Market Basics

The adoption of cryptocurrency as an alternative medium of exchange and store of value continues to grow worldwide. Crypto continues to gain acceptance from consumers, investors, technologists, regulators, merchants, and entrepreneurs – and is clearly more than a passing phenomenon.

Crypto aims to solve some of the challenges faced by fiat currency across foreign exchange, global payments, and other areas. With this said, cryptocurrency is not backed or recognized by any country or government entity.

This article briefly compares traditional currency and cryptocurrency and outlines the differences between these two mediums of exchange.

What is Traditional or Fiat Currency?

Traditional or fiat currency is a form of money that is centralized, backed, and managed by a recognized government entity, like the U.S. Federal Reserve. In 1971, the U.S. government ended the convertibility of the U.S. dollar into gold. All major international currencies followed suit and became fiat. In essence, a country’s government and central bank vouch for the currency’s worth.

What are Fiat’s Pros?

• When managed by economically strong governments, fiat currency is generally stable.
• Fiat currency policy changes tend to reach consensus quickly due to its centralization.
• Governments may offer asset protection – such as FDIC and SIPC insurance in the U.S.
• Fiat is generally easy to use in its digital and physical form.
• Many countries have enacted laws that can provide consumer protections against digital fiat fraud or theft, which makes it easier to recover lost funds.

What are Fiat’s Cons?

• Fiat holders must share some control over their finances and privacy with a bank.
• The existence of intermediaries often results in significant fees charged to users.
• Fiat currency may become vulnerable over time to both inflation and value erosion.
• Physical fiat is vulnerable to theft, loss, or getting destroyed – it can be very difficult or impossible to recover.
• Fiat continues to be one of the most popular tools used by money launderers and other criminals globally.

What is Cryptocurrency?

A cryptocurrency is a digital representation of value that is built on a blockchain and utilizes cryptography. Crypto can function as a medium of exchange, a unit of account, and a store of value. Unlike fiat currency, most crypto is entirely decentralized and operates peer-to-peer without any intermediary. Some cryptocurrencies operate on private ledger systems that are controlled by a single entity. Cryptocurrencies are generally backed only by the faith of their users.

What are Crypto’s Pros?

• Without intermediaries, consumers may be able to take greater control over their finances and privacy.
• Some blockchains can provide privacy, security, and 24-7 access to any global user.
• A sort of swiss-army knife, users can earn, fund, invent, invest, pay, and program.
• Cryptocurrencies can offer lower associated fees and more cost-efficient transactions.
• Cryptocurrencies may be valuable tools for implementing the shift to a global, trustless and open new digital economy.
• Some cryptocurrencies enable millions of smart devices to perform transparent and frictionless financial transactions, without human intervention, in the Internet of Things (IoT) universe.
• Some cryptocurrencies, like Bitcoin, are highly transparent and make it easy for authorities, like the IRS and the FBI, to track criminal activity.
• The so-called “travel rule” under federal anti-money laundering regulations requires financial institutions to transmit information relating to the originator and the beneficiary when cryptocurrency is transferred, which reduces the anonymity of crypto transactions.

What are Crypto’s Cons?

• Some popular cryptocurrencies have experienced extreme price volatility, which can limit their use and negatively impact purchasing power.
• Cryptocurrency suffers from a complex user experience, often making it confusing for individuals to buy, sell, and hold.
• Digital assets may be susceptible to online theft, forgotten passwords, and accidental loss. With fewer or sometimes no intermediaries, it can be even more difficult than fiat, and often impossible, to recover.
• Cryptocurrency has properties that attract money launderers and other criminals globally. The nature of cryptocurrency may lead to an increased risk of fraud or cyber attack.
• Because they’re not currently backed by a government, asset protection/custody or insurance is crypto platform dependent.
• The value of cryptocurrency is generally derived from the continued willingness of market participants to exchange fiat for cryptocurrency, which may result in the permanent and total loss of value of a particular cryptocurrency should the market for that cryptocurrency diminish or disappear.
• There is no assurance that persons and companies who accept cryptocurrency as payment today will continue to do so in the future.
• Some cryptocurrencies, like Bitcoin, require mining and significant electricity input for unit creation, which may have an adverse effect on the environment.
• Cryptocurrencies issued with a fixed number of units may be susceptible to deflation.

How Are Crypto and Fiat Currency Similar?

As we’ve covered, crypto and fiat are vastly different mediums of exchange. They do, however, share one notable similarity regarding their digital form.

Crypto is widely known as a digitally native asset. Behind the scenes, however, fiat currency is also held by global institutions in electronic form and has been since the early days of computers. According to a 2020 report issued by the International Monetary Fund (IMF) and research provider Trading Economics, less than 10% of the world’s money manifests in physical form as printed legal tender. The remainder of the world’s money exists as digital records in databases controlled by global commercial banks that manage deposits, savings, and money market accounts.

While some countries are researching the concept of central bank-issued digital currencies (CBDC) for consumer use, popular cryptocurrencies have been available to individuals for use since 2009. Although crypto is banned in a handful of countries – most global consumers with an internet connection can today find a way to access and use the leading cryptocurrencies.

Three Takeaways

• Traditional currencies are managed in a centralized hub-and-spoke system, while many cryptocurrencies operate in a decentralized structure with no intermediaries.
• Although crypto aims to remove intermediaries, improve cost-efficiency, and advance customer access and control, it does not provide the backing, price stability, or protections of fiat currency.
• While cryptocurrency and fiat currency are poles apart in many regards, they both can exist in digital form.