Cryptocurrencies and Fiat currencies: Differences and Similarities?
Cryptocurrencies and fiat currencies are both ends of the same pole, connected by the term money or currencies.
They share similarities, but also have differences.
In this article, you’ll learn more about what those similarities and differences are.
Let’s get right to it.
What is “money”?
According to Wikipedia:
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context.
Money plays three vital functions: as a store of value, a unit of account, and as a medium of exchange.
Over the years, money has evolved from commodity money to representative money, before the present fiat currencies.
Definition of fiat currencies
These are currencies controlled, created, owned, and issued by governments, through their central banks.
According to Investopedia,
Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of fiat money is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it.
Although they are relatively more stable than cryptocurrencies, the value of a fiat currency is also subject to economic policies, sociopolitical occurrences, and the laws of demand and supply. They can drop massively in response to hyperinflation.
Definition of cryptocurrencies
Cryptocurrencies are digital assets that exist only virtually and are independent of control by any central authority. All transactions are recorded on a public ledger otherwise known as the blockchain, which is publicly accessible.
Cryptocurrencies started with the creation of bitcoin in 2009. Since then, we’ve seen the launch of several cryptocurrencies. Some have gone on to massively increase in value, while others have disappeared without a trace.
Cryptocurrencies versus fiat currencies
Cryptocurrencies and fiat currencies differ in many respects. The only uniting factor between the two seems to be the mention of “currencies”.
They differ in the following respects:
- Means of storage
- Underlying technology
Let’s X-ray these features, one after the other.
Immutability of transaction records
All transaction records are stored on the blockchain. And unlike other centralized ledgers, no single transaction can be destroyed or altered. As long as it’s on the blockchain, it stays there forever — for as long as the network exists.
This is because all transaction data are cryptographically encrypted, bundled together, and distributed across different servers or nodes.
The owners of these servers are maintainers of the network and are also called miners. They are in charge of ensuring that all fictitious transactions are eliminated. This way, the network, although not tamper-resistant, is tamper-evident.
To use cryptocurrencies, you do not need to register or provide any personal information, unlike banks and other financial institutions. They’re mandated by law to provide KYC (know your customer) forms, which capture personal details, for any customer that wishes to open an account.
In contrast, the only prerequisites to transact with cryptocurrencies, are your public and private keys, which are cryptographically encrypted.
Public keys are synonymous with bank account numbers, email addresses, or house addresses. Public keys are for receiving cryptocurrencies into your account.
Private keys are like your passwords to your social accounts, in that they are known only to you. And as long as they’re kept private, no one can gain access to your assets. This translates to increased security, and privacy, for cryptocurrencies.
The transaction record associated with each cryptocurrency is available on the blockchain and is accessible to anyone, regardless of location. Hence, each cryptocurrency is traceable.
To view the transaction record, input the transaction address in a cryptocurrency explorer. Or you could own a verifying node.
In contrast, fiat currencies cannot be traced. And neither are the financial authorities controlling them transparent.
Cryptocurrencies exist virtually, on the blockchain. Hence, you can’t hold nor feel them. On the other hand, fiat currencies are represented by notes and coins, which you can hold physically.
The issue of tangibility has been touted as an obstacle to the massive adoption of cryptocurrencies, especially by the educationally disadvantaged. But that is changing.
Beginning from 2020 — especially during the pandemic — more and more people began to learn more about the space.
Hence, in the long run, tangibility wouldn't be an obstacle for mainstream adoption. Instead, it would be seen as the advantage, that it is.
Source of value
Governments, through laws and policies, make fiat currencies the legal tender for transacting businesses and paying for goods and services.
Unlike gold or silver coins, fiat currencies have no value in themselves. Government laws and decrees give them value.
On the other hand, cryptocurrencies do not have centralized control. No government, or central authority, controls them. Their value is subject to market forces, speculation, and so on.
Fiat currencies can be printed arbitrarily by governments, in a bid to grow or stabilize the economy, with terrible consequences. Although central banks deny this, history has proven that the reverse is the case.
