The general difference between cryptocurrency and fiat currency is that most cryptocurrencies have a constant money supply or inherently deflationary (limiting money supply), while fiat currency is inflationary (increasing money supply every year.
Before getting into the pros and cons of fiat vs cryptocurrency, let us first gain an overview of the characteristics between the two monetary systems:
Fiat currency and its blurry history
A fiat currency is a currency without intrinsic value established as money and often legal tender by government regulation. The history of fiat currencies is a somewhat blurry picture as noted by monetary scholar Edwin Vieira; every 30 to 40 years the reigning monetary system fails and has to be retooled. The last time around for the U.S. was in 1971, when Nixon cancelled the convertibility of the US dollar into gold. Remarkably, the world accepted the unbacked US dollar as its reserve currency, but only because that was the path of least resistance. Fast forward to today and the world is growing increasingly dissatisfied with a fiat reserve system, looking at the history of fiat currencies, the risks become obvious.
According to a study of 775 fiat currencies by DollarDaze.org, there is no historical precedence for a fiat currency that has succeeded in holding its value, rather the contrary. Twenty percent of the 775 fiat currencies failed through hyperinflation, 21% were destroyed by war, 12% destroyed by independence, 24% were monetarily reformed, and 23% are still in circulation approaching one of the other outcomes.
The average life expectancy for a fiat currency is 27 years, with the shortest life span being one month! Founded in 1694, the British Sterling is the oldest fiat currency in existence today. At a ripe old age of 317 years it must be considered the most successful fiat currency. However, success should be measured on a relative scale. The British pound was defined as 12 ounces of silver, so it’s worth less than 1/200 or 0.5% of its original value. In other words, the most successful long standing fiat currency in existence has lost 99.5% of its value. It reminds us of a famous Voltaire quote:
“At the end fiat money returns to its inner value—zero.” – Voltaire
Looking beyond intrinsic value, fiat currency lives and breathes on perceived value. If consumers around the world agrees that a 100 dollar bill is worth what it says on the paper, then the market economy and fiat system should function well. However, what happens if a big portion of the world population is excluded from this system? What happens if 39% of the world’s population, mostly comprised of the population in developing countries, does not have a bank account?
What happens is that 39% of the world population will then manage their store of value themselves, be it fiat money or other mediums of exchange, earning no interest. When you earn no interest in a fiat system by depositing to a bank, your money is losing value every day due to inflation. When your money loses value fast, you either want to spend it fast or exchange to other currencies. In that situation, the fiat system quickly breaks down due to lack of savings and lack of trust in the fiat currency.
At the same time, if you are unbanked you don’t have access to the technology that typically follows fiat systems. You cannot store your money safely, you cannot spend your money with a debit card and you cannot send as well as receive money easily. The saying goes “it is expensive to be poor” and it couldn’t be more true for example for remittances, where fees have surged 102% over the past 10 years ($63.9B in 2016).
It seems in a fiat system where “it’s expensive to be poor”, it goes the other way as well, “it is inexpensive to be rich”. Panama papers and a growing list of money laundering schemes using fiat show that the rich is getting richer through clever tactics, heavily interconnected with the central banks and government.
Fractional reserve banking, governments and a debt-based economy
As illustrated in Cryptocurrency and blockchain, a superior alternative to a debt-based, trust-dependent, financial system, it is clear that the current fiat system is a vicious circle of issuing more debt to continue growing the global economy. The system is basically set up with the central bank at the top printing currency, trickling down to commercial banks who create money out of thin air due to the fractional reserve system:
The pyramid with the central bank at the top, trickling down money to commercial banks and on to consumers, simply does not work very well. We need a better system. And finally with blockchain there appears to be a superior alternative.
This brings us to cryptocurrency. Unlike fiat currency and fractional reserve banking, cryptocurrency cannot be debased by any government. Even the governments cracking down on cryptocurrency are actually making it more valuable. Cryptocurrencies are stored on a decentralised network, the blockchain, a hydra that no government or entity can shut down without shutting down the internet itself. The question remains, is it a real alternative to fiat currencies?
Cryptocurrency, speculation and fixed money supply
Historically, cryptocurrency has undergone incredible growth, volatility and speculation since Satoshi Nakamoto launched the first cryptocurrency, Bitcoin, in the wake of the global financial crisis in 2009.
Any new groundbreaking technology will undergo extreme situations, and cryptocurrency has received its fair share of challenges. From Mt Gox – one of the largest cryptocurrency exchanges – losing what is worth billions of dollars in Bitcoin to Jamie Dimon calling Bitcoin a fraud to one of the largest ICO’s – Tezos – having an internal dispute after raising $232 million.
