In September 2021, Bitcoin became legal tender in El Salvador on par with the US dollar, sparking debate about the future of fiat money and the prospects for cryptocurrencies as an alternative. Both currencies can be used to pay for goods and services but before comparing them, you first need to understand how they work in general.
Most of the major world currencies are classified as fiat. Fiat currency is issued by the government and its value is not backed up by any commodity like gold. Fiat currencies have no intrinsic value but they build value through the faith that the government will be able to fulfill its obligations. It works so because most of the fiat funds are generated through loans. The value for fiat currencies depends on supply and demand. But the supply and demand can be influenced by the central bank through the regulation of the money supply and the base rate.
Bitcoin is also not backed by any commodities and is often viewed as an asset with no intrinsic value. But Bitcoin creates value due to the stability of the network and the rules prescribed by the Bitcoin network architecture. The Bitcoin price also depends on supply and demand but there is no regulator or single point of failure in the Bitcoin network that can affect it. The Bitcoin network is decentralized, and miners are responsible for the emission of new coins, competing to find a new Bitcoin block.
As you can see, Bitcoin and fiat currencies have some similarities and differences. But the differences do not end there, so let’s dwell on them in more detail.
National fiat currency is legal on the part of the state since it is itself issued by the state. Mainly, the fiat currency is distributed and controlled through the banking system and is used to pay for goods, services, and taxes. Sometimes countries can also use the currency of another country (Namibia and South Africa’s ZAR) or association (Eurozone) as a legal tender.
On the other hand, Bitcoin is not controlled by the authorities of any country. The network is immune to outside influence due to decentralization. Attitudes towards Bitcoin differ from country to country that affects its legality. In some countries, Bitcoin is considered a currency and legal tender (El Salvador), somewhere it is treated as a commodity and regulated accordingly (USA). There are also countries where Bitcoin is banned (China) or its status has not yet been determined (UAE). One way or another, the Bitcoin adoption level is increasing every year, forcing regulators in different countries to form legislation and describe the legal status of Bitcoin. Also, some payment service providers like CexDirect enable instant transactions with cryptocurrencies which are not prohibited by law since they run through exchange in the backend.
Fiat currencies have an infinite supply. This means that central banks have no limits on how much money they can print. However, central banks are trying to control supply to keep up with the economic growth or help stimulate it. The lack of restrictions means that fiat currencies are prone to inflation or decreased purchasing power. For example, the purchasing power of the US dollar has decreased by more than 6 times since 1971, when the gold standard was abolished. A thoughtless supply increase could lead to the rapid depreciation of fiat currencies that was recently observed in Venezuela and Zimbabwe.
But Bitcoin is deflationary. Bitcoin architecture states that the max supply is 21 million bitcoins. Also, every 210,000 blocks or approximately every 4 years, the reward for finding Bitcoin blocks is halved. This event is known as halving and it gradually reduces the number of new bitcoins that become available in the circulation until the max supply is reached. The last Bitcoin is expected to be mined sometime in 2140. Unlike fiat currencies, Bitcoin’s supply is predictable. Besides, Bitcoin’s deflationary nature makes it more relevant as a store of value, even taking into account BTC price volatility.
Fiat currencies can take both tangible (cash) and digital forms. Basically, you don’t need to provide personal data for cash transactions. Also, cash transactions between two individuals hardly be tracked, so they are predominantly anonymous and opaque. But digital fiat currency transactions are being actively monitored by banks and other financial institutions. For using banking services, you must provide personal information. In this way, digital transactions of fiat currencies are transparent to those who have access to them.
Bitcoin only exists in digital form. With blockchain, information about transactions within the Bitcoin network is open and transparent for all users. However, the addresses of the senders and recipients of transactions are just a collection of letters and numbers and they do not provide any information about owners. Bitcoin users can create an infinite number of addresses, and there is generally no need to provide personal information to do it. Therefore, Bitcoin is pseudo-anonymous, meaning transactions can be kept anonymous with due care.
Since fiat currencies can be both tangible and digital, they are quite versatile in terms of storage. You can store your cash at home, in your wallet, or anywhere else you want. Digital fiat money can be stored in online wallets and banks.
Bitcoins can only be stored in special cryptocurrency wallets. Depending on the storage method, cryptocurrency wallets are divided into cold and hot. A hot wallet means it is always connected to the Internet, while a cold wallet stores cryptocurrency offline. There are many types of cryptocurrency wallets, they can be stored on a desktop, mobile phone, flash device, or even a piece of paper.
Besides, there are also such tokens in the crypto market as stablecoins. These tokens are a kind of crypto counterpart to fiat money. With stablecoin, you can preserve the value of fiat funds in the crypto world and, in a sense, store fiat in a cryptocurrency wallet. You can always quickly exchange stablecoins for fiat, for example, if you decide to sell Tether (USDT) for USD and vice versa.
The bottom line
Like fiat currencies, Bitcoin has all the attributes that make it legal tender. But Bitcoin still has a low adoption level because cryptocurrency legislation has only recently begun to take shape in most countries. However, the crypto market continues evolving, so it may only be a matter of time before Bitcoin becomes legal tender alongside fiat currencies in an increasing number of countries.