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Fiat VS Crypto: The Ultimate Guide

Daniel Rogers

Oct 18, 2022 16:53

Any viable monetary system must serve as a medium of trade, a store of value, and a unit of account. Both fiat cash and cryptocurrencies provide this usefulness, but they differ significantly. Fiat currency is legal tender whose value is pegged to a government-issued currency, such as the U.S. dollar. In contrast, cryptocurrency is a digital asset whose value is derived from its original blockchain. Central banks control the issuance and governance of fiat currency, whereas blockchain protocols, codes, and communities govern cryptocurrencies. The circulation of fiat currency requires middlemen, whereas "trustless" cryptocurrency transactions rely on dispersed and decentralized networks.

What Is the Definition of Fiat Currency?

Fiat money originated from asset-backed currencies when governments minted or printed money either made from a natural commodity — such as precious metals such as gold or silver — or could be redeemed for the equivalent amount of that item. With time, however, it became impractical for governments to maintain enough precious metal to back every coin or piece of paper currency, so fiat currencies became widespread.

 

In the United States, for instance, the present fiat money system emerged throughout the 20th century, when many countries abandoned the gold standard when currencies were directly related to gold. Fiat money cannot be exchanged for an underlying asset; hence, its value is determined by government policy and foreign exchange markets.

 

There are around 180 fiat currencies in circulation today. The value of fiat currencies is determined by supply and demand dynamics. Central banks such as the Federal Reserve established monetary policy to control the money supply by estimating the amount of cash required by the economy and printing appropriately. The greatest danger is that they could print too much money, resulting in hyperinflation – fast, out-of-control price hikes that can devastate the economy.

 

The credibility of a fiat currency is contingent upon the stability of the government that issues it and the credibility of the central bank that controls its supply. Herein is a more in-depth examination of the fiat-currency systems that are integral to modern economies. 

How Does Fiat Currency Function?

Fiat is derived from Latin and generally refers to "a formal authorization; a decree." Therefore, fiat money refers to a government order that gives these currencies value and recognizes them as legal tender.

 

No gold or silver reserve gives fiat currencies their value.

 

Instead, each government's authority backs fiat currency. According to the Federal Reserve, the U.S. dollar is supported by the "full faith and credit" of the U.S. government.

 

"Dollars cannot be redeemed for gold, silver, or any other commodity, and they are not backed by anything. The banknotes have no intrinsic value; they are only worth what they can purchase. In another sense, Federal Reserve notes are "backed" by all the goods and services in the economy because they are legal money.

 

Because governments can generate as much money as they like, fiat money may be more prone to inflation and deflation. Additionally, the value of these currencies depends on consumer confidence and the currency markets. 

What Provides Value to Fiat Currency? 

For a considerable time, dollars were backed by reserves of valuable assets such as gold and silver. In the 1930s, the United States abandoned the gold standard for internal transactions and ceased foreign conversions in 1971. Since the 1960s, dollars have not been redeemable in silver.

 

Currently, the U.S. Federal Reserve is mandated to keep collateral equal to the value of circulating currencies, and it accomplishes so by holding government-issued debt.

 

Therefore, the dollar has value for two primary reasons:

  1. Because the United States government says so.

  2. Because investors throughout the world are sure that the United States will cover its loans.

Pros and Cons of Fiat Money 

Pros of Fiat Money 

  • Fiat is governed. The government's regulation of fiat money is one of its most significant advantages. This implies that businesses may rest assured that they are legally compliant and need not worry about violating any restrictions. For instance, if you own an internet store that sells CBD goods, you can accept fiat payments without fear of breaching the law.

  • Fiat enjoys wide acceptance, and Fiat currency remains the most generally accepted form of payment worldwide. This indicates that firms will have no difficulty locating clients and suppliers ready to take fiat currency. For instance, if you operate an online company that offers consumer electronics, most of your consumers will likely be willing to use traditional payment methods such as credit cards and bank transfers.

  • Fiat is solid. The price of cryptocurrencies can change significantly, whereas fiat currency is considerably more stable. This ensures that firms have access to steady capital, which is crucial for planning and forecasting.

