Since the onset of civilizations, human beings have always looked for a medium of exchange. There was a time when we used to exchange goods for other goods but that system was soon found to be inefficient.
Soon, some cultures adopted shells as a medium of exchange. A certain value would be attached to the chosen medium. With advances in humanity, fiat money emerged. This has been used since then and proved to be quite a useful system.
In the current digital era where the Internet keeps us connected and defines how we buy and sell goods, there arose the need for a more effective medium of exchange. This led to the emergence of cryptocurrencies.
What is Cryptocurrency?
Cryptocurrency is a digital medium of exchange based on the Internet and one which is secured via cryptographic functions. Cryptocurrency relies on blockchain technology in order to realize transparency, decentralization, and immutability.
One of the most highly publicized features of cryptocurrency is that it is not controlled by a central authority like the Federal Reserve (Central Bank). The fact that it is decentralized makes the digital assets immune from the government’s tendency to control and interfere with transactions.
When fully adopted, it would be possible to send money anywhere on earth and it reaches instantly. The fact that transactions incur minimal processing fees since it is sent directly between two parties or via private and public keys make cryptos an intriguing concept.
What is Fiat Money?
Fiat money is a currency issued by the government and does not have any physical commodity like silver or gold that backs it apart from the government that issued it. This money gains value based on forces of demand and supply as well as the stability of the issuing government.
The actual definition of this type of currency can be best understood from the Latin name out of which it is derived. The term ‘fiat’ refers to let it be done or it shall be. There are numerous examples of fiat money including the United States dollar, the euro, AED, among other global currencies.
Cryptocurrency & Fiat Money Compared & Contrasted
Both fiat money and cryptocurrencies have their own set of advantages and disadvantages. Understanding the difference between the two is important as it informs your decision to invest in cryptos. There are three key factors one can look at to understand the differences:
Circulating supply refers to the amount of currency available on the market. The circulating supply of cryptocurrencies can increase or decrease over time. For instance, Bitcoin has an overall cap of 21 million coins.
This means that the cryptos supply will continue increasing until this mark is reached. This gradual increase is as a result of mining, a process by which individual verify transactions on the blockchain and get rewarded with cryptos.
By assumption, the more they get the rewards, the more coins are available for circulating. However, there are cases of coin burn which permanently remove coins from the market. Circulating supply should not be confused with total supply which quantifies the number of coins in existence. Cryptocurrencies total supply and circulating supply is limited.
Fiat money has an unlimited supply. The Federal Reserve has the leeway to issue as many of these as it wants. It can also manipulate their value in comparison to another currency. The fact that the supply of fiat money is at the mercy of the government is a risky state of affairs.
The government could release in excess of this cash, watering down the value in the process. This has happened before in countries like Zimbabwe.
The limited supply of cryptocurrencies is quite an interesting development of events. Given that the demand is on a constant increase while the supply remains unchanged after the 21 million mark is reached, the value will sharply rise in the face of its inherent scarcity.
One of the strongest features of cryptocurrencies is that they are decentralized. This is in comparison to fiat money which is centralized.
Decentralized means that there is no central authority that controls the currency. Bitcoin was the first decentralized cryptocurrency to be created. It uses the SHA-256 cryptographic hash function which is used for proofing purposes.
With decentralization, you do not require a third-party to verify transactions. Rather, miners working on the blockchain (some kind of public ledger where every transaction is recorded) are used to authenticate a transaction in exchange for a reward. This reward comes in the form of coins, which continuously brings us closer to the total coins available.
With decentralized cryptocurrency, you do not have to trust a central authority to safeguard your information and money. If previous cases are anything to go by, the central authorities can be a major let down. There are times the organization you trusted with your data and money may shut down or get bought, jeopardizing the integrity of your data.
A well-designed decentralized network ensures that you do not have to trust third parties with your money. You can become your own bank by storing the money in wallets or even at times in paper form.
Decentralized cryptocurrencies furthermore help with fraud prevention. Given that blockchains are an open ledger, all transactions get recorded on it. For that reason, you can easily tell if fraud is happening. The miners help with the preservation of blockchain integrity.
Being able to carry out a transaction on the Internet and still keep your private data anonymous is one thing that many people longed for. Fiat money cannot provide this functionality. It is easily identifiable. For instance, if you pay your bills using electronic means from your bank, the recipient immediately sees your name and other key details attached to the transaction.
The same cannot be said for crypto. Given that there is no central bank, users are not required to identify themselves when they make a transaction. What happens is that when you pay using Bitcoins, Ethereum, or any other altcoin, the system does a check to see whether you have the coins you purport to be yours. It does not check your personal identification.
The identification that is based on is the address of your wallet. Thus, if you were to receive a payment from another crypto user, you just give them your wallet address and not personal information and many other documentations needed by a bank or financial institution.
It is worth mentioning that some countries have been putting forth legislation aimed at regulating cryptos. This kind of regulation directly breaks the overall intent cryptos. The fact that the countries are unable to directly control Bitcoin itself, they target exchanges. That is why before using a trading platform, you will often be asked to verify your identity before trading the virtual currencies.
The issue of anonymity is one that is received with mixed reactions. The proponents of fiat money feel that given that is not anonymous, it helps halt criminal activities and money laundering.
Every medium of exchange has its set of advantages and disadvantages. However, fiat money appears to be more disadvantageous compared to cryptocurrency. From giving users top security in transactions to getting rid of the central authority, cryptos have continuously gained momentum. Their usage is set to grow as more businesses like Microsoft adopt them as a medium of exchange.
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