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Crypto vs Fiat
Can cryptocurrency replace fiat as the dominant means of exchange around the world?
In 2009, Bitcoin broke the mold as the first cryptocurrency to go mainstream, leaving its predecessors in the dust. While the reasons behind its meteoric rise are still much debated, many attribute it to its decentralized design and anonymity - though whether those claims are true is hotly contested.
Its release during the 2008/09 financial crisis surely also helped. The crisis damaged trust in monetary institutions and led to growing calls for a currency that wasn’t centrally controlled.
A fiat (Latin for let it be done) currency is one issued by a government and not backed by a physical commodity such as gold. The value of a fiat currency comes from the trust people have in the government issuing it. Nowadays, most currencies are fiat currencies including the British Pound, US Dollar, and the Euro, but could this be about to change?
Properties of Cryptocurrencies
Cryptocurrencies supposedly have many advantages over traditional fiat. These include decentralization, anonymity, and accessibility. Let’s go deeper into some of them and see if that really is the case.
Perhaps the main pro of widespread crypto adoption would be taking control of the currency out of the hands of centralized institutions. Trust in financial institutions has been hit hard in the last 15 years and continues to fall across the west as rising inequality and inflation take their toll on the average person.
Crypto gives the chance to take control of the currency out of the hands of the rich and powerful and give it back to the people. But whether this dream can ever be realized is uncertain, and there are problems regarding the centralization of crypto.
In Bitcoin’s case, although it’s often cited as being decentralized, 9.6% of addresses own 98.5% of all Bitcoin. Is this really the decentralization much of the crypto community claim it possesses?
The second biggest crypto, Ethereum, is also highly centralized. Vitalik Buterin, who first conceived of Ethereum in 2013, remains the leader of the project and largely controls its development. It’s the same for Charles Hoskinson at Cardano and Gavin Wood at Polkadot. These individuals have such a massive influence on the community that although in theory, they don’t control it, in practice, any comments they make greatly impact the price and the project itself.
The three projects mentioned above are meant to be ecosystems that allow developers to build apps on top of them. However, if a potential fiat currency were to be built on top of Ethereum, it would still seem to me, to be a major problem to have Ethereum itself being so centralized. What would happen to the currency itself if something happened to Vitalik?
Many cryptos are also held on centralized exchanges such as Coinbase or Binance. We saw the dangers of this with the collapse of FTX, an exchange that turned out to be built almost entirely on a lie, and Mt Gox, an exchange that abruptly closed in early 2014 at a time when it was handling 70% of all Bitcoin transactions.
So although many claim that crypto is decentralized, this actually isn’t the case a lot of the time. That’s without even mentioning the impact that public figures like Elon Musk and Michael Saylor can have just through tweeting.
It seems that the decentralization the crypto community espouses doesn’t necessarily exist for the most popular cryptos at the moment. What about the anonymity?
Much like with decentralization, although many in the crypto world claim it’s anonymous, in a lot of cases, it’s not.
When transferring crypto, you need someone’s address to be able to transfer money to them. Once you’ve got the address, you can run it through services like Etherscan or Blockchain.com and see every transaction the address has ever made!
Although all you can see is the other wallet address that the user transacted with, which doesn’t give too much away, it’s still fairly unnerving. Imagine being able to see every purchase your friend had made along with the amount, other party’s address, and time the transaction was made as well as how much they currently had in their account.
The entire point of blockchains originally was that the information is publicly verifiable. In one way this is good - it increases trust in the currency. But on the other hand, it makes it much easier to trace individuals.
Governments around the world are also introducing more stringent Know Your Customer (KYC) rules which require you to reveal your identity on centralized trading platforms. Authorities can then see the transactions you’ve carried out and what’s in your wallet.
Thankfully, there are cryptos that have found ways around this problem. Monero claims to be “the only major cryptocurrency where every user is anonymous by default.” In the Bitcoin world, transactions are recorded using a pseudonym (the wallet address), whereas Monero achieves complete privacy.
So crypto can provide an anonymous means of transacting, although unfortunately, not all cryptocurrencies do this, and certainly none of the biggest ones at present.
One area where crypto undoubtedly beats fiat is accessibility. All you need to be able to buy and send it around the world is an internet connection.
Crypto also means there’s no need to involve a third party to verify transactions. The consensus mechanism of a blockchain automatically verifies all transactions and stores the information so it can be verified publicly later.
One area in which its accessibility is proving a boon to local communities is Africa. Small retail payments, particularly in sub-Saharan Africa, are powering the growth and widespread adoption of the technology. 80% of crypto payments less than $1,000 take place there according to Chainalysis.
They say that:
“this reflects the trend of many young people in Sub-Saharan Africa turning to cryptocurrency as a way to preserve and build wealth in spite of low economic opportunity, as opposed to other countries where we see many using cryptocurrency as a way to multiply their existing wealth.
