Any successful unit of account must serve as a medium of exchange and a store of value. Both fiat money and cryptocurrencies provide this utility; however, there are some key differences between the two. While a cryptocurrency derives its value from its native blockchain, fiat currency is legal tender with value tied to a government-issued currency, such as the US dollar.
While blockchain protocols, codes, and communities control cryptocurrencies, central banks control the issuance and management of fiat currency. In order to understand how cryptocurrencies compare to and differ from fiat currency, it's important to learn how both function. This guide to fiat and cryptocurrencies explains how they work and the advantages and disadvantages of both.
What is Fiat Money?
Similar to precious metals such as gold and silver, commodity money derives its value from its intrinsic value. Fiat currency has no intrinsic value; it has value only because a government declares it legal tender.
What are cryptocurrencies?
Digital assets called cryptocurrencies are used as a method of trading between two parties. They allow direct exchange between people without an intermediary, such as a bank. While central banks can produce additional fiat currency at any time, the most popular cryptocurrency, Bitcoin, has a fixed quantity of 21 million, making it even rarer than gold.
Benefits of Cryptocurrency
The first cryptocurrency, Bitcoin, was created as a form of digital cash that enabled direct, anonymous peer-to-peer transactions between users. Cryptocurrencies, therefore, have a number of advantages over paper money that make them attractive to developers who want to create decentralized peer-to-peer software.
Protection from fraud and scams
Every Bitcoin transaction is recorded in a blockchain ledger that is accessible to the public and can be independently verified by the majority of other computers on a peer-to-peer network.
Although there is always the possibility of a malicious attack, this setup makes it nearly impossible to alter the records or forge transactions.
Secure transactions
Fiat money transfers must go through an intermediary that has the power to reroute, postpone, or stop the transaction. The sender and receiver exchange cryptocurrency directly.
Privacy and independence
Privacy-conscious people find cryptocurrencies a great way to send and receive money without disclosing personal information to third parties, such as their identity or address.
Drawbacks of Cryptocurrency
As cryptocurrencies are still a rapidly changing field, consumers need to be aware of the challenges involved.
Cryptocurrency is unregulated
There is no legal protection as there are no laws or legislation regulating cryptocurrency transactions. Moreover, if you forget your wallet's passcode or send money to the wrong address, you will lose your money permanently.
Highly volatile
The price of a cryptocurrency on an exchange can fluctuate quickly, and if the market trend is not in your favor, you can lose a lot of money. However, the same volatility attracts speculators who can also make significant profits from market fluctuations.
Limited public acceptance
At the time of writing, there are only a few businesses accepting cryptocurrency as payment.
Advantages and Disadvantages of Fiat
The below examines the pros and cons of fiat currency:
- It is relatively stable in value. Fiat has a predictable value for investment and expenditure as long as the government that issues it maintains its stability.
- It is widely accepted. Not only do practically all companies accept fiat money in exchange for services, but there are also laws in existence that provide legal protections in the event of fraud or mistake.
- Fiat money gives governments more freedom to control their own currency, set monetary policy, and maintain market stability.
- There is potential for inflation. Economic and monetary policy determines the value of fiat currency, which has no intrinsic value. Overprinting money can lead to inflation, which lowers the value of the currency.
- It is tied to national governments. A nation's fiat currency can be negatively affected by political events, especially in the case of political unrest or violence
- Due to its unlimited supply, it has the potential to create an economic bubble.
What Are Central Bank Digital Currencies (CBDC)?
The emergence of CBDCs, virtual currencies generated and backed by a country's CB, could be an exciting development.
Because cryptocurrencies are, by definition, decentralized and not backed by a central authority, the term "CBDCs" may seem contradictory to some people. However, according to a survey conducted by the Bank for International Settlements in January 2020, 80% of central banks are investigating and experimenting with CBDCs. This number has increased since then.
| Fiat | Cryptocurrency |
| Issued and regulated by the central bank, physical money | Digital assets that were built through a decentralized system |
| A store of value | It cannot be a store of value due to its volatility |
| Accepted by virtually all merchants and retailers | Rarely used as payment in brick-and-mortar outlets |
How Does Cryptocurrency Work in the Real World?
Although Bitcoin may be the most well-known, there are many other cryptocurrencies. Other popular cryptocurrencies include Ethereum, Tether, Binance Coin, stablecoins, and more.
Stablecoins are a type of currency that adds more credibility and stability to blockchain technology. A stablecoin is a digital currency that is pegged to the value of a real asset.
Although many stablecoins are tied to the USD, stablecoins can theoretically be tied to crypto assets, such as gold or similar commodities. As a result, companies that want to transact with known crypto assets can do so without leaving the blockchain.
Even though it is unlikely that cryptocurrencies will ever fully replace the US Dollar, many other industries are beginning to accept cryptocurrencies as a form of payment. Due to the advantages of speed and affordability, many blockchain startups have been early adopters of cryptocurrencies for B2B payments. In addition, no currency conversion is required for overseas transactions.
What is the Future for Fiat and Crypto?
Of course, fiat money is not going away anytime soon, but cryptocurrencies have many applications and are expected to continue to expand.
Fiat currency will likely continue to be the most widely used form of money, both for saving and spending, since fiat money can be used almost anywhere and is easier to use when making purchases.
However, cryptocurrencies have their uses as well. Crypto has gained popularity as a form of investment and can be used in place of traditional currencies for sending money.
Remember, participating in the crypto market should always be done with caution, but since it will play a role in the future of money, it's a good idea to get familiar with it.
