Currencies have long been used to buy financial instruments such as stocks and bonds, but the advent of cryptocurrency has increased interest in investing in currencies themselves. We explore how the differences between fiat and cryptocurrency could impact your investment decisions.
Understanding the different ways that fiat and crypto currencies work can lead to better-informed investment decisions. Whether you’re interested in the relative reliability of traditional fiat currencies, or the innovative trends of crypto, this is what you need to know.
What Is Fiat Currency?
Fiat currency is government-issued money that is used as a form of tender and is the traditional form of money which most people use daily. It is typically not backed by a physical commodity like gold and instead derives its value from the trust and authority of the government that issues it.
Also referred to as fiat money, fiat currency is the most prevalent form of currency used globally and is central to modern economic systems. Common examples include the pound sterling, euro, and the US dollar.
Tip: Fiat currencies can be invested in and traded by accessing the forex markets.
What Is Cryptocurrency?
Cryptocurrencies are digital or virtual forms of currency. They use blockchain technology, or a similar form of distributed ledger technology, to track, validate, and secure transactions. The use of a distributed ledger means that cryptocurrency transactions are largely transparent.
Cryptocurrencies operate independently of a central bank, a fact which has traditionally been appealing for some investors, and examples of cryptocurrencies include Bitcoin, Ethereum, and Solano.
Tip: Bitcoin was the first cryptocurrency to come into existence and was launched in 2009.
What Are the Differences Between Fiat Money and Cryptocurrency?
Despite both fiat money and cryptocurrencies being mediums of exchange and stores of value, they differ significantly in their structure and operation.
Fiat money is centralised and regulated by governments, whereas cryptocurrencies are decentralised and operate on peer-to-peer electronic networks. The fact that cryptocurrencies are community driven means that any individual or group can set up a cryptocurrency. In contrast, the management and distribution of fiat currencies is the responsibility of a country’s government or central bank.
No two cryptocurrencies are the same. The protocols they use, and functionality features associated with them can be significantly different. There are still shared characteristics of all cryptocurrencies which makes it possible to run a high-level comparison of fiat currencies vs cryptocurrencies.
| Features | Fiat Currency | Cryptocurrency |
|---|---|---|
| Control | Centralised by governments and central banks | Decentralised, community-driven |
| Form | Physical and digital | Digital only |
| Regulation | Heavily regulated | Varies by jurisdiction |
| Issuance | Can be increased or decreased by governments and central banks | Often limited supply, capped in many cases |
| Transaction fees | Generally low, but can vary, especially internationally | Generally high, may include blockchain fees |
Tip: It is important to factor transaction fees into any strategy’s cost-benefit analysis.
What Are the Pros and Cons of Fiat and Crypto Currencies?
Both fiat money and cryptocurrencies have their advantages and disadvantages, which can influence investment decisions.
Pros of fiat money
- Stability: Fiat currencies are generally stable and less volatile than cryptocurrency.
- Widespread acceptance: They are universally accepted for transactions.
- Regulation: Government regulation provides a level of security and trust.
Cons of fiat money
- Inflation risk: Governments can print more money, leading to inflation, which essentially affects its ability to act as a store of value.
- Centralised control: Decisions regarding levels of money supply can be influenced by political rather than economic priorities.
Pros of cryptocurrency
- Decentralisation: Offers autonomy and is not controlled by any single entity.
- Potential for high returns: Volatile markets are risky to trade, but do attract speculative investors looking to make a return in a short period of time..
- Transparency: Blockchain technology ensures transparency and security.
Cons of cryptocurrency
- Volatility: Prices can fluctuate dramatically.
- Limited acceptance: Not universally accepted as a form of payment.
- Regulatory uncertainty: Varies widely by country and can affect its systemic adoption.
- Transaction processing times: Transactions can take minutes or even hours to be confirmed.
- Carbon footprints: Operating blockchains is very energy intensive.
Final thoughts
Fiat money and cryptocurrency present different types of opportunities and challenges for investors. The relative reliability of fiat currencies and the way they are widely accepted might be attractive to many, but crypto currencies offer innovation and potentially higher returns.
As an investor, it’s essential to weigh up all of the factors associated with the currency you are considering buying, ensuring you have a well-thought-out strategy and understanding of the principles of risk management.
Learn more about different types of currencies by joining the eToro Academy.
FAQs
- How big are the fiat currency markets?
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The fiat currency markets, or forex markets, are the largest financial market in the world. The average size of trades booked in currencies such as US dollars and euros is estimated to be a total of $7.5trn each day.
- What are “Proof of Work” and “Proof of Stake”?
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Proof of work and proof of stake are the two most popular ways that cryptocurrency networks verify transactions and holdings on their blockchain systems. The two protocols have their relative pros and cons and these go some way to explaining the different “characteristics” of cryptocurrencies.
- Why are there so many different types of cryptocurrency?
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Most crypto projects use open-source technology. That makes it easy for aspiring crypto developers to view the source code of an established coin and replicate it to create their own crypto. This extreme accessibility has resulted in tens of thousands of different cryptocurrencies termed “altcoins” being launched since Bitcoin first appeared in 2009.
- What are “open-market operations”?
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Open-market operations (OMOs) is the term used to describe activity carried out by governments and central banks to adjust the levels of fiat money supply. If the US Federal Reserve goes into the bond market and buys US Treasuries, this will increase the money supply by passing cash to the former bondholder in return for ownership of the Treasury certificate.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments.
This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Not all of the financial instruments and services referred to are offered by eToro and any references to past performance of a financial instrument, index, or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.