In most cases, to create a bank account you need proof of address, ID, and in some cases an initial deposit, to create a crypto wallet all you need is an internet-connected device.
To most in the west, opening a bank account is relatively easy, but to may in the developing world it’s simply not possible. Thankfully, crypto gives them another place to store their wealth.
No one can say that crypto will never become the primary means of exchange at some point, but I think it’s unlikely that any crypto in its current form will do so. New ones are always being invented, and it’s entirely possible that one will come along eventually that can replace fiat currencies.
At the moment however, many of the properties that proponents of crypto say exist, just don’t, especially when it comes to the major ones.
Perhaps the main pros of using a fiat currency are the wide acceptance, stability, and regulation (maybe). Let’s look at these in more detail.
I think many would agree that the main advantage that fiat currencies have over crypto is that they’re already accepted around the world. By some estimates, fiat has existed in China for over 1,000 years, and it was commonly used throughout the Roman empire way before that.
Its value is purely based on the faith people have in it and government support, rather than a physical commodity that affects the value of the money as it goes up and down and imposes limits on governments trying to support the economy during a recession.
People will accept fiat currency (provided it’s the local one) all around the world. And in many countries, they’ll accept US dollars even though they’re not.
Unlike cryptocurrency which isn’t really widely accepted anywhere, except El Salvador and the Central African Republic, fiat currency is accepted as a form of payment and has been for thousands, of years. It doesn’t need any kind of massive change in technology or society as a whole to become widely adopted.
Another huge area it differs from crypto is in its stability. It’s not uncommon for the price of even major cryptos such as Bitcoin or Ethereum to swing more than 5% in a single day. Were a major fiat currency to swing more than 5% in a day it would likely be news across the world (as it was during Brexit).
This stability is mainly due to centralized control, government backing, regulations, and ultimately, trust in the currency.
Centralized control allows governments to adjust monetary policy in response to economic conditions. This means that the value of fiat currency is more predictable and less subject to sudden price swings than cryptocurrencies. The backing of governments and regulatory measures also help to ensure the stability of fiat currency.
In contrast, the value of a cryptocurrency is largely determined by market demand, which can be influenced by a wide range of factors including media hype, speculation, and rumors. The lack of centralized control can actually act as a negative; cryptocurrencies can be subject to sudden and unpredictable price swings, which can make them more volatile than fiat currency.
The stability of a currency is essential to maintaining its value and predictability. Fiat is undoubtedly more stable than crypto, albeit crypto hasn’t been around for anywhere near as long. While cryptocurrencies may offer advantages in speed and security, the stability of fiat currency is still preferred for most investors and individuals at the moment.
The legal status of fiat currency can provide a level of stability and security that cryptocurrencies lack. Central banks can take measures to maintain the stability of their currency, which can help prevent significant fluctuations in its value.
In contrast, cryptocurrencies often operate in a legal gray area, with uncertain or inconsistent regulatory frameworks. This can make it difficult for businesses and individuals to know how to comply with the applicable laws.
Regulations also help improve consumer protection. Financial institutions are normally required to comply with strict anti-money laundering (AML) and know-your-customer (KYC) regulations, and as mentioned, these tend to get stricter over time.
Cryptocurrencies, due to their decentralized and pseudonymous nature, can make it difficult to comply with these regulations, and make it harder for them to be used in certain types of transactions.
In addition, regulated fiat currencies can provide consumers with protections against fraud, scams, and other illegal activities. This lack of consumer protection makes it harder for cryptocurrencies to gain widespread adoption, particularly among those concerned about security and fraud.
Regulations can provide important protections and stability for fiat currencies, but they can also create challenges for the growth and adoption of cryptocurrencies.
As regulatory frameworks evolve and mature, perhaps cryptocurrencies will become more widely accepted and integrated into the financial system. But at the moment, it’s unclear how these technologies will coexist and interact with existing regulatory frameworks in the years to come.
Fiat’s main advantage is that it’s already been around for thousands of years; people trust it.
Of course there have been cases of it failing as well. Notably in Zimbabwe and Weimar Germany. It also has the added disadvantage of always losing value due to inflation, as we’re getting first-hand experience of now with global inflation at its highest in decades.
But despite this, it’s not going away anytime soon.
Many in the Web3 community dream of a day when merchants all over the world will accept payment in crypto of one form or another. But unfortunately, as we’ve seen, if that is to happen, there’s probably quite a long way to go.
Cryptocurrencies at the moment lack many of the things required for wide adoption, and even some of their supposed positive features don’t actually exist in a lot of cases. Where they, particularly Bitcoin, do have a role to play is as a store of value.
In my opinion, crypto is highly unlikely to replace fiat currencies anytime in the next decade. Where they might become prominent, in one form at least, is through the use of Central Bank Digital Currencies (CBDCs), many of which are being tested right now.
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