Out with Fiat, In with Digital Currencies?

digital versus fiat currency

Richard Nixon dished out so many economic changes in 1971 that the series became known as the Nixon Shock. Of these, none were as consequential to the financial system as the cancelation of the gold standard. From the ashes of the Bretton Woods Agreement rose a new financial phoenix in the form of national fiat currencies, a new global monetary world order in which each government regulated its own currency and exchange rates between national currencies floated flexibly.   

Disruption has defined economies for millennia, but the digital era has precipitated unprecedented changes in financial systems; its effect on currency is no exception. FXTM Senior Staff Writer Nikola Grozdanovic explores whether another potential shock to the world’s financial system has already taken hold.

Nikola Grozdanovic FXTM

Nikola Grozdanovic, FXTM

The exorbitant rise in value of cryptocurrencies since the beginning of 2017 has given birth to the debate around the longevity of fiat currency. Are we headed towards a digitised monetary structure, one that is governed not by regulators or central banks, but through a decentralised peer-to-peer system? Proponents of cryptocurrencies, believers in ICOs (Initial Coin Offerings) and blockchain enthusiasts alike all point to three major reasons why the fiat system may be swept under the digital rug.

The first of these is the nature of decentralisation, a key selling point for all cryptocurrencies. Without a central authority to govern and regulate the transactional flow, digital coins are free to roam from peer-to-peer, unchained from government or Central Bank agendas. The second major reason comes in the form of reliability thanks to blockchain technology, which is the main transactional avenue for digital money. Whatever happens to cryptocurrencies, many believe that blockchain will live on in other industries and through other non-fiscal data.

The third reason given by pro-digital future advocates is convenience and costs. There are no “trusted” third parties playing middle men between the origins and destinations of transactions, and, as a result, any associated costs are generally lower than their fiat counterparts.

On the flipside, digital currencies have some challenges if they are ever to actually replace the fiat system. It’s true that more and more crypto-friendly merchants and businesses are popping up around the world, but with that comes significant regulatory backlash. Take, for example, the recent crackdown on crypto exchanges in South Korea – a major hub for digital coins. Just recently, authorities in Seoul uncovered $600 million worth of illegal crypto trades. Coupled with the fact that the total market cap of cryptocurrencies (less than $500 billion) is completely overshadowed by the fiat equivalent (around $80 trillion), there is a long way to go before such a big transition occurs.

Another big concern is safety. A significant amount of digital currency has been stolen in the past decade. Mt. Gox is the most infamous example: the notorious cryptocurrency exchange was pushed into bankruptcy after hackers stole over 800,000 bitcoins in 2014 ($460 million at the time). The price of bitcoin plummeted as a result, and it took over a year for people to regain confidence in the currency. Recently the Japanese cryptocurrency exchange, Coincheck, fell prey to a hack in which Y58bn (£380m) of digital coins were stolen. The coins were stored in an internet-connected “hot wallet”, rather than a “cold wallet” which is more secure because it is stored offline.

Safety remains a threat, despite the sophisticated encryption that exists as a security net. Blockchain and cryptocurrency transactions are still prone to hacks, software glitches and hardware malfunctions.

Another significant obstacle to full crypto adoption is money laundering. The amount of money that financial firms and institutions would need to spend to comply with regulators could triple at the very least. Lukman Otunuga, Research Analyst at FXTM, argues that:

Anti-money laundering issues, and the upcoming GDPR (General Data Protection Regulation), may make it even tougher for digital currencies to conform. The cryptocurrencies that end up surviving might be the ones that agree to compromise on core principles, such as decentralisation or anonymity.

The future of these assets remains an enigma even to seasoned economists and futurists. We have no historical analogue to compare it to, so this is one instance where the old aphorism “time will tell” really holds water.

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