The rise of cryptocurrency has started a debate on the future of fiat money, those that are backed by the government, like the US Dollar or the Indian Rupee. Though the virtual currency is gaining wide acceptance, it is not yet in a position to replace fiat currency, which remains the preferred means of exchanging value across the world. Most people see cryptocurrency as a way for rapid wealth creation, given its volatile nature. So to understand how cryptocurrency fares in relation to fiat money, we need to understand how both the currencies operate and what separates them from each other.
What is cryptocurrency?
Cryptocurrency is a new form of exchange, only a decade old, that is secured by cryptography. This electronic form of encryption makes it nearly impossible to counterfeit or double-spend. Like the fiat money, it can be used to buy goods and pay for services. Many companies have issued their own crypto coins. Think of them as casino chips that you exchange for fiat currency and use to access goods and services.
All cryptocurrency trade is entered on a distributed online ledger that is accessible to everyone all the time, so there is no requirement of any central authority. According to CoinMarketCap.com, a market research website, there are more than 10,000 different cryptocurrencies in circulation today.
How is it different from fiat money?
Unlike fiat money, cryptocurrency is not regulated by central authorities or backed by governments. This makes the virtual currency less credible than the real one (hard cash or digital money in bank accounts). Cryptocurrency is also much more volatile than fiat money. The volatility is primarily driven by the speculative nature of the trade, where investors are focussed on wealth creation quickly by booking profits.
Crypto coins don’t require an intermediary to validate a transaction, like a bank in the case of fiat money. The crypto transactions are verified using the blockchain technology, because of which all trading activities are recorded permanently, enhancing the security of every exchange.
What are the similarities?
Both these forms of currency largely derive their value from the wide acceptance they have around the world. More acceptance means more credibility. They are also divisible — just as a rupee can be divided into 100 paise, 1 Bitcoin can be divided into as little as 0.00000001 BTC. Like fiat money, crypto coins can be used to pay for services or buy things. They can also be given as a gift used as a store of value.