Will Cryptocurrency Replace Fiat Currencies?
Updated: Feb 8
Cryptocurrencies in general have really picked up steam in the past two years. With millions of people receiving government stimulus, sitting around the house "quarantined" scrolling through social media, it's no surprise that something so mysterious and exciting has garnered such attention.
On the surface at least, cryptocurrencies make a lot of sense (because we're already using it... but more on that later): A decentralized monetary system enabling people to purchase things of value without having to physically exchange anything. The key word in that description being "decentralized", which is the single greatest factor that separates cryptocurrencies from fiat currencies (i.e. the Dollar). Decentralized means that, unlike the current monetary systems, the local government does not have control over it's supply, which is a BIG deal because of how powerful supply manipulation is in controlling the economy.
A perfect example of this are the effects from the recent $6.5 trillion US Government stimulus. To put things simply: There is only a given amount of people on the earth (or in a country) at any given time, and those people are only buying and selling a given amount of value, which they are paying for with currency based on what the currency is worth. What something is worth is based on the law of supply and demand. So again, put simply, if there is more total money available in the system to pay for goods and services than there was before, the system will naturally equalize by raising prices. Said another way, if I know my neighbor got a raise, I'm going to charge him more to mow his lawn. Of course, this doesn't happen instantly, but takes years to balance out. Along the way, politicians look great because the economy looks great and everyone is happy because all the numbers say that everyone is making more money! DUH!!! If everyone has more money, of course they're going to make more money! Simple law of cause and effect lol.
It is very similar with other monetary policies the government controls, like interest rates for example. The rates for just about all forms of lending are based on the Federal Funds Rate, a rate set by the Federal Reserve. This is because the Federal Reserve is how financial institutions (banks) transfer and store money, so the Federal Funds Rate determines the profit margins banks work with to set the rate they charge people and businesses to borrow money. Put simply, if the Federal Funds rate is low then it'll be cheap to borrow money, which helps people spend more, and provides businesses with the capital they need to expand... which helps the economy do well, which makes everyone happy, which makes politicians look good!
Are you beginning to recognize a pattern?
Currently, centralized currencies are essential to the way the world works on a fundamental level. Literally the entire financial system, and thus our entire way of life, hinges on the government's ability to control the supply of money, and the rate at which people borrow it. So a decentralized currency in which the government is excluded from the party and has no control over these factors scares the living daylights out of policymakers.
But where there is democracy, there is social pressure, and getting someone's vote means swimming with the current of public opinion... and the public's opinion of cryptocurrency is becoming increasingly more favorable. Thus policymakers are scrambling to come up with a way to retain the control that is vital to economic stability, while pacifying the general public who honestly has no idea what they're really asking for. Oh the irony.
Cryptocurrency as a Currency
All that being said, let's consider for a moment the practical application of cryptocurrency as an actual currency (not an "investment"... but don't get me started) and see if it even makes sense as a concept... And for the sake of this discussion, we will be referring to paying with crypto via digital wallets, since physical crypto wallets largely defeat the point when considering crypto as a viable means of payment (I mean, who would want to risk losing $220m?).
As a consumer, the primary incentive of cryptocurrency over cash is convenience and safety. Unlike cash which requires acquiring, storing, counting, paying, counting again, storing again, then re-depositing, only to repeat the cycle over and over, using a digital currency simply requires the consumer to choose a method of payment, make an agreement to pay the merchant... and they're done! If you choose an emailed receipt as well, the transaction is completely digital with nothing to hold, keep track of, or clutter up your pants pocket and get caught in the washer.
Digital is safer as well, because unlike cash which can easily be stolen, exposing you to the risk of being mugged, there is nothing physical to steal with digital currency! So criminals are disincentivized from mugging you because they wouldn't get anything.
Therefore, at least at first glance, cryptocurrency appears to be a superior alternative to cash... until you learn that it actually costs you money to pay with cryptocurrency. You heard me right, you have to pay... to pay! But how can that be?
