25
May
20

Bitcoin versus Fiat Currency - Crypto Education

The Covid-19 pandemic has accelerated the use of digital payments and several central banks around the world are exploring central bank digital currencies (CBDCs). This shows that standard paper currency may soon become passe, and there is a genuine possibility that cryptocurrencies like Bitcoin may potentially dominate future transactions. If that’s indeed the case, then we should all know the fundamental differences between Bitcoin and fiat currency.

 

What is fiat money?

 

Fiat money is a government-issued currency that is not backed by a physical commodity, such as gold or silver. The value of fiat currency is derived directly from the people’s trust in the government. Most of the modern, global currencies, like the USD and EUR, are fiat currencies.

 

The problems with fiat currency

 

The problem with fiat currency is that since it is backed by something as abstract as “trust,” there is a real danger of it being utterly worthless due to hyperinflation. Let’s take the example of the Zimbabwean dollar. During five years between 1991-1996, the country went through a period of extreme hyperinflation. In November 2008, the hyperinflation rate went up to a staggering 79,600,000,000% per month. The government ran out of the paper needed to print money. In fact, they were forced to print a trillion-dollar note.

 

 
Because of this severe hyperinflation:
 

  • Zimbabwe’s banking sector collapsed.
  • Farmers were unable to collect loans, which inevitably lead to a sharp drop in food production.
  • Unemployment rose to 80%.
  • Zimbabwe was forced to give up its currency and adopt the USD.
  •  

    The current state of the Fed Reserve balance sheet

     

    Another interesting thing to note about fiat currencies is how central banks can seemingly print them out of thin air. During the current coronavirus pandemic, the Federal Reserve has apparently injected trillions of dollars directly into the American (and Global) ecosystem. According to USA Today, the Fed balance sheet has ballooned by $2.2 trillion to a record $6.7 trillion since mid-March as they desperately try to keep the economy as liquid as possible.

     
    The graph shows the influx of money supply in USD over the past 20 years. Big spikes were during the 2008 financial crisis as well as during the corona pandemic in 2020.
     

    However, therein lies one of the biggest problems with fiat currency – the dependence on a central authority. Central banks and governments have undue control over the financial policies governing their citizens. This is why, during a crisis, they can increase the circulating supply to bail out banks and enterprises. However, all actions have consequences. The price of this uncontrolled inflation has to be paid by the citizen in the form of increased tax rates and unemployment.

     

    Bitcoin and decentralization

     

    Satoshi Nakamoto created Bitcoin in the wake of the 2008 financial disaster. The idea was to create a digital currency that could be independent of the government’s control. With the use of public-key cryptography, ever user gains complete control over their money. In essence, you become your own bank. So, instead of having a centralized entity, Bitcoin is governed by a network of users from all around the world.

     

    Bitcoin vs Fiat Money

     

    Let’s look at the differences between Bitcoin and fiat money.
     
    #1 Legal Status
     

    Fiat money is deemed legal tender since it is issued by the government itself, who has full control over the monetary supply and the policies governing it.

     

    Bitcoin doesn’t have a central governing body. Plus, it should also be noted that some countries have banned the use of cryptocurrencies.

     
    #2 Physical presence
     

    Fiat currencies have a physical aspect in the form of paper currency. Cryptocurrencies like Bitcoin are a purely digital asset. However, as we have discussed before, paper currency transactions may soon die out.

     
    #3 Transfer of Value
     

    Users can transfer fiat money either through a digital means or via physical means. Cryptocurrencies can be transferred only through your digital wallets. If someone wants to send you Bitcoin, they will need to send it to your public address, which you can unlock with your private key.

     
    #4 Utility
     

    Fiat currencies are limited to only being used as a means of transfer of value. Cryptocurrencies, on the other hand, can have multiple utilities based on their underlying protocol. For example, EOS allows its holders to stake in the ecosystem, participate in on-chain governance, and be a means of value transfer.

     
    #5 Supply
     

    Fiat currency can have an unlimited supply, which is a huge point of contention. On the other hand, Bitcoin has a hard upper cap limit of 21 million. Plus, it also happens to be a strictly deflationary asset. After every 210,000 blocks, the amount of new bitcoins entering the ecosystem gets halved. With Bitcoin, you can always tell the total number of coins in circulation, which is nearly impossible to do with fiat currencies.

     
    #6 Storage
     

    Fiat currency is pretty versatile when it comes to the storage aspect. You can store it in your savings account. You can keep physical cash inside a safe in your house. You can even use payment providers like PayPal to store fiat in it in the form of digital currencies. Bitcoin needs to be stored in a digital wallet.

     

    Conclusion

     

    So there you have it. We hope that we were able to give you some clarity about the differences between Bitcoin and fiat currency. At the end of the day, it comes down to the decentralized/centralized and deflationary/inflationary argument.

     
    Is Bitcoin (or any cryptocurrency) going to replace fiat in the future? That is speculation. Yet it is possible, when citizens demand sound money (Bitcoin or Gold) instead of inflatable currency (fiat).
     
    However, are cryptocurrencies here to stay? Definitely as a store of value, digital asset, and maybe as a means of payment.
     
    Learn more about Bitcoin in our ultimate guide.

    disclaimer

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    Rajarshi Mitra
    Blockchain Researcher