Money is a prerequisite of any financial transaction and is a collectively accepted representation of value around the world.
During the eras of early civilization, societies denominated money in livestock like cows, goats, and camels.
Then, everything from cowrie shells to salt saw was widely used as a form of money, before giving way to the more familiar form of precious metal coinage.
Today, fiat money — government-issued legal tender with no intrinsic value — represents the most dominant iteration of money.
Nevertheless, as history has shown us, money evolves, and its next stage is upon us.
Cryptocurrency is a new kind of currency that is secured by cryptography, a kind of electronic encryption that makes it impossible to counterfeit.
The emergence of blockchain technology and cryptocurrency over the last decade presents a foundational update to the world’s systems of money and value.
Cryptocurrency is built on decentralized blockchain networks, and it is not controlled by a single governmental body and offers significant opportunities for financial inclusion worldwide.
Though virtual currency is gaining wide acceptance, it is not yet in a position to replace fiat currency, which remains the preferred means of exchanging value across the world.
Most people see cryptocurrency as a way for rapid wealth creation, given its volatile nature.
So to understand how cryptocurrency fares in relation to fiat money, we need to understand how both the currencies operate and what separates them from each other.
What Is Fiat Money?
Fiat Money is a form of currency, that is issued by the government and regulated by a central authority such as a central bank.
This kind of currency act like legal tender and are not necessarily backed by a physical commodity.
Rather, it is based on the credit of the economy.
Fiat currencies such as the US Dollar, Indian rupee, Pound or Euro, derive their value from the forces of supply and demand in the market.
Such currencies are always at risk of becoming worthless due to hyperinflation as they are not linked to any physical reserves such as commodities.
Fiat currency first existed at around 1000 AD in China before spreading to other parts of the world.
At first, currencies were based on physical commodities such as gold.
It is only in the 20th century that President Richard Nixon stopped the conversion of U.S dollar into gold.
Advantages of Fiat Money
Fiat Money has stayed legal tender in most countries in part because they are highly stable and controlled.
Other forms of money, such as cryptocurrencies and commodity-based currencies are relatively unstable, except fiat currencies.
The stability of fiat money allows regulators and governments to navigate the economy against recession and inflation.
Stability also allows fiat money to act as a means of storing value and facilitating exchange.
It can also be used to offer a numerical account.
Greater control also gives central banks the ability to manage various economic variables such as liquidity, interest rates, and credit supply key to ensuring a robust, stable economy.
Disadvantages of Fiat Money
Though Fiat Money is considered a stable currency, yet that is not always the truth in some cases.
Economic recessions over the years have stated some of the deficiencies associated with Fiat money.
However, the fact that a central bank’s greater control at times does little to stop inflation or recession has made most people believe that gold could be a much stable currency given its unlimited supply.
The general notion of the central bank’s control over the economy and the constant increase in global prices creates the need for cryptocurrencies.
What is cryptocurrency?
Cryptocurrency is a new form of exchange, only a decade old, that is secured and verified by cryptography.
This electronic form of encryption makes it hard or nearly impossible to counterfeit or double-spend.
Similar to fiat money, it can be used to buy goods and pay for services.
Different companies have issued their own crypto coins.
All cryptocurrency trade is entered on a distributed online ledger that is accessible to everyone all the time, so there is no requirement of any central authority.
According to CoinMarketCap.com, a market research website, there are more than 10,000 different cryptocurrencies in circulation today.
Unlike fiat currencies, cryptocurrencies are not controlled by any central authority such as a central bank.
Rather, they are limited entries in a database such as a blockchain that no one can change or manipulate, unless certain conditions are met.
Cryptocurrencies came into existence as a side product of Satoshi Nakamoto, the brainchild behind Bitcoin cryptocurrency.
Satoshi Nakamoto did not plan to create a currency but a peer-to-peer electronic cash system for facilitating transactions without any central oversight.
The decentralization aspect of the network means there is no central server where transactions are hosted or controlling authority.
In a decentralized network like Bitcoin, every transaction to has ever happened is displayed for everyone to see.
