Another repost from my blog. Original viewable here:
http://bitcoinbuildify.com/index.php/2018/03/16/fiat-currency-vs-crypto-currency-whats-the-big-difference/
Along with my YouTube commentary here:
The community here on Steemit is just too focused and unique not to share this with. I put too much thought and work into it not to. Please do let me know your thoughts and opinions on what you read.
by Trevor M. | Mar 16, 2018 | Crypto Blog |
The subject of this post is the differences between fiat currency and cryptocurrency. I must admit that I am personally partial to the latter. But, even in saying so, I do realize that fiat currency has its place. I do not believe it is inherently bad but only that it could stand to be improved upon. And this notion, the one that our money system can be improved upon is exactly why I believe cryptocurrencies are such an amazing technology. Here in early 2018 we are still in the early days of these technologies being adopted or even known about. The coming years are likely to be an interesting time for the crypto world.
A lot hangs on how the governments of the world will react to and attempt to regulated crypto currencies. In just a few days at the G20 summit on March 19th and 20th 2018 crypto currencies will be on the agenda (scroll to the bottom of page 3 after clicking the link). Thankfully, despite enormous FUD (Fear Uncertainty and Doubt) in the cryptomarkets and all kinds of reactions and predictions ranging from the sensible to the mostly unhinged, the outlook is surprisingly good. To quote from the document linked above:
“FACT: The technology behind crypto assets has the potential to promote financial inclusion. At the same time, however, it is important to analyse its implications to financial stability, tax evasion, and financing illegal activities. The issue is an important item on the meeting agenda; delegates will consider a common response that would mitigated the risks without discouraging innovation.”
While some may consider this something akin to “the man moving in on their game” or the government otherwise attempting to clamp down on the currently unregulated crypto markets, I would instead see it as a sign that cryptocurrencies are finally being taken seriously be the most powerful countries in the world.
This could of course produce mixed results. Given the highly egaltarian, fringe nature of the beginning of cryptocurrency, it is only natural that those who have been involved with them for any amount of time may feel some serious FUD when hearing the news that governments of the world are moving in. However, based on the wording quoted above, it seems although we may see some changes regarding access to and movement of cryptocurrencies there is reason to remain somewhat optomisitc about their future.
FIAT VS. CRYPTO
Anyway, to the main focus: what is the difference between fiat currency (the financial system used in the US and most other countries in the world) and cryptocurrency (a rising technology that shows promise of completely revolutionizing how money works)?
First, let us set our definitions:
Fiat currency: currency that a government has declared to be legal tender, but it is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. It is essentially a representation of the currency and not the currency itself; an IOU if you will.
Fiat currency is essentially summoned into existence purely by the power of authority. There is no inherent base to the currency as there is nothing to back it in the way of gold or some other commodity. It is essentially monopoly money and must be, at some level, controlled and regulated by completely artificial means. That is it can be printed at will, loaned by banks who don’t even have what they are loaning and generally devalued and inflated into total uselessness.
Cryptocurrency: a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank. Decentralized cryptocurrencies such as bitcoin now provide an outlet for personal wealth that is beyond restriction and confiscation”.
Cryptocurrencies do not have an actual physical existence in the form of bills or coins. They exist entirely in digital form but, somewhat surprisingly, many of them prove to be more durable than fiat currencies. This is because they are impossible to counterfeit and therefore make it very difficult for such things as inflation and other effects of fractional reserve banking and financial cowboy antics to manifest.
Fractional reserve banking is a system in which a bank or other financial institution with the proper licensing can lend money with only a fraction of what they lend actually in their possession. It’s the equivalent of person A lending person B $100 USD when they only have $1 USD in their account.
In recent months the term “cryptocurrency” has been thrown around quite a bit in the media. And there seem to be a few schools of thought toward it:
those who see it as something to invest in and make money: this is probably the loudest if not biggest camp as there currently is a lot of opportunity to make money in trading and mining.
those who see it as a new kind of technology with unprecedented implications: this is a smaller group and one that has quietly been innovating and designing since the early days when Bitcoin was created way back in the old days in 2009. As this group is somewhat limited, knowing who its members are and what projects they are currently involved in can serve as an excellent reference for determing the validity and likelihood of longevity for some of the newer crypto projects.
those who see it as both: this group understands or at least deeply appreciates the technological implications of cryptocurrencies and is also interested in the financial opportunity in trading, investing and mining as well. To be fair, though. It is unusual to not have at least a little bit of crossover among the members of group 1 and 2. A person who strictly belongs only to group 1, given the current volatility of the crypto markets, is probably someone to keep at an arm’s distance as they are more of a gambler than a trader.
those who see it as a fad at best and a scam at worst: this group is generally composed of either A) people who are scared sh$#less of cryptocurrencies and what they could do to central banking and B) people who have no idea what they’re talking about, no experience to speak from and will unquestioningly believe the people in group A under one condition: they say it on TV.
those who have no idea about any of it or simply don’t care: there is inevitably a group of this nature no matter what the trend in question may be. The only reason I mention it is that, in this case, they may really be missing out on something. This group belongs to that part of the vast herd of humanity that will begin to follow something only after it has seen mass adoption and there is effectively very little choice in not joining in or, at least, some degree of inconvenience either to themselves or others. Think people who “don’t do” cell phones in the 21st century.
