- Cryptocurrency has a variety of use cases from a global payments system to a store of value like gold.
- Fiat currency is mostly used as an exchange and store of value that is backed and issued by a government or reserve bank.
- Fiat currency that isn’t legal tender is practically worthless, as it is not backed by a commodity such as gold or silver.
In spite of crypto’s growing popularity, fiat currency is by far the most-used asset in the entire world. Currencies like USD are often the foundation of importing and exporting important goods like oil, livestock, and so on. In this article, we will dive into the pros and cons of fiat currency, why crypto is necessary, and the major differences between the two.
What Is Fiat Currency?
To understand the difference between fiat and crypto, we need to first understand the former. Fiat currency is what most people traditionally know as “money” or “cash”. It’s a government-issued currency typically backed by an official reserve bank. Fiat currency often has no intrinsic value, as it isn’t backed by an asset like gold or silver. Rather, its value is derived from a government declaring the currency can be used as “legal tender”. This means the currency can be used to pay for government-based activities like taxes, bonds, and debt.
What Is The Difference Between Cryptocurrency and Fiat Currency?
Fiat currency is the money we use every day, like coins and banknotes which are issued and controlled by Governments and banks. They decide how much there is, and how it works as legal tender to pay taxes, as well as purchase goods or services. Cryptocurrencies, on the other hand, are generally not issued by a centralized authority and use a technology called Blockchain that it's not controlled by any government or bank.
Rather, they use a variety of complex mechanisms (such as mining or staking) to create and deliver new coins. This means that their value is not derived from being legal tender, but rather, from buyers speculating on the asset’s underlying functions and its potential for global adoption. They are stored in special cryptocurrency wallets and can be sent to anyone around the world quickly and with lower fees than fiat currency.
Digital assets can be purchased using a fiat-to-crypto platform that supports multiple fiat currencies and payment methods. These exchanges provide the infrastructure between buyers and sellers of crypto.
|Central Authority||Controlled by central banks and government authorities||Decentralized, no central authority or CEO|
|Regulation||Subject to government regulations and monetary policies||Generally unregulated or lightly regulated|
|Physical Form||Exists as physical cash and digital bank balances||Digital form only|
|Transaction Speed||Slower settlement times (bank transfers, clearing, etc.)||Faster transaction processing (particularly for cross-border transactions)|
|Transaction Fees||Variable transaction fees set by banks and intermediaries||Generally much lower transaction fees|
|Anonymity||Less private, requires personal identification||Can offer greater anonymity and pseudonymity|
|Security||Rely on trusted third parties for security||Cryptography and blockchain provide better security|
|Supply Control||Determined by central banks||Cryptocurrencies have predefined supply mechanisms|
|Value Stability||Subject to inflation and fluctuating exchange rates||Volatile, can have significant price fluctuations|
|Smart Contracts||Not natively programmable||Can have programmable contracts and decentralized applications (DApps)|
|Accessibility||Widely accepted as legal tender||Acceptance varies by country, not universally recognized|
What Are The Advantages Of Cryptocurrency Over Fiat Currency?
Cryptocurrency has several advantages over fiat currency.
- Greater utility. Cryptocurrency possesses similar characteristics to fiat currencies. Certain coins can be used as a relatively stable medium of exchange (for example, Tether) store of value (Bitcoin), and unit of account (most digital assets). However, certain tokens can also be used to create NFTs, vote on proposals, or participate in securing a blockchain.
- Outperforming inflation. Since its inception in 2009, Bitcoin has been a good hedge against inflation, making it a much better store of value compared to fiat currency.
- Cheaper and faster global payments. Cryptocurrencies like XRP and Stellar Lumens are designed to provide international investors the ability to pay across borders with minimal transaction times and fees. Whereas payment gateways like PayPal and Wise incur conversion fees on top of transaction fees, the cost of sending tokens like XRP to another international wallet is minuscule.
- Better accessibility. Nearly one billion consumers in the world are unbanked, which means their access to fiat currencies is often limited. This is especially true in developing countries with low-value, hyperinflated currencies that consistently lose buying power. Cryptocurrencies can be accessed by anyone with an internet connection – there is often no requirement for identification that may be impossible to attain from some governments.
- Blockchain reduces certain criminal activity. Blockchains are quite secure and often immutable due to various factors such as their decentralized nature. The way they are structured makes it extremely difficult for criminals to double-spend or create counterfeit currency. This is not necessarily the case with fiat currency, with approximately USD $70 million in counterfeit bills circulating in the United States alone.
What Are The Drawbacks Of Cryptocurrency Over Fiat Currency?
- Cryptocurrency is unregulated. Admittedly, many investors prioritize cryptocurrency due to its unregulated nature. However, this is a limitation to wide-scale adoption as the lack of government oversight means there are fewer protections in place in case of crypto bankruptcies or theft.
- Cryptocurrency is volatile. Although cryptocurrency has generally outperformed most major index funds and inflation over the past decade, it is still a notoriously unreliable asset. Major swings in the value of ~20% overnight can wreak havoc on a portfolio. Additionally, these wild changes in price make it difficult for cryptocurrencies to be used as legal tender in certain countries, given what 1 BTC can buy today might change significantly by tomorrow.