Cons of Fiat Money

  • Fiat payments can be time-consuming. One of the disadvantages of using fiat currency is that payment processing might be time-consuming. For instance, if you operate a digital business and need to accept bank transfers from your consumers, you may be required to wait several days for these funds to clear. In comparison, cryptocurrency payments are frequently instantaneous.

  • Fiat currency is susceptible to inflation. Inflation vulnerability is another downside of fiat currency. This means that the value of your money can degrade over time, which can be troublesome for businesses that must maintain substantial cash reserves. For instance, you may need to maintain a substantial cash reserve if you own a business that deals in high-priced commodities. However, if the value of fiat money declines, so will the value of your cash assets.

  • The government governs fiat. One of its primary weaknesses is that fiat money is vulnerable to government control. For instance, if you operate an online business that sells goods and you want to accept fiat payments from your clients, the government may be able to shut down your website or restrict access to your funds. This might be a significant issue for organizations that must promptly handle transactions. There are both pros and cons to adopting fiat currency. Despite its limitations, it is the most generally accepted means of payment worldwide.


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What Is Cryptocurrency? 

Instead of having real cryptocurrency, cryptocurrencies reside in internet databases that record transactions. A cryptocurrency is a digital currency or an asset that functions as a medium of exchange and is safeguarded through encryption. It began as a peer-to-peer electronic cash network. Unlike fiat cryptocurrency, which requires a bank to authenticate a transaction, cryptocurrencies do not require an intermediary to verify a transaction.

 

Also, neither a government nor a central bank has control over cryptocurrency. Fiat currency can be issued indefinitely, whereas cryptocurrencies have a fixed quantity. Due to the absence of government regulation and backing, cryptocurrencies are more volatile than fiat.

How Does Cryptocurrency Work?

Bitcoin may be the most popular digital currency, but there are thousands of others. Stablecoins, Ethereum, Tether, Binance Coin, XRP (formerly Ripple), and many others are among the other prominent names in digital money.

 

Stablecoins are a sort of currency that lends legitimacy and stability to blockchain technology. A stablecoin is a cryptocurrency that is tethered (or "pegged" in crypto parlance) to the value of a tangible object. Theoretically, stablecoins can be tied to other assets, such as gold or other commodities, even though most stablecoins are anchored to the U.S. dollar. Effectively, this enables entities that seek to transact in known assets never to leave the blockchain.

 

Although it is unlikely that cryptocurrency will replace the U.S. dollar shortly, numerous sectors now accept it as payment. Due to the cost and time advantages, numerous blockchain technology businesses were early adopters of cryptocurrencies for B2B payments. Additionally, currency conversion is not required for overseas transactions.

Pros and Cons of Cryptocurrencies

Pros of Cryptocurrencies

  • Cryptocurrencies are digital and worldwide. Digital currencies are an excellent alternative for organizations that need to make international payments since they can be transferred between accounts swiftly and efficiently. Thus, cryptocurrencies are ideally suited for online enterprises and eCommerce platforms. For instance, suppose you own a company in a high-risk area such as online gambling, medicines, or foreign exchange. You may need to make frequent foreign payments, which can be costly and time-consuming when using fiat currency. In contrast, cryptocurrency enables you to conduct these transactions without incurring the exorbitant costs banks pay for international transfers.

  • Cryptocurrencies are pseudonymous. One of the most significant drawbacks of fiat currency is that every payment you make may be traced back to you. This means that your spending patterns are potentially exposed to government authorities and other institutions with access to this information. Cryptocurrency transactions, however, are anonymous and pseudonymous. Once a transaction has been completed, it is impossible to identify the sender or recipient. This makes cryptocurrency an excellent option for enterprises that need to keep their transactions confidential, such as political campaigns and non-profit organizations.

  • Digital cryptocurrencies are secure. The blockchain technology behind cryptocurrencies is a distributed and decentralized ledger. This implies that all blockchain transactions are recorded and verified, but cannot be altered or tampered with. Thus, cryptocurrencies are incredibly secure. For instance, once a transaction has been completed, it is hard to undo or cancel it—this aids in preventing scammers from exploiting businesses that accept cryptocurrencies. Therefore, you may discover that taking cryptocurrency reduces chargebacks and fraud if you have a high-risk merchant account.