Whatever school of thought you fall under it can’t be denied that cryptocurrencies are getting a lot of attention. But why? What is going on?
WHY ARE CRYPTOCURRENCIES SEEING SUCH A RISE IN POPULARITY AND MEDIA ATTENTION?
There are probably a few reasons. First and foremost, cryptocurrencies are a new technology and proving to be a very funcitonal one, too. To say nothing of how much money people are making with them. Second is that cryptocurrencies are rather controversial. This combination of novel utility and mixed-reputation is a perfect recipe for attention.
To be fair, though, there is a huge variety of different types of cryptocurrencies out there. So it can be difficult to speak in general terms about them and still be fair or accurate about all the platforms out there. At one extreme we have what are absolutely amazing works of technological innovation. Platforms like Bitcoin, Ethereum, and Cardano have a real mission behind them and each fulfill a need based on the projects that preceded them. At the other extreme we have what may best be described as sleazy knock-offs that you should avoid as you would a live hand grenade. No names will be mentioned but suffice to say that when someone in the know tells you that 90% of what’s out there is a scam, they’re not joking. The figure of 90% may be a little harsh but let it be known that there is a growing number of people out there looking to cash in on the trend as quickly and easily as possible. So please be careful.
Also try to keep in mind that Bitcoin, the original cryptocurrency, was originally concieved as a way to help people. This is also true of many other cryptocurrencies but certainly not all. Probably the most valuable advice you can keep with you in determining the utility of any given cryptocurrency is by asking yourself the question: “What does it provide and how is that better than more traditional platforms?” Ideally, any new technology should offer a level of improvement over any old technology, no? And new technology is essentially what cryptocurrency is. The old technology is fiat currency. Some people swear by it. Others hate it. But, to date, it has proven very, very difficult to get through life without it.
So what’s the big deal? What is it about cryptocurrencies that make them supposedly “better” than Fiat currencies?
WHAT IS A FIAT CURRENCY?
Well, first Fiat currencies are an outdated and highly unstable technology. One of the only things that keeps them going is tradition. Well, maybe a better way to say that would be the tradition of authority. That is, the government keeps them going. But, if you were to look into the fundamental nature of Fiat currencies, you would find there is nothing backing them. They are literally created out of thin air. This is why they are called “Fiat” currencies (Fiat is latin for “formal authorization”, “decree” and, more accurately “an arbitrary order”). Yes, arbitrary. That is: without true base or reason but simply because somebody somewhere felt like it. THAT in a nutshell is essentially what our economy currently runs on.
This is not to say that the system doesn’t work. Clearly the economy has had its ups and downs but to say it has been a failure altogether wouldn’t be quite accurate. Although there are those who would disagree. Be that as it may, let’s focus a little more on how Fiat currency works.
It’s core driving element is the value assigned to it by a governing body. That is a small minority of a population is endowed with the right to say what is and isn’t money. In saying what is money, whatever it may be, they effectively give it value and no one outside their group is allowed to argue with them (that has proven to historically unwise and a lot of the people who tried it did not, ahem, survive the argument). That is, the only thing that gives a Fiat currency value is an element of authority which, to verying degrees, enforces it — nothing else. This authority is further enhanced and supported by the history of use cases and the established consensual agreement among the community using it that it really is money. Anyone from outside the group or anyone not familiar with such a system could very easily mistake this kind of “money” for nothing more than digital ones and zeros. For nothing more than the monopoly money it very convincingly appears to be.
Again, there is nothing fundamentally wrong with this. If Fiat currency were unworkable, our economy would have collapsed and stayed that way indefinitely. Just like the first attempts at powered flight, our Fiat based economy would never have gotten off the ground. But here’s the thing: while virtually every technology in our lives has seen consistent and sometime exponential levels of development and improvement, our money system with the exception of coming off the gold standard in 1973 hasn’t seen any fundamental changes in over 500 years. Accounts are still kept in the same way and even if it is a computer doing it on a scale and at speed that we couldn’t have imagined even 10 years ago the fundamental process is the same.
Coming off the gold standard introduces a whole other world of issues both debatable and non. But, suffice to say, our system of money is no where near what it could be and is frankly not only frustrating to work with but a little embarrassing, too.
