Cryptocurrencies are taking the world by storm. Bitcoin has crossed $50,000 and the entire crypto market cap has exceeded $1 trillion for the first time in history.
Even though crypto is taking off like one of Elon Musk’s rockets, there are still billions of people who don’t know why crypto can be better than traditional fiat money.
That’s why we’ve written this article, to discuss fiat money and how it compares to crypto.
What is Fiat Money?
Fiat refers to the government-backed currencies that are used all over the world. Dollars, Euros and Yen are a few of the largest fiat currencies. The fiat currencies we use today are different than what they used to be. In the past, most fiat currencies were backed by gold. You could actually take your paper dollars to a bank and redeem them for an equivalent amount of gold.
Over time the gold standard was done away with. By pegging their currencies to gold, governments gave up flexibility. They couldn’t print their currencies whenever they wanted and the circulating supply of fiat was determined by how much gold a country held in its vault.
The gold standard limited government money printing, which meant that countries couldn’t spend as lavishly as they do today. However, the drawback was that central banks had fewer tools to respond to economic downturns.
We’re seeing that having a pure fiat standard (no gold backing) is more harmful than helpful.
- Government debt is off the charts. We’re already at record levels of debt yet governments are continuing to spend money they don’t have
- Fed money printing disproportionately benefits asset holders. Fully 50% of Americans don’t hold any assets like stocks or crypto, and so they don’t benefit from these markets which are at record highs
- Given that central banks are printing money to buy government debt, inflation is likely to get worse in the future
The fiat standard is falling apart. Is crypto any better?
Fiat vs Crypto
Cryptocurrency is an emerging asset class that some people feel is a better form of money than fiat. Here are a few reasons why a fiat to crypto exchange might be a good idea.
Unlike fiat, most cryptocurrencies have a maximum total supply. For example, there will only ever be 21 million Bitcoin. No matter how much demand there is for Bitcoin, no more will be created.
This is important because it gives cryptocurrency holders an assurance that the value of their crypto will not be inflated away. If you have USD, and the Federal Reserve prints trillions of new dollars, that inflates the supply and diminishes the purchasing power of your cash.
The fact that more crypto cannot be created out of thin air is one reason why cryptocurrencies like Bitcoin and Ethereum have value.
Crypto = Equality
One of the major problems with central bank money printing is that it disproportionately benefits those that are closest to the money spigot. We call this the cantillon effect, the idea that whoever touches the newly printed money first benefits the most.
In the case of the central bank fiat creation, it’s the government and large banks that benefit from the printed money. By the time the newly printed money reaches the average citizen, those dollars’ purchasing power is already lessened.
With crypto there is not a pronounced Cantillon effect. Miners receive the newly minted coins, but the inflationary effects are already baked into the protocol since the supply schedule is known in advance. Furthermore, anyone can become a miner.
Crypto Cannot be Seized
If you think that the dollars you keep in a bank account are yours, you are sadly mistaken. The government can freeze those funds at any time. It happens more than most people realize.
Unlike dollars in a bank account, the government cannot take your crypto. If the police raid your home and gain access to your laptop you could lose your crypto. However, what the police can’t do is take your crypto remotely. Also, if you encrypt your laptop, the government can’t take your crypto even if they have your devices!
In this way, crypto is even more secure than gold.
Crypto is Portable
When you compare fiat vs crypto, with crypto you can send money all over the world for a small fee. For example, in late 2020 someone sent about $1 billion worth of crypto and only paid about $5 for the transaction.
Sending $1 billion through the traditional financial system would have cost thousands of dollars.
Crypto can be easily sent between any two people, regardless of where they live. That’s not always possible within the existing financial system. The traditional system depends on liquidity. It’s easy to send fiat crypto in high-volume corridors like UK-USA. However, it’s more difficult to send money via low-liquidity corridors.
For example, South Africa to the Philippines is a low-volume corridor which means higher fees and longer transfer times. This is one of the major disadvantages with fiat money and the existing financial system.
Crypto is Programmable
With cryptocurrency you can do all sorts of interesting things. You can create multisignature (multisig) accounts. With a multisig account the crypto can only be sent when several people or institutions approve the transaction.
Developers can also create applications on top of smart contract platforms like Cardano and Ethereum, such as:
- Decentralized exchanges
- Lending platforms where users can lock up their crypto to get a loan. Alternatively, investors can deposit their crypto to earn interest on it
- Yield farming protocols that allocate deposits to whatever lending protocol pays the highest ROI
There are so many cool things that you can do with programmable cryptocurrencies. When you look at fiat vs crypto, the fact that crypto is so flexible gives it a big advantage.
Governments all over the world treat cryptocurrency differently. Some countries like Portugal have declared that cryptocurrency is entirely legal. Other countries like India have outlawed digital assets.
Most countries are somewhere in the middle. The United States treats Bitcoin as a commodity similar to gold. Under this framework Bitcoin is entirely legal, however, that framework doesn’t apply to all cryptocurrencies in the United States.
Other cryptos, most notably ICOs, may be considered securities. This is why we’ve seen the SEC enforce legal action against so many cryptocurrency projects for being unregistered securities. Of course the biggest example is XRP. The SEC claims that Ripple has been selling XRP as an unregistered security.
Could cryptocurrencies be reclassified as currencies? It’s possible. Classifying Bitcoin as a currency instead of a commodity would change the tax implications for Bitcoin holders.
Could the United States ban cryptocurrency?
There is a precedent for this. The American government made it illegal for citizens to keep gold from 1933 to 1974. However, every week that goes by the odds that the government will ban crypto go down.
Tesla, MicroStrategy and many other companies are holding BTC on their balance sheet. BNY Mellon and Fidelity, among other financial institutions, are now offering a crypto service. If the United States government banned crypto they would be hurting all of these businesses.
In six months, dozens more companies will hold crypto, and enacting a ban will be even harder. A fiat to crypto exchange is perfectly legal now and it will probably remain legal for the foreseeable future.
How are Cryptocurrencies Valued?
One of the best ways to value a cryptocurrency is to look at its network effect.
- How many people hold the cryptocurrency?
- How many exchanges have it as a trading pair?
- How many wallets and other applications support the cryptocurrency?
The larger the network effect is for a cryptocurrency, the higher its value is. The same idea holds true for a social network. Facebook and Instagram are valuable because so many people use the platform.
It’s difficult to create a new social network because not many people are on it and the network effect is small. The same is true for a cryptocurrency. Bitcoin may not have the best tech, but it has a massive network effect which is one of the main reasons why BTC is so valuable.
The Great Fiat vs Crypto Debate
The world is waking up to the value proposition offered by cryptocurrencies. Bitcoin is a digital version of gold and Ethereum is the largest smart contract platform in the world. When you consider fiat vs crypto, both of these cryptocurrencies offer something that fiat doesn’t.
It will be fascinating to watch cryptocurrencies like Bitcoin and Ethereum as they continue to grow and add new features. They may not become THE global standard currencies that everybody will use (world governments are already working on their own Central Bank Digital Currencies to rival Bitcoin) but they will certainly give fiat a run for its money, at the very least.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.