Is Cryptocurrency the New Fiat Money?

BitcoinThere is no denying the irresistible hype that surrounds the crypto-craze. Digital currency has captured the imaginations of investors, journalists and the general public alike, to the extent that some even consider it a worthy pretender to the throne currently occupied by fiat money. So, what are the chances of cryptos overthrowing fiat money to become the dominant system of currency? FXTM Senior Writer Ben Lovell-Viggers peers behind the glitz, glamour and celeb-packed ICOs to find out.

It’s been nearly 50 years since the global economy transitioned from commodity-backed currencies to fiat money system. Concerned by the United States’ waning economic influence and the spiraling costs of the Vietnam War, then-President Richard Nixon decoupled the dollar from US gold reserves and ended the Bretton Woods Agreement. Crypto-enthusiasts would have us believe that the stratospheric rise of assets like Bitcoin, Ethereum and Ripple sounds a resonant death knell for fiat money. They argue that, after half a century of tight financial regulation by governments and central banks, it’s time for individuals to reclaim total control of their money - a lofty goal that is achievable if digital currency becomes the economic status quo.

So, what advantages do cryptocurrencies such as Bitcoin offer over fiat currencies?

For starters, they are convenient. Cryptocurrencies have the potential to save businesses and financial services firms a significant amount of time and money by cutting the middleman out of transactions; fees for these transactions tend to be significantly lower too. And that’s not all: a major criticism of the fiat system is the way in which the value of a country’s currency can change outside of domestic borders. The Nigerian Naira is a prime example of this – its value drops 30% as soon as it is taken out of Nigeria. Digital currencies – for the most part - are not issued by any nation or state and are therefore not subject to the same geographical fluctuations.

Then, there’s the infallible record-keeping and anonymity provided by blockchain. A continuously-growing, cryptographically-safeguarded record of transactions, blockchain was developed alongside Bitcoin by the mysterious Satoshi Nakamoto. Blockchain is a valuable defense against fraud, as records cannot be altered once processed – it also allows for full decentralization, a feature of cryptocurrencies which is valued more than any other. Decentralization means that cryptos are not regulated by any government or financial authority, and therefore unencumbered by the policies and agendas of central banks. Instead, cryptocurrencies self-regulate through their own peer-to-peer networks.

So far, so good. Unfortunately for the legion of crypto-devotees, there are a slew of compelling reasons not to replace fiat money with digital currency. Chief amongst these is the current speculative frenzy driven by big-name coins like Bitcoin and Ripple. It’s too soon to see whether the dizzying highs achieved by Bitcoin in late 2017 constitute a genuine financial bubble, but there’s no getting away from the fact that BTC – and cryptos in general – are enjoying an unprecedented level of hype. And why not? Cryptocurrencies are innovative, technology-led and undeniably futuristic; qualities that make them irresistible to both the media and the general public. The problem with such hype is that often leads to a ‘glossing over’ of practical and fundamental concerns, including:

Money laundering and decentralization – Anti-money laundering (AML) initiatives are a major preoccupation of the financial services industry, with banks and firms spending vast amounts of money to ensure regulatory compliance. If digital currencies replace fiat, the anonymity allowed by technology like blockchain would make AML extremely difficult, costly, and time consuming. Many banks and other financial organizations would be reluctant to adopt cryptos for this reason. A similar issue arises from digital currencies’ much-lauded ‘decentralized’ nature. Governments and financial authorities are extremely unlikely to sanction any currency over which they exert no influence or control.

Security – Whilst blockchain ensures that crypto transactions are securely recorded, the same security rarely applies to the ‘coins’ themselves. Cryptos are vulnerable to hacking, power supply issues, software problems and good-old-fashioned human error. Something as innocuous as a split cup of coffee or a hard drive crash could result in the loss of millions of dollars’ worth of Bitcoin. Pity the investor who accidentally threw away a laptop containing 7,500 bitcoin and spends his days scouring landfills (true story); losing your credit card does not render the funds in your account permanently inaccessible.

Scale – The market cap for the world’s various fiat currencies is roughly $81 trillion. You could gather every cryptocurrency in the world and the combined market cap wouldn’t exceed $127.5 billion. Digital currencies have a long way to go before the fiat system starts looking over its shoulder. The cost, time and effort required to overhaul the fiat system and replace it with a purely digital one is astronomical – national economies, businesses, financial institutions and consumers would all have to be transitioned from the system they have used for nearly half a century.

Ultimately, digital currencies are probably going to have to become much more like fiat money if they want to achieve mainstream acceptance. Financial institutions and governments are getting wise to the proliferation of cryptocurrencies, with some, like Sweden and Russia, already well on their way to developing their own national altcoins. They seek to take advantage of the efficient enforcement of interest, ease of taxation and cost savings that digital currency offers, without the security issues, money laundering facilities and lack of central oversight. This means that the cryptocurrencies of the future will almost certainly exist on the terms of central banks, financial institutions and governmental bodies. Sorry idealists – the Man strikes again!

 

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