Each transaction file also consists of the sender’s and recipient’s public keys.
Advantages of Cryptocurrencies
Cryptocurrencies can be purchased with just a click of a button, all over the world.
Anyone that can perform an online transfer can also purchase and own a digital coin of choice.
Although the process is can be complicated, in the future, it will be easier to buy, sell and own cryptocurrencies.
Fast settlement times are another attribute that continues to accelerate the widespread adoption of virtual currencies.
Not like other electronic cash settlement systems that could take days to process transactions, cryptocurrencies allow instant settlements.
Cryptocurrencies have emerged as a preferred means of sending money across borders due to lower transaction fees.
It can be quite expensive to transfer money using other bank gateways, given the number of fees charged along the way.
Privacy is another advantage that has made cryptocurrency desirable as users don’t have to share or reveal their identity to be able to perform and complete transactions.
There are altcoins whose primary functions are to maintain the privacy of the people behind transactions.
Disadvantages of Cryptocurrencies
Cryptocurrencies can be a bit hard to understand – one of the reasons why some countries and regulators continue to shun them.
A lack of knowledge on how cryptocurrency works and to use them is another headwind that continues to clobber digital currencies prospects and sentiments.
Another disadvantage of cryptocurrency is that it is not possible to reverse a transaction once it is made is another headache that has forced most people to shun cryptocurrencies.
If a wrong transaction is made the only way to get back your cryptocurrency is to ask for a reversal from the recipient.
There is nothing one can do on recipients of a wrong transaction decide to turn down a request for a refund
Volatility is by far the biggest disadvantage that has clobbered cryptocurrencies sentiments.
Volatility can affect the value of a coin, which can be difficult to understand or contend with.
What determines whether cryptocurrency is, in fact, money? It all comes down to satisfying three key criteria:
The Utility of Money
Every effective form of money must act as a store of value, medium of exchange, and unit of account. Without fulfilling these requirements, money cannot attain scalable utility.
- Store of value: For something to be called money, it must act as a store of value. For this reason, there must be widespread confidence that money will retain its value. Although almost all of the fiat currencies are reliable, there are many exceptions that are subject to currency inflation and ineffective monetary policy. During this early period of evolution in the cryptocurrency and blockchain space has been marked by significant market volatility, the emergence of stablecoins (price-stable digital assets with underlying collateral structures) strengthens the use case of digital currency as a store of value. Using an underlying asset (fiat money, crypto, or a commodity) to peg cryptocurrency value has brought a reliable store-of-value functionality to cryptocurrencies.
- Medium of exchange: For something to be called it money, it must be a widely accepted form of payment. Both sides in a transaction must share the perception of value. Similarly, when cryptocurrency was first introduced in 2009 many were hesitant to accept cryptocurrency as a form of payment. The fast expansion and adoption of digital currency markets indicate a growing acceptance of cryptocurrency on both the individual and the institutional levels. Nevertheless, fiat currency remains the dominant medium of exchange, cryptocurrency is growing at a fast pace as more and more people begin to realize the value of digital assets.
- Unit of account: To function as a unit of account, money must be able to price financial transactions by effectively denominating the value of different products and services throughout the economy in relation to each other. With fiat currency, a monetary policy formulated by central banks is used to manage the value of each currency in relation to others. By printing money or adjusting interest rates for borrowing, governments try to raise or lower the value of their fiat currency. The value of each crypto unit relies on prevailing crypto market prices. To be a valid unit of account, each unit of money must also be divisible. For instance, the fiat dollar can be broken down into quarters, dimes, nickels, and pennies. Cryptocurrency is typically well suited towards divisibility because it is digital in nature. For example, Bitcoin is divisible into units as small as one satoshi, which is one hundred millionth of a single bitcoin. Beyond these criteria, money must also be durable, portable, uniform, limited in supply, and widely accepted. It’s apparent that the fiat money we make use of today meets all of these requirements, hence its universal use.
Issuance and Governance
One of the major criticism of fiat money is that it lacks intrinsic value, rather deriving perceivable worth from its status as legal tender.