- Cryptocurrencies can’t be used to pay for government debt. Very few nations have approved crypto-assets as legal tender. This means that their role in society is diminished, at least when using digital assets as a mode of exchange. While fiat currency will always remain relevant while it can be used to pay the debt, there is always a chance new technology comes along and makes many current digital currencies redundant.
What Is Fiat Currency Used For?
Fiat currency has three key applications – if it does not possess these qualities, its value is significantly altered.
- Medium of exchange. Fiat currency’s primary use case is as a medium of exchange. This function is obvious and nearly everyone will have had experience with it. Simply put, money can be exchanged for goods and services. The vast majority of businesses in a country will only accept a native currency. For example, buying a basketball from a Singaporean sporting store will most likely require the use of SGD. For this to work, fiat currency has to be fungible, so that one person’s 100 SGD is worth the same as someone else’s.
- Store of value. Fiat currency is what most citizens are paid in (whether it be cash or bank transfer), so the asset must be quite stable so it will retain its value over time. There are factors that influence how well a fiat currency can act as a store of value, such as inflation, trade partners, and that nation’s natural resources. As a general rule, most fiat currencies slowly lose value over time. For example, goods worth $100 in 2012 are worth approximately $126 today. However, a $100 banknote would still be worth $100, giving its owner less spending power.
- Unit of account. Fiat currency must be able to value assets differently depending on their intrinsic worth. For example, one would expect to pay more for a car than they would a ceiling fan – and fiat currency must reflect this.
Advantages Of Fiat Currency
- Fiat currency is managed by a centralized government entity and is therefore regulated. Admittedly, some may see this as a bad thing. However, in most developed nations (particularly those with strong currencies like the USD) this allows fiat currency to be an extremely stable asset.
- There are often protections in place for consumers who store fiat currency in a bank account in the event of bankruptcy, theft, or hacking. For example, the United States and Australia protect losses of up to $250,000 in case of criminal activity or insolvency.
- As legal tender, fiat currencies will always have a use case. Everyone that earns a living must pay taxes to their government in legal tender, which is nearly always the nation’s fiat currency. This means they will always have some form of value, unless/until the government starts to accept alternate payment methods.
- Fiat is widely accepted. Nearly every business will accept that nation’s fiat currency as payment, whereas cryptocurrency has far fewer applications as a mode of exchange. Very few companies accept crypto as payment as of 2023.
Disadvantages Of Fiat Currency
- Fiat currency is issued and regulated by a government, which puts the power of personal finances largely in their palms. The centralized model that controls fiat currency is off-putting to a lot of people. It means that governments can block certain payments, adjust interest rates (and therefore alter a currency’s relative value), and so on. Many believe that assets should be freely exchanged on an open market with minimal intervention.
- Holding cash or fiat currency is an investment just like any other. As inflation is a key feature of fiat currency, the spending power of $100 today is more than it will be a decade or two down the line. Therefore, owning fiat currency is like owning an asset that drops in value by 1-4% every year. For some, this is a small price to pay for stability. For others, this means that holding any surplus cash at all is disadvantageous.
- Global cash payments using fiat currencies are typically slow and expensive. Conversion between two different fiat currencies can not only invoke unfavorable exchange rates but there is also a string of fees attached that can significantly impact profit margins.
- Fiat currencies in countries with poor economic stability and minimal trade agreements are notoriously unstable. For example, the Venezuelan bolivar experienced inflation rates of over 100% in 2022. Similarly, the Russian ruble collapsed 20% overnight due to pressure from European sanctions in light of the Ukraine/Russian War.
The History Of Fiat Currency
Although most fiat currencies aren’t backed by a commodity such as gold or silver, this hasn’t always been the case. The first known instance of government-backed currency came around during the 11th century in China, although coins made out of gold, copper, and electrum had been around for many centuries prior.
For many years, this was how fiat currency derived its value – the coins were crafted from valuable gold, silver, and other precious metals. Between 1870 and 1971 gold was used as the basis for most money around the world. This came to a halt in 1971 when Richard Nixon prevented USD from being directly converted into gold.
This move from the United States lead to fiat currency as we know it – a monetary system, issued by a central authority (generally a government) that isn’t backed by a commodity. Because fiat currency is intrinsically worthless without being legal tender, the value of a nation’s currency must be more than the value of the metal/paper it is printed on.
Fiat currency is the most broadly-owned asset in society – nearly everyone has had some experience using it to buy or sell goods. The concept of a centralized, government-owned currency has been around for 1,000 years (or possibly longer), while cryptocurrency is a very new technology that is still maturing.
Crypto offers many benefits over traditional methods of payment, however, it remains to be seen whether this will be enough for it to usurp fiat currency as the world’s de facto legal tender. Ultimately, most investors should consider owning a combination of both digital and fiat currency to ensure their portfolio is as diverse as possible.