When cryptocurrency was first introduced, it seemed to be used interchangeably with digital currency. But over time, the differences between fiat currency, cryptocurrency, and digital currencies have become more apparent. Join us as we put fiat currency vs cryptocurrency vs digital currency in perspective.
As blockchain technology becomes more integrated into our everyday lives, it’s essential to understand the differences between fiat currency, cryptocurrency, and digital currencies. Understanding what these three currencies are, how they can be used, and their pros and cons are essential, especially when building your investment portfolio.
What Is Fiat Currency
A fiat currency is a currency that is issued by a government or central bank but has no intrinsic value. In other words, fiat currency only has value because the government or central bank says it does. The U.S. dollar is an example of fiat currency, as its value is based solely on faith in the U.S. economy and government, not a commodity such as gold or silver.
What Is Cryptocurrency
Cryptocurrency is a digital asset that uses cryptography for security and is decentralized, meaning any government or central bank does not control it. Bitcoin, the world’s first cryptocurrency, was created in 2009 as a response to fiat currencies and the global financial crisis. Cryptocurrencies are digital currencies, but they differ from fiat currencies because they are not issued or backed by a government.
What Is Digital Currency
Digital currency is any form of money that only exists electronically and can be used for online transactions. It includes fiat currencies such as the U.S. dollar, cryptocurrencies such as Bitcoin, and other digital currencies such as e-cash, loyalty points, in-game money, and a host of NFTs. Digital currency is not physical money like coins or bills but exists only on the internet.
Fiat Currency Vs. Cryptocurrency
One of the biggest debates on the financial market today is between fiat currency vs cryptocurrency. While fiat currency is issued by governments or central banks and backed by those entities’ full faith and credit, cryptocurrency is not backed by any government or central bank, making it a decentralized form of money. As a result, fiat currency tends to be much more stable in value than cryptocurrency, which can experience substantial price fluctuations. Below is a detailed comparison between the two:
As stated, fiat currency is the widely accepted and recognized form of currency issued by governments or central banks and backed by those entities’ full faith and credit. It is highly regulated, meaning government agencies can monitor its flow through the economy to ensure stability.
Fiat currencies are distributed mainly by intermediaries such as banks or credit card companies and come with associated fees.
Advantages Of Fiat Currencies
Fiat currencies have several advantages over using cryptocurrencies, such as:
They Are Stable
Fiat currencies are backed by governments or central banks’ full faith and credit, making them relatively more stable in value. Even though the value of the fiat currency may vary depending on how the economy performs, it enjoys more stability than cryptocurrencies.
Fiat currencies are much more accessible than cryptocurrencies as they can be obtained from banks, credit card companies, and other fiat currency exchanges. You don’t have to know about cryptocurrencies or technologies to access Fiat currencies. Instead, they are in circulation in both physical and electronic forms.
A Good Store Value
Fiat currencies are a good store of value as compared to cryptocurrencies. While fiat currency is backed by the full faith and credit of a government or central bank, cryptocurrency lacks this backing. This means that fiat currencies can be held over time without losing their value as opposed to cryptocurrencies, whose prices keep fluctuating.
Disadvantages of Fiat Currency
One of the reasons that led to the development of cryptocurrencies is some of the limitations that fiat currencies had: They include:
Vulnerable To Inflation
Fiat currencies are vulnerable to inflation since hard assets do not back them. This means that fiat currencies can quickly depreciate, making them less attractive as a store of value. Moreover, fiat currencies have been shown to lose their purchasing power over time when other investment options, such as stocks, gold, and real estate, and even digital currencies yield better returns.
Governments or central banks heavily regulate fiat currencies. This means that fiat currencies cannot be accessed in certain parts of the world, making them less attractive to international investors and businesses. Moreover, fiat currency transactions can attract hefty transaction fees and taxes, making them expensive.
Fiat currencies are limited by their location or government. Fiat currencies cannot be used in different countries as they must be exchanged for local currency. This means that fiat currency users must go through a long process of exchanging foreign currencies when they want to travel or do business in another country.
High exchange and transaction fees
Fiat currencies are associated with high transfer fees when transferring fiat currency from one country to another. This makes fiat currencies not cost-effective for international transfers and transactions. Moreover, foreign exchange rates and transaction fees can be pretty high when exchanging fiat currency for another fiat currency.
Cryptocurrency is a digital or virtual currency secured by cryptography, making it nearly impossible to counterfeit or double-spend. It runs on a distributed ledger technology called blockchain and can be used for various transactions such as fiat currency conversion, payments, or trading.
Advantages Of Cryptocurrency
Cryptocurrencies have several advantages over fiat currencies, such as:
Low Transaction Fees
One of the main advantages of cryptocurrencies is that they offer low transaction fees when transferring money from one user to another. This makes them attractive for international transfers and transactions as it can save users a lot of fees.
Cryptocurrencies are highly secure as they are based on blockchain technology, making them tamper-proof and immutable. This means that transactions made using cryptocurrencies cannot be reversed or manipulated, making them reliable for digital payments.
No Geo-location Limitations
Cryptocurrencies do not have any geo-location limitations, as they can be used around the world without having to go through fiat currency exchanges. Users can quickly transfer money from one country to another without worrying about exchange rates and fees.
Cryptocurrencies are uncensored, which makes them suitable for transactions in countries with strict censorship laws. As such, people can trade and buy things without worrying about government intervention or censorship.
Long-Term Investment Possibility
Cryptocurrencies are viewed as long-term investments by some due to their volatile nature. Although prices fluctuate, the market is expected to stabilize over time. With time comes stability, making crypto a good option for those looking for long-term returns.