  • The speed of cryptocurrency transfers is high, and another issue with fiat currency is the time required to complete transactions. In contrast, cryptocurrency transactions can be validated and processed instantly, making it an excellent option for firms that need to make quick payments, such as e-commerce companies.

Cons of Cryptocurrencies

  • Cryptocurrency is a very volatile asset. The cost of cryptocurrencies can be highly flammable, which means that your investment's value may increase or decrease exceptionally rapidly. In December 2017, for instance, the price of Bitcoin soared to about $20,000 before plummeting to around $3,000 a few months later. This volatility might be problematic for companies that accept cryptocurrencies. Suppose, for instance, a cryptocurrency's price decreases significantly overnight, and you must pay for your inventory or supplies in fiat currency. Consequently, you may not have sufficient finances to make these payments.

  • Unregulated is cryptocurrency. The cryptocurrency market is currently unregulated, one of its most significant issues. This means that the government has little control over it, which can be problematic for enterprises that must adhere to regulations. A corporation that offers high-risk payment options, such as online gambling, may be required to comply with anti-money laundering (AML) legislation. However, because cryptocurrency is unregulated, compliance with these requirements can be challenging.

  • Cryptocurrencies lack widespread acceptance. Currently, cryptocurrencies are not generally recognized as a payment method. Identifying businesses that accept cryptocurrency may be challenging, which can be problematic if you intend to use it as your primary payment method. Now that we've examined the advantages and downsides of cryptocurrencies, let's look at fiat money and determine why it's still a popular option for most organizations. With the rise of cryptocurrencies, many individuals have begun to doubt the necessity of fiat currency. Nevertheless, despite its limits, there are several reasons why businesses continue to favor fiat currency over cryptocurrency.

Are Fiat and Cryptocurrencies the Same? 

True and no.

 

Cryptocurrencies are money as they serve as a medium of trade and a store of value. However, cryptocurrencies offer benefits that the old monetary system cannot: they can be spent and received by anyone, anywhere, and at any time, without the need for a bank or a government. This is the most innovative characteristic of cryptocurrencies.

 

In addition, fiat money is essentially equivalent to debt. A central bank prints banknotes simultaneously and issue a portion of your government's obligation to you, the consumer. How can this be, you would logically inquire? Consider how the E.U. and the United States, for example, make money. Governments assign value to fiat money by declaring it legal currency; it has no intrinsic value.

What are the Differences Between Fiat and Crypto

Payment

Some proponents of cryptocurrencies argue that digital currencies will one day replace fiat currency as the primary form of payment due to their ability to facilitate near-instantaneous transactions under certain circumstances. They claim that although faith in a fiat currency is placed in the government that backs it, trust in cryptocurrencies is placed in the strength of blockchain technology.

 

However, cryptocurrencies have not yet taken off as a form of exchange. While some vendors and businesses accept cryptocurrency as payment, most global transactions are conducted with fiat currencies.

 

Critics contend that the volatility of cryptocurrencies such as Bitcoin renders them less desirable as a payment method. Imagine receiving a paycheck in Bitcoin; market movements might substantially increase or decrease a person's income within days.

Value

Cryptocurrencies such as Bitcoin have arguably functioned more as a store of value, similar to how precious metals have been used traditionally. As with precious metals, cryptocurrencies such as Bitcoin must be "mined," limiting their quantity. In truth, Bitcoin was created with a limit of 21 million coins that could be produced.

 

In contrast, the quantity of fiat currencies such as the U.S. dollar, is potentially infinite. As of December 2020, there is around $2 trillion in U.S. paper currency in circulation. Since 2007, the Federal Reserve's balance sheet – a proxy for the amount of money in the system — has increased by an extraordinary amount as the central bank fought off recessions during the 2008 financial crisis and the Covid-19 epidemic of 2020.

 

Meanwhile, speculators and investors have invested in the cryptocurrency market with the expectation that their coins will sustain or significantly increase in value.

 

However, many argue that digital currency's volatility renders them unreliable as a store of value.

Governance

Central banks, which function as the monetary authority of a nation, are in charge of fiat currency. Through monetary policy, they determine the amount of money in circulation and whether to increase or decrease the money supply.

 

Cryptocurrency is decentralized by design and is not governed by a central body. How the supply increases or decreases depends on the type of cryptocurrency; each cryptocurrency has its laws.

