In both traditional and crypto economies, currencies play a crucial role. While fiat money has long been the backbone of traditional financial systems, the emergence of cryptocurrencies has introduced new possibilities. But how do these two forms of currency relate to each other?
What is Fiat Money?
Fiat money, or legal tender, is currency issued and recognized by a government. It has no intrinsic value and derives its worth from the authority and stability of the issuing government. The value of fiat money is determined by supply and demand, and it is used for daily transactions within the country.
Fiat money has replaced commodity-based monetary systems and offers advantages such as ease of use and government control over the economy. However, its value relies on trust in the issuing government and the stability of its systems.
Types of Fiat Money in Different Countries
Different countries have their own specific fiat currencies, which are issued and regulated by their respective governments. Here are a few examples:
- Vietnamese Fiat Currency: The Vietnamese Dong (VND) is the official fiat currency of Vietnam. Both paper and polymer banknotes are used as unrestricted means of payment throughout the country.
- US Fiat Currency: The U.S. Dollar (USD) is the official fiat currency of the United States. The USD is issued in both coin and paper money forms.
- British Fiat Currency: The British Pound (GBP) is the official fiat currency of the United Kingdom, including England, Scotland, Wales, and Northern Ireland, as well as certain overseas territories. The currency is issued in both coin and banknote forms.
- Other well-known fiat currencies include the Euro (used across multiple European countries), Yuan (China), Franc (Switzerland), Yen (Japan),…
It’s important to note that each country has its own specific regulations and classifications for its fiat currency.
Where can Fiat Money be Used?
Fiat money can be used in various locations and for a wide range of transactions. The global acceptance of fiat currency allows individuals to utilize it for buying and selling nearly any type of goods or services.
Every country has its own specific fiat currency system in place. Individuals can also convert between different fiat currencies when traveling, vacationing, or sending money internationally.
It’s important to note that the widespread use and acceptance of fiat money make it a versatile form of currency for conducting transactions on a global scale.
The History of Fiat Money
Fiat money has a rich historical background that traces its origins back to ancient times. Its earliest documented use can be found in China during the 11th century. Facing a shortage of coins, the government introduced paper notes as a substitute for conducting transactions. This marked the birth of fiat money in its primitive form.
Over time, the concept of fiat money spread to other regions. In the 17th century, countries like Spain, Sweden, and the Netherlands embraced fiat money systems. As colonization expanded, fiat currencies were also implemented in New France (Canada) and the American colonies during the 18th and 19th centuries.
A pivotal moment in the evolution of fiat money came in 1972 when the United States, under the leadership of President Nixon, abandoned the gold standard. This decision severed the direct link between paper money and gold reserves, ushering in a new era of fiat money dominance in the global economic landscape.
The journey of fiat money from its early origins in China to its widespread adoption across nations reflects the dynamic nature of currency and the evolving needs of economic systems.
The Operation of Fiat Money
Fiat money operates based on the trust and confidence between the issuing authorities, owners, and users rather than being dependent on any underlying commodities. If faith in the currency’s value is lost, its demand diminishes, leading to a decline in its worth.
Currency serves as a measure of value for goods and represents a nation’s Gross Domestic Product (GDP). It signifies the productive capacity of a country. As a nation’s productive capacity increases, its fiat currency’s exchange value also rises, and vice versa.
Governments hold the exclusive power to print fiat money. Consequently, they have the authority to control the monetary system and implement monetary policies (such as easing or tightening) or utilize relevant tools during significant financial events and crises to ensure financial stability within the nation.
Monetary policy refers to managing the money supply by the Central Bank to achieve desired interest rates for economic stability and growth. Monetary policy can be categorized into two types: expansionary and contractionary.
Expansionary monetary policy: This involves the Central Bank buying government bonds or other securities in the market, reducing interest rates, and lowering the reserve requirement ratio. The result is an increase in the money supply, promoting economic development.
Contractionary monetary policy: Unlike the expansionary policy, a contractionary monetary policy involves the Central Bank selling government bonds or other securities, raising interest rates, and increasing the reserve requirement ratio. This reduces the money supply, curbing inflation and addressing economic bubbles.
