Fiat currencies are legal tender controlled by governments. Cryptocurrencies are digital assets that use blockchain technology.
After reading this, you'll understand:
Many cryptocurrencies use automated market makers and liquidity pools to determine their value.
The value of fiat currency is tied to government and economic stability.
Fiat currencies generally offer more price stability than cryptocurrencies.
As more and more people learn what cryptocurrencies are and how they're used, questions continue to emerge about how they relate to fiat currencies. Fiat currencies were used as early as the 11th century and are still backed by governments today. The US dollar transitioned from a representative currency to a fiat currency in 1971, when the United States abandoned the gold standard. Still, many people aren't entirely sure what fiat money is and how it differs from cryptocurrency.
In this article, we'll take a closer look at fiat vs crypto and their similarities and differences.
Fiat currencies are forms of legal tender that governments control. These currencies are generally not tied to the value of another commodity, such as gold. Instead, their value is tied to government and economic stability. Fiat currency value is also determined by the amount of currency in circulation. When too much money is printed, the value of the currency drops. In other words, newly-printed money borrows value from the money already in circulation.
Central banking entities like the Federal Reserve typically control a country's money supply. Nowadays, most money is digital, although central banks can partner with governmental institutions, such as the United States Treasury, on printing money and minting new coins. In some cases, central banks are technically government agencies, although they are run more like private companies.
Central banks can inject new money into a country's money supply by buying treasury bonds or other assets. Similarly, they can reduce the money supply by selling the assets on their balance sheet. This strategy for controlling the money supply is known as open-market operations.
Cryptocurrencies are digital assets that use blockchain technology, or a similar distributed ledger technology, to track, validate, and secure transactions. These currencies can be used as a store of value, for speculative trading, or to unlock utilities specific to a given token. Many cryptocurrencies suffer from extreme volatility, meaning they aren't a reliable tool for value storage. However, the emergence of stablecoins has made other cryptocurrencies a viable means of storing value.
Many cryptocurrencies use automated market makers and liquidity pools to determine their value. In this way, some cryptocurrencies are more similar to representative currencies than fiat currencies. For example, if you were to create a cryptocurrency called "A-coin" and set up a liquidity pool with 100 A-coins and $100, each A-coin would be worth $1. On the other hand, if you deposited 200 A-coins and $100, each A-coin would be worth $0.50.
Fiat currencies and cryptocurrencies are primarily used for transactions. Nonetheless, they differ in many ways. In this section, we'll dive into how these two types of currencies compare.
There are many ways that fiat transactions can be traced back to the person making the transaction. Cryptocurrency transactions are viewable on the public blockchain, but you can see only the wallet addresses of the senders and receivers. This anonymous structure makes it harder for people to trace a transaction's origins.
Transferring fiat money from one country to another can be slow and expensive. This is because these types of transactions require intermediaries. Cryptocurrency lets you transact with people around the world securely and efficiently. These digital currencies use smart contracts to automate blockchain transactions, meaning you don't have to involve a third party.
Fiat currency exists in digital and physical forms. Physical fiat currency is often stored in banks and protected by law enforcement. However, large-scale physical theft is possible. In most cases, bank robbers are caught, and the money is recovered. Still, there are numerous unsolved robberies. Sometimes, large sums of stolen money are never recovered.
Every cryptocurrency is a digital currency without a physical equivalent. These currencies are secured by advanced cryptography that makes them impossible to counterfeit. Transaction records can't be altered, and cryptocurrency wallets are nearly impossible to access unless someone obtains your private key. Still, the decentralized and unregulated nature of the cryptocurrency ecosystem lends itself to various scams.
For example, if you created a popular token called "A-coin," a scammer could create their own token called "A-coins" and try to convince people to buy it instead. The two currencies would have different asset IDs, so knowledgeable buyers could tell the difference. Still, those new to the cryptocurrency ecosystem might not know the difference.
Fiat currencies generally offer more price stability than cryptocurrencies, although they aren't completely protected from devaluation. For example, one dollar, by today's standards, is worth roughly 63 times less than it was in 1700. Still, because this devaluation happened gradually over time, most people were able to adjust to the falling dollar value. Alternatively, hyperinflation can cause dramatic changes in value. In 2022, the Zimbabwean dollar lost roughly 76% of its value in a single year.
Cryptocurrency prices can rise and fall at unprecedented speeds. A single BTC was worth roughly $100 in 2013. Its value grew to a staggering $40,000 in 2021 before losing roughly 45% of its value the following year. Stablecoins were created to address this extreme price volatility, giving crypto enthusiasts a reliable way to use crypto as a legitimate currency. Still, situations like the fall of TerraUSD have shown that some stablecoins are far from perfect.
Fiat currencies are heavily regulated by central authorities, safeguarding against fraud, money laundering, and other illicit activities. Central banks regulate the money supply and interest rates while partnering with other governmental agencies to implement monetary policy.
The cryptocurrency regulatory environment is far less developed. It does not offer the consumer protections of the fiat world. These technologies evolved quickly, and regulators struggled to keep up as people began to accept cryptocurrency. In the past few years, the White House, Securities Exchange Commission, and other governmental agencies in the United States have begun working toward crypto regulation.
Other regions have come up with their own unique stances on cryptocurrencies. For example, China banned cryptocurrency exchanges from operating in the country, while Australia requires them to register with the Australian Transaction Reports and Analysis Centre.
As cryptocurrencies evolve, many look for ways to use them more traditionally. While most cryptocurrencies are too volatile to be reliably used as currencies, others are designed to avoid volatility. Hedera supports the development of stablecoins and gives crypto assets like USDC a fast, secure way to offer fiat-backed stablecoins. The Hedera network has lightning-fast finality and low, predictable fees, making it a viable way to use stablecoins for micropayments.