In recent times, the economies of Zimbabwe and Venezuela have been decimated by hyperinflation, due to the governments’ arbitrary printing of currencies, to prop up their failing economies. In some cases, such as in Nigeria, rumors of Central bank printing currencies are rife.
In direct contrast to fiat currencies, the supply of cryptocurrencies is capped and is algorithmically determined. No central authority can influence their supply. They obey the fundamental laws of demand and supply which make their value increase with scarcity.
Cryptocurrencies are typified by massive volatility. It’s for this reason, that they’re fodder for speculation and trading.
But this characteristic makes them a very imperfect replacement for fiat currencies — except for stablecoins, that is.
In contrast, fiat currencies maintain their value over time. Their drop in value, is usually infinitesimal, except for during hyperinflationary events.
The control of cryptocurrencies lies in the bearers. Hence, the popular crypto mantra: your keys your coins. No government can control, issue, or claim ownership of cryptocurrencies.
This makes them immune from the — sometimes — faulty monetary and economic policies of governments, socio-economic occurrences, and the likes.
To this end, any transaction involving cryptocurrencies, involves just two parties, without an intermediary.
On the other hand, governments retain sole ownership and control of fiat currencies. The government has the right, to take hold of all currencies within Its jurisdiction.
Means of storage
Cryptocurrencies exist virtually and can only be stored in digital wallets — cold or hot wallets. This shifts the burden of ensuring the protection of the assets to the bearer.
In the case of fiat currencies, they can be stored as physical cash, or as digital currencies in credit cards, payment platforms, and the like. For instance, physical cash can be stored in piggy banks whereas digital cash can be stored on PayPal, credit cards, etc.
What makes cryptocurrencies extraordinary, is not unjust the advantages they possess, but the technology backing them.
Blockchain technology brings decentralization, transparency, privacy, reliability, and increased security.
Even traditional financial systems, have begun to see the use of blockchain technology. For instance, banks have begun exploring the possibility of using blockchain technology to increase efficiency and eliminate fraud and errors.
Now that we’re done exploring the differentiating factors between fiat currencies and cryptocurrencies, one may ask:
What are their advantages and disadvantages? Well, read on to find out.
Advantages and disadvantages of fiat currencies
When you think of fiat currencies, two words come to mind: stability and mainstream adoption.
Their stability, makes them fit for transactions and as a tool for the control of a countries’ economy.
In terms of mainstream adoption, government laws make them generally accepted as legal tender. Therefore one can step boldly into a coffee shop with dollars, euros, or pounds (as the case may be) and be sure that the shop owner would accept it as payment for their cup of coffee.
Disadvantages of fiat currencies
Despite their stability, hyperinflation can decimate the value of fiat currencies, which leads to a total collapse or near-collapse of economies. We can see examples of this in countries such as Zimbabwe, Venezuela, and many others littered throughout history.
This usually results from poor economic policies by central banks, which are the central authority in control of fiat currencies.
Advantages and disadvantages of cryptocurrencies
Advantages of cryptocurrencies
Because they exist virtually, they can be used for payments across the world. And since they are available 24/7, unbanked regions are not left out of the financial process.
Secondly, payments are processed in seconds. Hence, the settlement time for transferred funds — especially between different regions of the world — is pretty low compared to transactions with fiat currencies.
Lastly, cryptocurrencies offer increased privacy and security. There’s no need for KYC and you have sole control of your assets, which are protected by cryptographically generated private keys, known only to you.
Disadvantages of cryptocurrencies
Volatility is by far the greatest disadvantage of cryptocurrencies. In less than 24 hours, a coin could drop by as much as 50 percent.
Secondly, the use of cryptocurrencies is reserved for technology-literate individuals. This is because they are hard to understand, cannot be held, felt, or seen, and involve the use of complex platforms.
As cryptocurrencies continue to increase in popularity, the battleground shifts from battles between various fiat currencies, to fiat currencies against cryptocurrencies.
It’s still uncertain who will come out top. But based on current happenings in the crypto space, the defeat of fiat currencies by cryptocurrencies isn’t a matter of if it will happen, but when it will happen.