Despite all the challenges, cryptocurrency has not only survived but continues to thrive. When the managing director of the International Monetary Fund, Christine Lagarde, say cryptocurrencies could displace central banks and international banking, there is clearly something massively disruptive underway.
Contrary to fiat currencies, most cryptocurrencies have a fixed supply that cannot be changed. This often leads to price increases of a particular cryptocurrency, and hence relative price decreases for the goods and services that can be purchased with the cryptocurrency. The deflationary tendencies for cryptocurrencies are problematic if it is to be a medium of exchange for the masses. If everyone expects a cryptocurrency to increase in value by tomorrow, most will wait to purchase goods and services until the day after, where they can buy more for the same amount, and so on. This is better known as hoarding and could cause stagflation (stagnation and deflation), or even worse, a recession with deflation like we saw during the Great Depression in the 1930s.
Challenges cryptocurrency needs to overcome to compete with fiat
For cryptocurrency to become a serious alternative in a market economy, there needs to be cryptocurrencies that solve the deflationary problem that avoids hoarding. Besides that, there are a couple of other issues that needs to be solved before mass adoption will occur:
- Scalability – chances are you’ve heard that cryptocurrency is slow and expensive. This is true, however, new developments are continuously being made to improve speed and reduce transaction fees. The Lightning Network is an added layer to the Bitcoin network, while the Raiden Network is an added layer to the Ethereum network. These additions process transactions off-chain to increase the speed of transactions through the use of smart contracts. They allow users to make micro-payments that would otherwise not be feasible due to fixed per-transaction fees. While the two largest cryptocurrencies, Bitcoin and Ethereum, struggle to find solutions, smaller unpopularized currencies are also fighting hard to overcome the issues associated with scalability.
- Spend-ability – Cryptocurrency payments that are accepted in-store are hard to come by. Today, only a few companies accept cryptocurrency as a form of payment. Some of the most well-known companies include Overstock, Expedia, Subway, Virgin Galactic, Shopify and Microsoft. However, cryptocurrency debit cards are being issued to solve that. LitePay, created by Litecoin and considered “an improved version of Bitcoin”, allow users of LitePay to convert LTC to USD and vice versa while making purchases in real time. LitePay allows users to upload coins to their debit card. These cards can be used anywhere debit cards are accepted and can be used to withdraw cash from designated ATMs. Allowing consumers the opportunity to use cryptocurrency as a form of payment on everyday purchases from coffee, to clothes, and much more!
- Regulations – While fiat currency and exchanges such as the NYSE and NASDAQ have been around for ages, the existence of cryptocurrency is relatively new. When something new enters the market, for example drones, regulation is inevitable. Although these regulations lag behind the devices/technology, eventually they follow (i.e. height zones, required registration, prohibited near airports, etc). In order for cryptocurrency to compete directly with fiat money, large bodies of governments first must accept them as “valid”. Many cryptocurrencies have been proactive through self-regulating measures. This means awareness of anti-money laundering regulations and complying with SEC regulations for utility tokes. These proactive measures ensure protection of consumers, as regulations of cryptocurrencies right now are few and far between. The European Union is strongly embracing blockchain technology, and only time will tell if they will acknowledge cryptocurrency and validate it as a payment system.
- Stability – Although fiat money is no longer backed by gold or silver or any other commodity these risks are relatively minimal as the USD is a stable currency. On the other hand, cryptocurrency is/has been referred to as volatile. Bitcoin’s value was over $19,000 USD in December of 2017, only to fall drastically in following weeks. As of now, cryptocurrency is seen is as an investment, as opposed to a way to pay for goods and services regularly. Stability creates a trust, and trust is needed in order for cryptocurrency to be used as a medium of exchange.
- Exclusivity – One of the most notable problems associated with cryptocurrency is the lack of understanding among the general public. How are consumers expected to trust something they don’t understand? That is why we at Blockbasis created a platform that is intended for the general public to learn, interact and better understand cryptocurrency. Most importantly, we created a process to simplify cryptocurrency transactions as we aim to make cryptocurrency more widely accessible to all.
Software is eating the world, Marc Andreesen from Andreesen & Horowitz famously stated. Currency is no exception. Interestingly, we live in a world where all our currency is becoming digital, so the question remains: Will this digital currency be governed by central organisations and corporations with fiat, or will they be governed by decentralised autonomous organisations with crypto? This is perhaps the biggest question today’s generation will need to answer and decide on.
Fiat currency is built on a system that dates back to the Medici family and the first bank in the 14th century, many challenges present themselves in a world that is getting increasingly digital. Cryptocurrency on the other hand, is completely new and still maturing as a serious alternative to fiat, with multiple problems that needs to be solved before it can become mainstream.
Time will tell which monetary system will define future generations, but one thing is for sure, we are in for a hell of a ride!