Fiat money’s value is deeply linked to decisions made by central authorities, such as governments and central banks, regarding their monetary and fiscal policy.
For fiat currency to be issued, a central bank simply gives the order.
But cryptocurrency derives intrinsic value from its native blockchain, where monetary policies are transparent and written into the protocol’s codebase.
Even though cryptocurrencies most of the time do not have a fiscal policy, it is Proof of Work important to keep in mind that their monetary policies are subject to the governance and consensus mechanisms of the protocol itself, rather than a single, central authority.
Most blockchain networks today depend on consensus mechanisms known as or Proof of Stake to mint new coins and many, but not every coin, have a finite supply of coins programmed into the protocol.
The moment money is minted or printed, both cryptocurrency and fiat currency can be brought on exchanges and held as an investment, traded for other assets, or exchanged and spent in return for goods and services.
The Exchange of Value
Transactions using fiat currency occur within the traditional banking infrastructure, except for cash exchanges.
In most cases, an intermediary is necessary to carry out the exchange of funds between two parties.
People who use credit cards or financial services apps to buy groceries are able to do that through payments technology companies like Visa or PayPal.
People sending money to relatives in another country use wire services merchants like Western Union to carry out the transfer.
Cryptocurrency transactions, however, happen via blockchain without the need for a centralized intermediary, instantly giving the system’s users more freedom.
Transactions are verified, validated, and recorded by a distributed, decentralized network of participants by way of that blockchain protocol’s consensus mechanism, enhancing the security of every exchange.
Money Is Evolving
As history has proven, money and the systems that underpin it will continue to evolve. From cowrie shells to crypto, the form and technology may change, but the requirements and usage in regards to value, exchange, and accounting remain the same. While fiat currency is still the dominant form of money, cryptocurrencies and the blockchain technology that underpin them may very well represent the next step in the evolution of money.
Differences Between Fiat Money and Cryptocurrency
While both fiat money and cryptocurrencies can be used as a means of payment, there are some differences.
Governments are the ones that issue fiat currencies, which are in return regulated by the central bank.
Fiat money is deemed legal tender in that it is mostly the official means of finalizing transactions.
Governments control the supply of fiat money and issue policies every time that affects their value.
On the other side, Cryptocurrencies are just digital assets that act as a medium of exchange that governments have no control over.
The decentralization aspect means no central body can control or influence their value.
Some countries have banned cryptocurrencies on concerns that some of them are being used to carry out illegal activities such as money laundering.
It is not possible to hold and have a physical feel of cryptocurrencies as they operate online as virtual coins.
Fiat currencies, on the other hand, have a physical part as they can be in form of coins and notes thus possible to have a physical feel.
Fiat money’s physical aspect at times does present a lot of troubles as it can be a nuisance to move around with vast chunks of money.
Cryptocurrencies exist in digital form as they are created by computers and operate as private pieces of code.
The means of exchanging cryptocurrency is thus digital.
In contrast, fiat money can exist in both digital and physical forms.
Electronic payment services allow people to transfer fiat money digitally. Moreover, people can transact with one another and exchange money physically.
One major difference between fiat money and cryptocurrency has to do with supply.
Fiat money has an unlimited supply which means central authorities (Government and Central bank) has no cap or to the extent to which they can produce money.
Most cryptocurrencies have a cap when it comes to supply, which means there is a set amount of coins that will ever be in supply.
For instance, the total number of Bitcoin coins that will ever be in supply is capped at 21 million.
With fiat money, it is impossible to tell the amount of money in circulation at any given time, but with cryptocurrencies, it is possible.
Cryptocurrencies’ digital aspect means they can only exist online thereby be stored in digital wallets commonly called cryptocurrency wallets.
While most digital wallets claim to provide safe and secure storage, some of them have been hacked resulting in people losing a substantial amount of holdings.
The versatility of fiat money, on the other hand, means it can be stored in various forms (physical and digital forms).
For example, there are payment providers such as PayPal that allow people to store fiat money in digital form.