When a country makes erroneous decisions regarding monetary policies, its fiat currency is at risk of losing value due to inflation or even becoming worthless in cases of hyperinflation. If people lose trust in a nation’s currency, it loses its store of value.
Notable examples of such situations include the events in Zimbabwe (2000-2009), Bolivia (1984-1985), and Hungary (1945-1946).
Characteristics of Fiat Money
Advantages:
- Acceptance and Legal Tender: Fiat money is widely accepted and recognized as legal tender for economic transactions.
- Stability and Standardization: Fiat currencies provide stability and a standardized unit of account for easy price comparison and economic calculation.
- Government Backing: Fiat money carries the backing and guarantee of the government, instilling trust in its value.
Disadvantages:
- Inflationary Risks: Fiat money is susceptible to inflation when governments engage in excessive money printing or implement ineffective monetary policies.
- Dependency on Central Authorities: The value and stability of fiat money depend on government and central bank decisions, making it vulnerable to political and economic influences.
- Limited Accessibility: Fiat money is typically only accessible within the issuing country and may not be universally accepted in international transactions.
Before delving into the comparison between Fiat and Cryptocurrency, let’s first explore the question: What is Cryptocurrency?
Cryptocurrency is a virtual transaction system that operates independently of banks. It allows peer-to-peer payments globally and is stored as algorithmic records on a virtual database. Transactions are recorded on a shared register, and digital wallets are used to store the currency. Cryptocurrency utilizes encryption for secure transactions and was first introduced with Bitcoin in 2009. Since then, numerous other cryptocurrencies like Ethereum, Litecoin, and Bitcoin Cash have emerged. Cryptocurrencies can be exchanged on decentralized platforms and used for various purposes, including purchasing goods and services.
Fiat Money and Cryptocurrency
To easily understand, let’s explore and compare the similarities and differences between fiat money and Bitcoin – the first digital currency recognized as legal tender by a country (El Salvador, Venezuela).
Similarities: Both are not backed by any specific commodity. Additionally, they are both created with the aim of developing a global financial economy.
Differences:
- Centralization: Governments centrally manage Fiat money, and its total supply can be unlimited. Cryptocurrency operates in a decentralized manner, with most having a limited supply (such as BTC) and all transaction information recorded and managed on a decentralized ledger called the blockchain.
- Digital Nature and Borderless Transactions: Cryptocurrency is a form of digital currency lacking physical characteristics and boundaries, allowing for seamless global transactions. Tracking cryptocurrency transactions is also more challenging as they are often conducted anonymously.
The Relationship Between Cryptocurrency and Fiat Money
The relationship between cryptocurrency and fiat money is complex and evolving. Fiat money is issued and controlled by governments and central banks, and its value relies on the trust and stability of the issuing authority. It has a long history and is widely accepted globally, making it challenging to be completely replaced.
In reality, cryptocurrencies currently coexist with fiat money, complementing each other in circulation. Users often buy cryptocurrencies for speculation or investment purposes and then convert them back to fiat money for purchasing goods and services.
Many people currently view cryptocurrencies as an investment asset rather than a new form of currency. Therefore, it is difficult for fiat money to be completely replaced at this stage. However, the future outlook could be different. History has shown the vulnerability of fiat money, while cryptocurrencies have emerged only in the past decade and still have a long way to go.
The future is uncertain, and it is highly possible that Bitcoin or other cryptocurrencies will not entirely replace the fiat money system. However, they may open up a new and promising financial system. Some countries have recognized the advantages and disadvantages of both types of currencies and are exploring the concept of “central bank digital currencies” (CBDCs), which combine elements of cryptocurrencies and fiat money.
Overall, the relationship between cryptocurrency and fiat money is a dynamic and ongoing process, with both coexisting and potentially influencing the future of the financial landscape.
How to Use Fiat Money to Buy Cryptocurrency
To use fiat money to buy cryptocurrencies, users can buy and sell transactions through peer-to-peer (P2P) platforms or top global exchanges to ensure safety (such as Binance, Remitano, etc.). Other methods are also available, such as using Visa cards or engaging in over-the-counter (OTC) transactions.
Note: In some countries, investing in and trading digital assets (coins, tokens) may not be recognized or protected by the law. Users should carefully consider the regulations of their respective countries to avoid any legal complications.