SO, WHAT’S WRONG WITH FIAT MONEY?
instability:
yes, this point applies to other forms of currency as well. No currency is utterly unshakeable if it is actually being used. Some are just more durable than others. Fiat money is particularly unstable because the nature of the lending and printing system breeds corruption and ponzi-schemes of all kinds.
high susceptibility to corruption:
if human beings, whether individually or in groups, have access to such things as the printing presses or lending apparatus it is statistically only a matter of time before they do something naughty. And the more they do something naughty and get away with it, the more they are going to do it. The tendency here is to push it as far as they can. And that has consistently been the case historically speaking in light of economic crash after economic crash.
high susceptibility to inflation:
again, printing presses and lending apparatus. These two elements have historically been employed to either smooth over or hide entirely real world economic problems and troublesome fluctuations in the market forces. That is, the government can make things look like they’re fine when they’re not. All well and good until an economy ends up with more money than you can shake a stick at and no demand for it. This is where the phrase “passing the buck comes in”, the fiat system essentially makes it possible to ignore a problem until the problem causes a massive system wide collapse.
centralization:
this is a key word in a fiat currency system. The problem with a central point of control is that it is also a central point of failure. That is, in a centralized system, all of the eggs are in one basket. On the one hand this makes management more concentrated. On the other it makes it much more vulnerable to such things as attack, manipulation, corruption and/or all of the above.
counterparty risk:
this involves that ever present yet unqualifiable element involved with transactions within the traditional double entry accounting system: trust. You see, even the most complex transactional systems involve an element of trust. This trust is included in both the counterparty (partner in the transaction) A) agreeing to fulfill their part of the transaction and B) verifying that it has occured. Given a high enough level of access or something like a complete collapse of one party’s institution computer records, contracts and account balances become worthless. This is because there is no substantial existence to the currency in a fiat system. It is simply agreed to exist as it is imposed by those with authority. This means there will always be an element of risk of fraud and theft in any transaction involving fiat currency. Always.
coercion:
as fiat currency is devised and put into use by those in authority, it involves a level of coercion in order to ensure its continued acceptance. Generally this is not something we give much thought to. This is partly because A) we have almost no alternative and B) the thought has been so excised from popular consideration that it is unlikely to occur to the average person as a thing remotely worth pursuing. However, there was a time in the early 20th century where types of currency other than the US Dollar were widely used in the United States. It was only in 1933 when the dollar was removed from the gold standard except in the international markets that the real face of coercion reared its head as the penalty for not accepting the new Federal Reserve Notes in place of Gold Certificates was: a $10,000 USD fine, 10 years in prison or both.
distribution of wealth or lack thereof:
again, given the nature of fiat currencies i. e. they are basically created and controlled by a priviliged minority, it is only a matter of time before the majority of the currency accumulates with those who create it. That is, with fiat currency the money will flow to the financial institutions and, through taxation, to the government. The problem is that legislation can be written on multiple levels of government and for certain favored industries that tend to accelerate this process.
For a longer and more comprehensive list of the problems with fiat money systems, click here. We think you will find it an interesting read and, hopefully, a thought provoking analysis of what stands to be improved upon in our financial system here in the early years of the 21st century.
We would also recommend that you consider these words by John Meyer of theperfectcurrency.org:
“Fiat currency monetary systems are open to abuse by government and private interests alike. Currency inflation is both the invisible tax of government and the large scale fraud of private financial institutions. It is far easier to print more money than to serve up doses of fiscal reality to the masses. As long as fiat money is controlled by special interests, abuse and crisis will be constant.”
You can visit the site and read the article in full here:
http://www.theperfectcurrency.org/main-history-of-money/monetary-system-flaws
It is beautifully written and highly insightful.
HOW DOES CRYPTOCURRENCY COMPARE?
So, now, what’s the big difference? How do cryptocurrencies compare to fiat currencies? First, let’s take the problems listed above and show how cryptocurrency overcomes them. To be honest, the reasons may seem somewhat repetitive because the nature of blockchain is actually quite simple. Through its tenets of decentralization and fixed supply, it tends to solve a lot of problems without really having to do much.
But let it be known that in saying “cryptocurrency” we mean those that are decentralized, mineable and employ a similar blockchain technology to Bitcoin. There are simply too many varieties of cryptocurrency and too much fluctuations in the quality and sustainability of the “ICOs” offering them to speak about them in a general way without being entirely inaccurate too much of the time.
So for the sake of brevity we will use Bitcoin as our main example. No, it is not the most efficient cryptocurrency out there nor is it likely the one that will see mass adoption. But, it is the original cryptocurrency and the one that has successfully introduced a template that can be developed to a degree where it very easily could see mainstream adoption and thrive.
instability:
Bitcoin is not susceptible to the same kinds of schemes and manipulation as fiat money is. It cannot be printed or even duplicated. And, so far, there is no way to employ anything approaching fractional reserve banking without introducing a second technology on top of it which would, well, totally defeat the point. The total amount of Bitcoin is set and any new Bitcoin is only accessible through a highly complex process known as “mining“. And no single institution can have a monopoly on it.