 

Bitcoin, for instance, employs the Bitcoin mining process to validate transactions and manufacture new currency. The procedure mints new coins every 10 minutes and will continue until there is 21 million Bitcoin in circulation.

 

There are other additional cryptocurrencies with different systems. For instance, some countries release their maximum quantity at once and progressively withdraw coins from circulation.


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What Would Occur If Cryptocurrency Replaced Fiat Currency?

In their current state, cryptocurrencies transcend boundaries and regulations, which has both positive and negative repercussions. Unlike fiat currencies in wealthy nations, they are not governed or influenced by central banks. Through interest rates and open market operations, central banks use monetary policy instruments to affect inflation and employment. Decentralization, one of the underlying ideas of cryptocurrencies, eliminates these instruments.

 

The ramifications of a total replacement of fiat currency are still under investigation and evaluation. The transition may severely affect economic and financial stability or usher in an era of complete global peace.

 

Due to price volatility, the International Monetary Fund (IMF) advises against using cryptocurrency as a primary national currency. In addition, the organization believes that macro-financial stability threats and the absence of consumer protections must be addressed.

 

However, the IMF acknowledges that adoption will likely occur swiftly in nations where cryptocurrency risks represent an upgrade over the existing financial system.

 

As a currency, cryptocurrency possesses the boundless potential and is manifestly advantageous. After fleeing the Russian invasion of 2022, many Ukrainians, for example, turned to cryptocurrency. Without cryptocurrency, many individuals may not have had the funds to exist. Many people in nations with severe fiat devaluation utilize it to protect their investments, transfer remittances, and conduct business.

What Will the Future of Currency Look Like? 

You can already exchange cryptocurrency for fiat currency through exchanges or deals with other cryptocurrency users. Utilization, popularity, comprehension, and acceptance of cryptocurrency and blockchain continue to increase. The greater it's understanding and application, the greater its potential value as a medium of trade.

 

If these tendencies persist, many currency scenarios may emerge. Initially, culture and economy could adopt cryptocurrency to the extent that the nation's fiat currency is supplanted. Its government would be compelled to recognize it as legal tender, and the usage of fiat currency would cease.

 

A second possibility is a combination of digital assets and fiat cash. Governments might recognize both, collect tax revenues, and fund their programs and military by identifying both. Consumers and businesses were free to select their preferred option.

 

Thirdly, a society could reject cryptocurrency altogether and continue using its established fiat money. However, this seems improbable because blockchain technology directs civilization toward a system in which financial data cannot be manipulated or forged.

 

Despite of the outcome, it is inevitable that cryptocurrency may help individuals and economies around the world. However, the future of fiat and cryptocurrencies is uncertain; both have shown to be beneficial as a medium of commerce, a unit of account, and a store of value. 

FAQs on Fiat vs. Cryptocurrencies 

Is Cryptocurrency Superior to Fiat Money?

Prices and values of fiat currencies are typically more stable than those of cryptocurrencies. As cryptocurrency is still in its infancy, it may become as rigid as fiat in the future. Each has pros and downsides, but the use of cryptocurrencies is increasing.

Will Cryptocurrency Replace Fiat Currency? 

Cash is the physical form of fiat currency, and cash transactions have been declining for some time; it is probable that cash use will continue to diminish and may be replaced by something else. At this time, debit and credit cards have supplanted mainly cash transactions.

What Are Some Fiat Currency Examples?

Most internationally traded currencies, such as the U.S. dollar, the Japanese yen, the British pound, and the E.U. euro, are fiat currencies. 

Is Bitcoin an example of a fiat currency? 

No. Bitcoin is the first and largest cryptocurrency ever created.

Final Thoughts

Fiat currency is not going anywhere, but cryptocurrencies have their purposes and will continue to develop.

 

It's a safe bet that fiat money will continue to be the most popular form of cash for saving and spending. It is a lot more secure and convenient option for purchasing anything, as fiat money can be used virtually anywhere.

 

But crypto also has applications. Bitcoin has become a popular investment vehicle and can also be utilized as an alternative to fiat currency for money transactions. This market should always be approached with caution, but it is worthwhile to be at least familiar with it since it will play a role in the future of money.