While both fiat money and cryptocurrencies serve as mediums of exchange, their origins and underlying mechanisms set the two apart.
Cryptocurrencies contrast in many ways with the fiat currencies issued by governments around the world. Though any currency—digital or otherwise—is intended to provide a way to store and transfer value, the ethos behind crypto and the practical considerations of their implementation have set them apart from traditional money.
Fiat currencies are typically issued by a nations’ central bank as legal tender, and their value is assured by the authority of that government. Therefore, governments can affect the value of these currencies with legislation and policy—such as issuing (“printing”) money and adjusting interest rates.
In creating Bitcoin, Satoshi Nakamoto intended to provide an alternative to the traditional financial system.
Cryptocurrencies are typically components of decentralized networks. As programmable assets, they are not subject to the whims of governing bodies. Instead, coins like BTC and ETH have inherent characteristics that are controlled with computer code, which can only be changed with democratized governance and community development. Like equities or commodities, their value is largely driven by the market’s supply and demand factors.
Therefore, the primary difference between fiat and crypto is the issuing party and its control over the asset. However, this has many downstream implications.
Advantages of cryptocurrency
Most of the world’s major currencies are fiat ones, and their primary strength is their long history of supporting the global financial system. They underlie government debt, bank stability, payment rails, personal wealth, and more. As the world’s most popular reserve currency, the US dollar cements how value is defined and transacted across borders.
However, many argue that fiat currencies suffer from inefficiencies. Governments are notoriously slow to incorporate new technologies, and traditional institutions’ reliance on intermediaries to transact with fiat takes both money and time to operate. This has translated into a system, for instance, in which cross-border (or even domestic) payments may take days to settle.
Powered by distributed ledger technology like the blockchain, cryptocurrencies use differnt technology to bypass intermediaries and efficiently facilitate transactions between parties. In allowing users more direct control over their funds, value is retained, and transactions occur more quickly (in many cases instantaneously). Crypto’s other advantages come from transparency, decentralization, and programmability. Crypto, unlike cash, can be programmable and their code can help guarantee things like a fixed maximum supply, specific rates of inflation and even deflation, or even used to power smart contracts.
Some of the advantageous features of cryptocurrencies also have their downside. For example, crypto’s natural transparency makes transactions at most pseudonymous and not anonymous. Furthermore, by subverting the traditional financial system, in most cases they can’t be used for many of the ways fiat currency can be used—like paying for taxes or taking out a mortgage.
Digital currency comparison
There are three main types of digital currencies, all with slightly different features.
Coins are native cryptocurrencies on a blockchain, like BTC and ETH on Bitcoin and Ethereum. They are how networks are secured and maintain their operations, in addition to their roles as financial tools.
Tokens are blockchain-based cryptocurrencies that are used for purposes other than securing and running decentralized networks. For example, ERC-20 tokens on Ethereum can be associated with specific decentralized applications or smart contracts.
Central bank digital currencies (CBDCs) are digital assets issued and controlled by governments. Unlike cryptocurrencies and tokens, and they can be considered simply as “digital cash.” They may be blockchain-based and programmable like crypto coins and tokens, but they are centralized.
Cryptocurrency Risks
While cryptocurrencies offer exciting possibilities, they also come with unique risks that differ from traditional currencies:
- Volatility: Crypto prices can experience extreme fluctuations in short periods, leading to substantial gains or losses. This volatility can make crypto a risky investment, especially for those seeking stability.
- Limited Recourse: Unlike bank deposits often protected by government insurance, crypto assets aren't typically insured. If an exchange fails or your wallet is hacked, recovering your funds can be difficult or impossible.
- Security Risks: Cryptocurrency wallets and exchanges can be vulnerable to hacking and theft. Protecting your private keys and choosing secure platforms is essential.
- Regulatory Uncertainty: The regulatory landscape for crypto is still evolving, creating uncertainty and potential risks for investors and businesses. Changes in regulations could impact the value and usability of your crypto assets.
- Scams and Fraud: The crypto space is rife with scams, from fraudulent projects to phishing attacks. It's crucial to do your own research and be cautious about where you invest your money.
It's important to weigh these risks carefully before investing in cryptocurrency. While the potential rewards can be significant, so too are the potential downsides. Always conduct thorough research, invest wisely, and never invest more than you can afford to lose.
Summary
Whereas fiat currencies are issued by the central banks associated with governments, cryptocurrencies are typically issued on decentralized networks based on blockchain (or related) technologies.
Some advantages of cryptocurrencies over fiat include increased cost and time efficiency, transparency, decentralization, and programmability.
One of the simplest ways to divide digital currencies is into three categories: coins, tokens, and CBDCs.