Basic explanation of fiat money and cryptocurrency and their core differences, advantages and disadvantages of both types of assets
We continue the series of basic articles within the crypto industry. The previous article was dedicated to Bitcoin and its history, and in this one will provide the comparison between fiat money and cryptocurrency.
Before Bitcoin, people only used money backed by governments and central banks. We also call it fiat money. Cryptocurrencies, such as Bitcoin, do not fall under any authority. They are decentralized and community-driven.
Dollars, euros, pounds, roubles, and all other national currencies are fiat money. Fiat money is all the cash and digital money in bank accounts. We use fiat money every day to pay for goods and services. However, Bitcoin and other cryptocurrencies offer alternative money that has a number of important differences.
Centralized vs. decentralized
Fiat currencies are centralized. Only governments and central banks can print new money and the supply of this money is virtually limitless. This causes inflation. Goods become more expensive because money slowly loses its value. In Bitcoin, the community issues new money (coins) by way of mining. The amount of coins to ever exist has a limit or a cap. Bitcoin, for example, is capped at 21 million coins. This is why inflation in cryptocurrencies is a non-issue, and the value of a bitcoin is only expected to grow.
Opaque vs. pseudonymous
To offer their services, banks and credit companies usually need to verify their clients’ identities to make sure that they are law-abiding citizens. This process is called the KYC procedure (Know Your Customer). All this information allows governments and banks to withhold money, freeze accounts, and reject or revert transactions. Cryptocurrencies, on the other hand, do not need any identity verification from users. Bitcoin is a pseudonymous network; people use addresses that do not carry any personal data.
SWIFT vs. blockchain
Today most banks are connected to a network called the Society for Worldwide Interbank Financial Telecommunications, or SWIFT for short. This system allows banks from all over the world to transfer money between one another. It was created in 1973 and some people think that it is rather outdated. Money transfers via SWIFT can take up to five business days and have relatively high fees. Open-ledger technology, used in cryptocurrencies, offers a new way for banks to communicate with one another and to make transactions faster and more efficient.
Before cryptocurrencies, digital money had one big issue — the double-spend attack. This means that a fraudster could spend some money, copy it, and spend it again, and there was practically no fully reliable way of knowing that. Bitcoin solved this problem using digital signatures, timestamps, and an open distributed ledger.
Though cryptocurrencies have many advantages over traditional digital payment systems, they are not without their flaws. Due to its core design principles, Bitcoin, as well as a number of other cryptocurrencies, has certain scalability issues.
Bitcoin is supposed to be run by a community of users. Bitcoin wants everyone to be able to fully participate in the network. This puts certain restrictions in terms of the size of its blockchain and, consequently, the transaction speed. Bitcoin, at the moment, can process at most 7 transactions per second (tps), while the speed of traditional fiat-based systems like Visa and PayPal averages at 1700 and 193 tps respectively.
Blockchains and open ledgers seem to have found answers to the problems centralized digital systems have been struggling with for a while. However, cryptocurrencies have a set of inherent drawbacks, which are now being addressed with varying degrees of success.