What is Central Bank Digital Currency (CBDC)?
Central Bank Digital Currency (CBDC) is a form of fiat money that exists in digital form. It is issued, controlled, and backed by the central bank of a sovereign nation or territory.
The purpose of CBDC is to digitize cash, provide a feasible method for controlling the digital economy, enhance the effectiveness of monetary policy, and promote economic growth. CBDC is typically designed to have a 1:1 exchange value with traditional fiat currency.
The technology used to create CBDC can vary depending on the issuing country. Some countries may implement CBDC based on blockchain technology, distributed ledger technology (DLT), or other decentralized systems. Currently, CBDC is in the testing phase in several countries and has not been officially rolled out for public use.
CBDC and Stablecoin
CBDC and stablecoins, particularly fiat-backed stablecoins like USDC and USDT, share some similarities. Both are forms of digital currency that are pegged to a 1:1 ratio with traditional fiat currency.
The main difference is that stablecoins like USDC or USDT are issued and managed by organizations (Tether Limited, Circle), while the government issues CBDC as a form of fiat currency and has legal backing from the government. Additionally, stablecoins like USDC or USDT are already operational and widely used in decentralized finance (DeFi) applications.
CBDC and Cryptocurrencies (BTC, ETH…)
CBDC draws inspiration from cryptocurrencies, so there are some similarities and differences to consider:
- Assurance: CBDC is issued and guaranteed by the government, ensuring ownership, value, and circulation through specific legal provisions. This is a characteristic that cryptocurrencies currently lack.
- Security: CBDC, like cryptocurrencies, utilizes decentralized data storage on blockchain platforms, employs encryption mechanisms, and records transactions continuously, making them tamper-proof.
- Anonymity: CBDC inherits the anonymity of both parties involved in a transaction. However, through the central bank, the government has the authority to access and identify the transaction details, reducing decentralization but enabling the regulation of illegal activities such as money laundering or counterfeit money usage.
- Payments: Both CBDC and cryptocurrencies enable fast, borderless transactions, overcoming the limitations of traditional cross-border transfers that involve lengthy processes and procedures.
Some CBDC Developments Worldwide
- e-Euro
The e-Euro will be issued by the European Central Bank (ECB) and national central banks within the Eurozone. It will coexist alongside physical cash rather than replacing it.
According to the ECB, the e-Euro testing phase began in July 2021 and is expected to continue until the end of 2023. Afterward, member countries will convene to discuss and consider the circulation of this currency in 2025.
The e-Euro issuance plan is a significant step for the European Union. The EU has ambitious plans to globalize the e-Euro, expecting it to support the digitization of the European economy and encourage innovation in retail payments.
- e-CNY (Digital Yuan)
In China, the People’s Bank of China (PBOC) announced the preparation for issuing its own digital currency, e-CNY, in August 2019. China aims to become the first country to issue its own digital currency.
China has conducted e-CNY trials in various regions to test the stability and reliability of the infrastructure and system. China will continue conducting e-CNY trials, including collaborations with countries like Thailand and the United Arab Emirates.
By issuing its own CBDC, PBOC aims to promote the global use of the digital yuan. Additionally, CBDC issuance aims to enhance the effectiveness of monetary policy in China’s comprehensive digital economy.
- CBDC in Japan
The Bank of Japan (BOJ) began CBDC trials in the fourth quarter of 2021. In the first three-month phase, BOJ plans to establish an internet-based system to test basic CBDC functions, including issuing and withdrawing funds from financial institutions and transferring funds between them.
In the second phase, BOJ will study ways to prevent threats to the financial system’s stability when transferring funds from bank savings accounts to CBDC.
The final phase involves participation from private businesses and consumers to test the feasibility and safety of digital currency as a means of payment alongside physical cash.
-> Research and development of CBDC are crucial, and major countries worldwide are dedicating significant time and effort to its development. While the research and development process is costly and time-consuming, it has the potential to bring numerous advantages to a country’s currency.
Conclusion
Fiat money and cryptocurrencies represent different approaches to money, with fiat money being government-issued and cryptocurrencies operating on decentralized networks. Both have advantages and limitations, and their relationship is evolving in the financial ecosystem. The future may involve a hybrid system combining the strengths of both.
