How Does Cryptocurrency Compare to Traditional Money?
Cryptocurrency is a radical departure from the way modern society has thought about and used money for financial transactions. Cryptocurrency circumvents governments and financial institutions to give you the power to conduct financial transactions without a middle man. In the past year, cryptocurrencies have started to transition from a relatively fringe movement into the mainstream as more and more consumers and companies start to pay attention. efore we dive into all things cryptocurrency, let’s take a minute and think about how the dollar bills and credit cards in our wallets actually work. This will help give some context to subsequent discussions about cryptocurrency.
The money you use on a daily basis, is known as fiat currency. The word fiat, is Latin for “let it be done.” Fiat money does not have any intrinsic value in the way that gold or silver does. Instead, it is money because a government declares that it is. The money you use today only has value because the government has declared that it is the legal tender of a country. This means that anyone you owe money to is required by law to accept the dollars in your pocket or bank account as a legal means of payment, which also creates demand for dollars.
The value of a dollar bill, euro or yen, is based on supply and demand which is generally controlled by a centralized bank. In the United States, the Federal Reserve controls the supply of money through a variety of tools, including adjusting interest rates and the buying and selling of government securities.
Digital money is any means of payment that exists in a purely electronic form. This includes electronic fiat money and cryptocurrency. Traditional digital money can easily be exchanged for fiat currency at a bank.
Cryptocurrencies offer a peer-to-peer, decentralized system of payments and financial transactions that eliminates the role of banks, governments and other traditional third parties. A cryptocurrency has value only because people believe it has value and are willing to use it for transactions. Bitcoin was the first cryptocurrency and has only been in circulation since 2008. There are now hundreds (if not thousands) of cryptocurrencies in circulation. Cryptocurrencies get their name because they are secured using encryption techniques (cryptography) that verify and record transactions in an online public ledger or blockchain. Today, many different businesses accept cryptocurrencies as payment, including Overstock, PayPal, Microsoft and Wikipedia.
Here is a very quick look at how Bitcoin and other cryptocurrencies work. We’ll get more into the details in later lessons.
Monetary policy is set by the government or closely related entities such as a Federal Reserve or Central Bank.
The government requires that payments made in the country’s legal tender must be accepted.
The government can choose to insure deposits made with certain banks so if something happens to the bank, the government guarantees your deposit.
There is no centralized governing authority and currently no cryptocurrencies are associated with a particular nation or state.
Participation is voluntary and nobody has to accept payment with a bitcoin.
Users must trust the integrity of the cryptocurrency blockchain. Losses are not insured.
Third Parties are Integral
Third parties such as banks and lending institutions are integral part of the financial system.
No Third Parties
The exchange of cryptocurrency as payment is peer-to-peer with no third party involvement.
Supply is Unlimited
Governments or central banks control supply by either printing more money, or taking money out of circulation. Nobody knows exactly how much money is in circulation.
Supply is Limited
Most cryptocurrencies announce a finite supply upon inception. For example, there will never be more than 21 million bitcoins.
Transactions are Public
Any transactions conducted electronically are linked to the individual who made the transaction.
Transactions are Anonymous
All transactions are electronic, but the identity of the user is encrypted.
Counterfeiting is Possible
Although governments are making it harder to print illegal tender, it is still possible.
Counterfeiting is (Sor Far) Not Possible
Cryptocurrency transactions are highly encrypted and documented in a continually updated ledger or transactions that make it, at this point, impossible to counterfeit.
Transactions Can Be Slow
The necessity of third party validation slows down transactions, sometimes by days or weeks.
Transactions are Nearly Instantanious
Since peer-to-peer transactions are validated by sophisticated mathematical calculations, they happen almost immediately.
Transactions Are Reversible
Let’s say you use your credit card to order something online and it never shows up. You can ask your credit card company to cancel the transaction and they can charge the sale back to the merchant.
Transactions Are Not Reversible
Because there is no third-party arbitrator, bitcoin transactions are not reversible. You can ask to be paid back by the original vendor, but once your bitcoins are gone, the transaction is complete and irreversible.
Digital and Paper Options
You can have digital dollars deposited by your employer into your bank account and then use your bank account to make a payment to the electric company without ever seeing so much as a paper check. You can also go to an ATM and take $20 out and use it to buy an ice cream.
There are no paper bitcoins.