When you pay a merchant via credit card, or debit card, you are not using your money in that moment. You are actually using Visa, or Mastercard, or whatever clearing house's money your card is based on. The clearing house checks your available balance (either your credit limit or your account balance) and, if the amount is available, gives the merchant the green light essentially saying "They're good. We'll get the money and give it to you." They then withdraw the money from your account, or add the amount to your balance and hold it for clearing (hence the name clearing house). After 1-2 days, they deposit the money into the merchant's account and the payment is complete. Well, while that money is floating in limbo, they keep it in an account that earns interest from very stable investments (usually short-term government treasuries). It's not much per dollar, but it really adds up on billions! And they earn that in addition to the 2-3% average cost to merchants and the mountains of interest charges they split with the bank! So essentially, the merchant and the government are paying the cost for you to have the convenience of using a credit card.
With cryptocurrency however, the clearing house is not able to invest it, and there is significant risk from price volatility, so they naturally have to charge higher fees to compensate for the risk and administrative costs of running their platform. Since charging all those fees to the merchant would discourage them from accepting the platform, they split the cost and charge a portion to the consumer. Thus costing you money to pay with cryptocurrency.
So then, why in the world would someone want to pay money to pay with crypto when they can just use a credit card, which is "free"?? Here lies the crux of the issue, for now. See, behavioral finance says that if something costs me something to do it, even if it makes sense, I have a high chance of not doing it. Especially when there are comparable alternatives that don't cost me money. Therefore, the only instances where cryptocurrency actually makes sense, at least right now, is for:
Foreign transactions: In theory, if both parties use cryptocurrency, it eliminates the risk associated with forex rates and volatility. Using crypto also significantly speeds up the transaction process since the process is so simple.
Fraudulent activity: The fact that cryptocurrency affords so much anonymity to it's users means that it's perfect for masking fraudulent transactions. Whether it be selling drugs, money laundering, or off-the-table dealing, law enforcement agencies are well aware of the underworld's use of crypto to hide their dealings.
When you combine the forces of the government resisting adoption to hold onto their control of the economy, with the payment industry's reliance on an established system to provide convenience to a consumer, who expects to make money when spending money, you have a recipe for failure as a viable means of payment... And when you really think about it, for the average person who just wants to pay for their groceries, isn't paying via credit card kind of the same thing?? I mean, in both scenarios you're paying with a digital currency. It's just one is crypto *sparkles*... and one is just, well, boring.
What would it take for cryptocurrency to succeed, as a currency?
I think it's pretty clear that there are a lot roadblocks preventing cryptocurrency from becoming a mainstream form of payment, but... what if?? What would it take for cryptocurrency to succeed and for your grandma to send you crypto instead of dollars for Christmas?
#1: The government would have to declare a particular cryptocurrency as a sovereign currency, or even the sovereign currency, meaning that it literally replaced the current sovereign currency (e.g. the Dollar) with a cryptocurrency... This would require dramatic modification to the monetary policies of all major governments and financial systems, but is entirely possible. We won't get into the details obviously, but just to give you an idea of how monumental that task would be, ponder these questions;
How do you accurately tax a currency that is technically not "yours"? (Before you get upset about taxes, take a moment to be thankful for the roads you drive on, fire departments that are there to save you, and police officers who keep us safe! Taxes are an essential element of living in a 1st world country.)
When creating budgets, how do you accurately plan using a currency that has no regulating backbone to keep it's price stable? (Governments and government agencies budget years in advance.)
#2: There would have to be a payment system in place, that is universally adopted, which costs nothing for the consumer to use, and is easy (and cheap) for merchants to adopt. As mentioned earlier, people simply won't switch to something else if the current option is an equal alternative and costs less. This would probably mean a company like Visa, Mastercard, or American Express embracing a cryptocurrency and enabling all of their existing merchants to receive payment via crypto without having to spend much in additional equipment (Remember how long it took for merchants to buy the chip readers?? Yeah, business owners are cheap. And very resistant to change.).
How likely are these two things to happen? The answer is obvious to me, but that's for you to decide.
As interesting as cryptocurrency is as a concept, and as much as I love innovation, given the facts mentioned in this article, I can't see cryptocurrency becoming a viable means of payment any time soon... Is it possible? ...Yeah. Anything is possible. But is it feasible? No. There are simply too many opposing factors preventing it from becoming a mainstream form of payment.
That being said, I do think crypto has its place in the economy and is useful as a store of value for businesses with international challenges. And one cannot ignore the powerful effect of social pressure from the public on government policy... So it'll be interesting to see how things evolve and develop. To see how crypto matures and finds it's place in society... Like an adolescent going through their awkward phase. They'll eventually figure out who they are, and who they want to hang out with, but it takes time, and a lot of questionable choices.