Further, no single institution can have a monopoly on the circulation or holding of Bitcoin. The distributed nature of the technology and high security of wallets would make it prohibitively expensive to even attempt. Also, approximately 80% of all Bitcoin is already either in circulation or held in private wallets. There is no way to coerce this away from its owners; at least not to any effective degree.
high susceptibility to corruption:
again, because Bitcoin exists on a distributed network that simply will not allow counterfeit currency or false transactions, the likelihood of a small minority of privilged individuals somehow manipulating the entire Bitcoin network is exceedingly small. This is especially true when we consider that those involved with the Bitcoin blockchain are distributed all over the planet in a mostly anonymous way.
high susceptibility to inflation:
the total supply of Bitcoin is fixed. And it is impossible to ever counterfeit any more as they simply will not be verified by the block chain. If anything, Bitcoin is a deflaitonary currency. This means that it is far more likely to go up in value than to go down.
Now, some may say “Wait! The volatility!”. The truth about this is that Bitcoin still has a tiny market cap and simply responds more violently to changes in market trends than more established currencies with far, far larger market caps.
centralization:
This is potentially one of the greatest problems with fiat currency. Centralization concentrates too much power in one place. Decentralization, on the other hand, does the opposite. This means that, with the decentralized nature of Bitcoin, control is distributed over the entirety of the blockchain. There is no way for one actor to try anything shady and succeed because the distributed ledger will automatically “know” the transaction is false.
counterparty risk:
Bitcoin is what is known as a “trustless network” because there is no need to trust anyone when making a transaction. The element of counterparty risk is effectively done away with because the nature of the blockchain itself ensures integrity of the transaction and full verification. They are one and the same. If a transaction is not authentic, it cannot be successfully verified.
This does away with a lot of the extra legalities and costs involved in ensuring both parties involved in a transaction are acting honestly. In terms of maintaining a functional balance between access and security, the blockchain offers far more advantages than the current system. It could also save enormously when you consider that a lot of the fees involved in keeping a bank or other financial institution afloat (because they are always getting hacked, robbed, suffering huge losses and otherwise being attacked without you knowing about it).
coercion:
again, because no one entitity, be it a bank or a government, can exercise full control over the blockchain it would be exceedingly difficult to use any element of coercion to control what people do and don’t do with their Bitcoin. It cannot be frozen (stolen) in your account or taxed away without full, voluntary consent.
distribution of wealth or lack thereof:
this is another element of fiat money which has historically proven to be a huge issue. Fiat money can be printed/generated in a computer at will. This does provide a platform for rapid economic expansion but also acts as a kind of tax on wage workers and those who attempt to save their money because it loses value no matter how much they save or work for. At the same time, those who stand at the spigot of the fiat currency (a tiny minority) stand to profit and gain at multiple levels of magnitutde above those below them (a huge majority).
As cryptocurrencies like Bitcoin cannot be artificially increased, it means that your personal holdings will more or less retain their relative proportion to the entire amount available in circulation; they will hold their value and may even see it increase. Yes, more Bitcoin will continue to be mined, but their introduction into the market will be gradual and based on the real work involved in mining. This means that they will have far less of an inflationary effect on the market; especially if both use and demand continue to rise accordingly.
That, in a nutshell, is how cryptocurrencies counter the faults of fiat currencies. On top of that, cryptos also offer several advantages that fiat money systems can’t even begin to approach. You can read more about this in our post: “Why the “Wolf of Wall Street” is wrong about Bitcoin” near the end of the section “why are we hearing more and more about Bitcoin?”. In brief the advantages are: convenience, security, anonymity, opportunity and indepedence.
FINAL THOUGHTS
Although the differences between fiat and crypto should be quite clear it still remains extremely uncertain how things will go. There are a lot of special interests at play on the side of fiat currency including all the central banks of the world and a good number of the governments at well.
On the side of cryptocurrency, although there are clear systemic and technological advantages, there is a huge X factor. That is no one can truly say how things would go if mass adoption were to occur. the idea of a mass change over would probably take quite a bit of time, political finagling and accustomization by the populations of the world. It would not happen over night and the form it may happen in would likely be very different from how we currently imagine it.
But one thing is for sure, this standoff between cryptocurrency and fiat currency cannot continue forever. Things will change as they inevitably have to. Let’s hope the change is a peaceful and benefitial one.
Thank you for reading.
If your further interested in the concept of value, I recommend this video. It’s a bit on the long side but well worth it. If you can’t sit down to watch it, at least give it a lesson.
Mr. Tucker is an exceptionally well-spoken and honest speaker as well as a deeply insightful thinker. We hope you will enjoy him as much as we do.