Moreover, the cryptocurrency price trends over the years have shown that cryptocurrencies gain value much more quickly than fiat currencies. For example, when bitcoin was first launched in 2009, it traded for under $1 for some years. However, as of 2022, Bitcoin had at one point broken the $500,000 mark. So, while the value of $1 of fiat currency remained $1 or less due to inflation, the value of 1 Bitcoin had increased by over 500,000% in just a few years.
Hedge Against Inflation
Inflation is common in any fiat currency-based economy, and it can cause fiat currencies to lose their value over time. On the other hand, cryptocurrencies offer an attractive hedge against inflation as their prices are not affected by government policies or local economic conditions. Instead, their prices are determined by factors such as the demand for a particular coin. Such demand can be caused by the community backing the crypto, the use cases, and more. As such, they are less vulnerable to fiat currency inflation.
Good For Day Trading
One factor driving a successful day trading strategy is the volatility of the traded asset. Day traders take advantage of price fluctuations to make quick profits. Cryptocurrencies are highly volatile, which makes them perfect for day trading as their prices can be expected to fluctuate more in a single day compared to fiat currencies.
Disadvantages Of Cryptocurrency
Cryptocurrencies also come with some disadvantages, such as:
One of the main concerns about cryptocurrencies is their high volatility. A plethora of market conditions can cause prices to quickly go up or down due to speculation. This makes it difficult for users to make long-term investments, as profits can quickly become unpredictable. While volatility is a good thing for risk-takers and short-term traders. If you’re planning to hold your investment for a long time, more stability in the crypto market is needed to guarantee success.
Due to the decentralized nature of cryptocurrencies, they are not necessarily backed by any government or regulatory body. In the world of cryptocurrency if an exchange is regulated it is voluntary on the part of the exchange’s management team. Lack of regulation can have both pros and cons:
- Regulation generally provides some assurance that an investment is safe because there is an authority watching the exchange.
- Users know the protocol for account storage etc.
- Governments rise and fall. A regulatory agency is no stronger than the government establishing it.
- It adds a high cost to the business plan of the exchange. It is very expensive to become certified.
In some cases this lac leads to a lot of uncertainty in the market. Additionally, since governments can’t regulate them, there is no guarantee that users will lose their funds due to fraudulent activities or other unforeseen factors.
High Risk Of Theft
Cryptocurrencies are digital assets, which means they are susceptible to cyber-attacks which can lead to the loss of funds. While blockchain technology and the KYC and AML protocols are trying to address the issues of theft, if a bad player could access your account, they can transfer all the cryptos to your account. Moreover, the cryptos can’t be retrieved as you can’t track them once they are transferred. The two things we recommend to guard against this risk are:
- Choose a reputable exchange such as Coinbase, or Binance.
- Hold the coins you are not actively trading in an offline hardware wallet.
Many people try to invest in cryptocurrencies early on during the launching stage. It’s often a strategy to maximize profits, but it comes with a high risk. Many launching-stage cryptos are often scams, and they can quickly disappear after taking the investors’ money.
There have been cases of pump-and-dump scams and ICO scams, where people have lost millions due to investing in scam coins. Always make sure you know who is backing an ICO and that they have a reputable track record!
Comparison Between Digital Fiat Currency Vs. Cryptocurrency
As earlier stated, digital currencies can be either fiat currencies or cryptocurrencies. They are electronic forms of fiat currency and cryptocurrencies, respectively. Here are the similarities and differences between the two:
- Both are stored digitally and can be used for digital payments, transfers, and purchases.
- They can be converted into physical fiat currency for traditional transactions.
- They both have different liquidity levels depending on the type of coin. For example, the U.S. dollar has very high liquidity compared to other currencies. In the same case, other cryptocurrencies are more desirable than others, depending on their popularity.
- Fiat digital currency is backed by a government or regulatory authority, while cryptocurrency isn’t supported by any central authority and relies on cryptography to secure its transactions.
- Cryptocurrencies are decentralized, while fiat digital currencies are centralized, meaning that fiat digital currencies are more volatile and can be impacted by government policies and economic conditions.
- Fiat digital currencies are fiat-based, meaning the country’s exchange rate determines its prices. At the same time, cryptocurrencies are not fiat-based, which makes them less vulnerable to fiat currency inflation.
- Cryptocurrencies provide better privacy and anonymity as the government, or regulatory authorities can track fiat digital currency transactions.
Should You Invest In Fiat Currency vs Cryptocurrency?
The choice between fiat currency and cryptocurrency ultimately depends on your investment objectives. If you’re looking for long-term investments, fiat digital currencies are the better option, as they have government backing. However, cryptocurrency trading is a better option if you’re a risk-taker looking for quick profits.
Whatever you choose, it is important to research and understand the risks associated with each type of currency. Additionally, diversification is critical when investing in any asset class, so spread your investments across fiat digital currencies and cryptocurrencies. That way, you’ll be able to maximize the potential of both types of digital currency.
Fiat currency vs cryptocurrency vs digital currency are all digital forms of money that have advantages and disadvantages. Fiat currency is backed by a government or regulatory authority and is regulated based on local economic conditions. On the other hand, cryptocurrencies are decentralized and not affected by fiat currency inflation.
On the other hand, digital fiat currency is a fiat-based form of money that is more volatile. However, it provides better privacy than fiat currency. When deciding which one to use, you must weight your goals and objectives. Always ensure you know the risks associated with each type of currency.