Modules for Personal Finance
Introduction to cryptocurrencies
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The relatonship between crypto and fiat currency
Cryptocurrency is a completely virtual currency with absolutely no physical form whatsoever. It is a decentralized form of currency, where there is no central entity governing its creation or supply. Cryptocurrency was first designed to be used as a medium of exchange between individuals.
However, of late, there have been several different types of cryptocurrencies that have evolved beyond being just a medium of exchange. One of the major selling points of this digital currency was the fact that transfers between two individuals was simply a peer-to-peer transfer and didn’t involve any third party such as banks or credit card companies.
What is fiat currency?
To put it simply, fiat currency or fiat money is simply the paper money that we use in our everyday lives. Fiat currency is issued and backed by a government, instead of a commodity or an asset like gold or silver. All major currencies in the world, including the Indian Rupee, U.S. Dollar, and the Euro are fiat currencies.
These currencies derive their value from factors such as the stability of the government that issues it and the forces of supply and demand. Since fiat money doesn’t require the backing of gold or silver, governments can simply choose to print more money to have greater control over the economy. However, printing more money can lead to hyperinflation, causing the economy to spiral out of control.
The relationship between crypto and fiat currency
Both cryptocurrency and fiat currency are based on fundamentally different principles altogether. For instance, cryptocurrency is based on blockchain technology, whereas fiat currency is issued by governments. And so, there’s no direct relationship between the both of them.
However, that’s not to say that crypto and fiat money share no similarities or differences. In fact, they do share a lot of them. To understand how the thin line between crypto and fiat works, let’s check out the similarities and the differences between them.
The similarities between crypto and fiat currency
Contrary to popular opinion, crypto and fiat currency share quite a few similarities with one another. Let’s take a look at some of the most important ones.
- They can be used for payments
As you know already, fiat currencies like the U.S. Dollar and the Indian Rupee is legal tender and can be used to purchase goods and services within the respective countries. Similarly, cryptocurrency, although not officially legal tender in many countries throughout the world, can still be used for purchasing goods and services.
- They can be divided
A unit of a fiat currency can be divided into smaller fractions. For instance, 1 Indian Rupee can be divided into 100 paise. Likewise, cryptocurrencies also allow for such divisions. 1 Ethereum coin, for example, can be divided up to 0.00000001 ETH.
- They can be stored
Fiat currencies can be stored in multiple different ways - as cash and in electronic bank accounts. Similarly, cryptocurrencies can also be stored safely through dedicated crypto wallets. Also, both fiat currency and crypto can be gifted to other individuals by way of a simple transfer.
- Their values are not dependent on commodities
As you’ve already seen above, the value of a fiat currency is not dependent on commodities like gold or silver. On a similar note, the value of cryptocurrencies are also not dependent on such commodities and instead rely primarily on the forces of demand and supply.
- They can be subcategorized
Fiat currencies can be subcategorized into different types based on the country that issues it - U.S. Dollar, Australian Dollar, Indian Rupee, Icelandic Krona, etc. Likewise, cryptocurrencies can also be subcategorized into different types - Bitcoin, Litecoin, Ethereum, etc.
The differences between fiat currency and cryptocurrencies
Now, let’s move on to the differences. Both fiat currency and cryptos also share a lot of dissimilarities. Here’s a quick look at some of them.
Fiat currency is backed and regulated by the government issuing it, whereas cryptocurrencies are independent and aren’t backed or regulated by any public or private entity.
This is a major difference between fiat and cryptocurrency. Fiat money has a physical form to it. Cryptocurrency, on the other hand, is completely virtual and has no physical form.
To conduct a transaction with fiat money, you need an intermediary like a bank or a credit card company. However, that’s not the case with cryptocurrency. You can conduct transactions on a peer-to-peer network without the need for the involvement of any third parties.
Another difference between fiat and cryptocurrency lies in the legality of the currencies. Since fiat currency is issued by governments, it is completely legal. The same cannot be said about cryptocurrency. While some governments have legalized it, others have outrightly banned the currency.
Can cryptocurrencies and fiat currency coexist?
Many individuals are of the opinion that cryptocurrencies have the potential to replace fiat currency in the long-run. However, they’re far more likely to coexist than replace one another. While fiat currency has its own set of problems - inflation, for instance, it is already deep rooted in society. Also, the adoption rate of cryptocurrencies are miniscule compared to that of fiat currency. All of this points towards cryptocurrencies and fiat currencies co-existing in the foreseeable future.
Going through the similarity and the difference between fiat and cryptocurrencies should have given you a fair idea of the relationship between these two currencies. In the next chapter, we’ll take a brief look at how you can create a cryptocurrency all by yourself.
A quick recap
- Cryptocurrency is a decentralized form of virtual currency.
- Fiat currency is issued and backed by a government, instead of a commodity or an asset like gold or silver.
- Both fiat and crypto share a lot of similarities - they can be used for payments, be divided, be stored, be subcategorized, and their values are not dependent on commodities.
- Similarly, there are differences between fiat and crypto as well.
- Fiat currency is backed and regulated by the government issuing it, whereas cryptocurrencies are independent and aren’t backed or regulated in any way.
- Fiat money has a physical form, whereas cryptocurrency is completely virtual.
- To conduct a transaction with fiat money, you need an intermediary. Cryptocurrency transactions can be conducted peer-to-peer.
- Since fiat currency is issued by governments, it is completely legal. Cryptocurrencies are not yet legal in many countries.
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