what buyers want to pay and what sellers want to receive. It’s the benchmark that makes everything else measurable. Think of it like the “manufacturer's suggested retail price”: Without it, you can't tell if you're getting ripped off.

If Bank A offers you 1.0950 EUR/USD and Bank B offers 1.0920, which is better? You can't know unless you know where the “fair” rate is. If the mid-market is 1.0850, then you know Bank A is marking up 0.92% and Bank B is marking up 0.64%. Now you can make an informed choice.

The mid-market rate is determined by supply and demand, just like all those black market dollars in exotic corridors—specifically, the best available prices where buyers and sellers are willing to transact at any given moment.

Let's say for EUR/USD:

• Best bid (highest price someone will pay for euros): 1.0850

• Best ask (lowest price someone will sell euros for): 1.0852

The mid-market rate is simply the mathematical midpoint: (1.0850 + 1.0852) / 2 = 1.0851.

That’s it. It’s not set by any authority or calculated through complex formulas. It’s literally just the average of the tightest spread in the market at that exact moment.

While the mid-market rate is just an average of two numbers, those numbers are the culmination of billions of dollars in trades, countless economic factors, and the collective intelligence (and sometimes panic) of the global financial system. Just as street prices for shadowy dollars are determined by supply and demand, it emerges organically from the collective actions of all participants.

Theoretically, the mid-market rate represents the fairest price—the place where supply perfectly meets demand. If banks are willing to buy euros at 1.0850 and sell them at 1.0852, the mid-market rate is 1.0851. This is the rate you see on Google or Bloomberg.

It's also the rate you'll never actually get, because nobody's in the business of giving away the spread.

How the FX market calculates the mid-market rate in practice

Who are the real players behind these shadow networks? Once more: Follow the money.

The mid-market rates you see are calculated by data vendors who aggregate price feeds from the interbank market. The major players are Reuters (Refinitiv), Bloomberg, EBS (Electronic Broking Services), and Thomson Reuters Matching.

These companies have direct connections to the banks and trading platforms where FX happens. Using electronic platforms, they collect the bid/ask quotes from dozens or hundreds of major market makers: JPMorgan might post a bid of 1.0850 and an ask of 1.0852 on its trading system, Citibank might show 1.0849/1.0851, Deutsche Bank 1.0850/1.0853, and so on.

The aggregator looks at these quotes and makes a call: “The best bid across all sources is 1.0850, the best ask is 1.0851, so the mid-market rate is 1.08505.” This happens multiple times per second.

Professional traders see these rates on Bloomberg terminals, Reuters terminals, or proprietary trading platforms. They pay upwards of $20,000 per year for those data feeds because they need the most accurate, fastest information.

No single entity decides the rate, but everyone agrees on what it is because they're all looking at the same aggregated data. It’s the snake eating its tail—traders make decisions based on the mid-market rate they see on their screens, but that rate is derived from the prices they themselves are posting.

In recent years, fintech companies like Wise, Revolut, or currency APIs like XE.com have started licensing these feeds to reflect the mid-market rate to customers. This is part of what’s made fintech so disruptive: That transparency has forced banks to make their customer-facing markups more reasonable.

Why FX fees are so maddeningly complicated

Now we’re getting into the crux of things.

Think about what’s happening. You've got this massive interbank market, where the big players trade at razor-thin spreads. That's the wholesale market. Then you’ve got regional banks, who pay a bit more. Retail banks pay more still. Then there’s currency exchange counters at airports, who basically just take whatever markup they can get away with. In a way, the latter are no different from the black market dollar slangers you might find in certain corridors.

Each layer adds friction. But the real complexity isn’t the layers; it’s that nobody wants to reveal them. Banks don't lead ads with, “we're marking this up 2.5%!” Instead, you see an “exchange rate” with the markup baked in.

Then there’s timing. Exchange rates move every second. Which rate applies to your transaction? The rate when you clicked “submit”? When the payment processes? When it settles?

All these moments represent an opportunity for slippage—or frankly, creative fee extraction.

This complexity exists for the same reason complexity exists in any mature market that handles other people's money: Simplicity would reveal the margins. If you saw “mid-market rate: $1.0851, our rate: $1.0950, our markup: $0.0099 per euro,” you’d know you’re paying a 0.9% fee. But bundle it into an “exchange rate” and most people just accept it.

That’s not to say there isn’t genuine complexity. Moving money across borders involves correspondent banks, compliance checks, settlement systems, and currency conversion at multiple points. Each has costs. But the core reason FX rates are complicated is because opacity is profitable. The moment true transparency arrives—and it's starting to, with fintech companies explicitly showing users the mid-market rate - margins compress.

Complexity is partly inherent to a decentralized global market. Mostly, though, it's maintained because it serves the people running the rails. When something in finance seems unnecessarily complicated, that’s usually not an accident. It’s a feature.

Your spywork is done. There it is, 42, the answer to everything.