As the name suggests, cryptocurrency is a type of digital or virtual currency that works well as a medium of exchange. These are based on a P2P (peer-to-peer) network that does not need an intermediary to carry out any financial transactions, unlike in the case of traditional Fiat currencies. Additionally, cryptocurrency is stored in virtual portfolios and wallets, and purchase, sale as well as exchange transactions take place in blocks.
With cryptocurrency spreading far and wide across the world and even Central Banks looking into launching their own digitized currencies, it is pointing towards the fact that digital assets could be the currencies of the future.
Therefore, it is crucial to understand how cryptocurrencies differ from traditional currencies otherwise known as fiat money. So, let’s find out!
The Divisibility Drive
Divisibility is an important factor for all forms of money, commodity, fiat or cryptocurrency, since that makes something of use or value into exchangeable money. If one wants to exchange goods across varying values, then that money can be further broken down into multiple small units. This is what happens in the case of Bitcoin.
- For instance, just the way we can divide 1 euro into 100 euro cents; in the same way, Bitcoin can be divided into smaller units, as small as 0.00000001 BTC, which makes it feasible for micropayments.
- The smallest value that is supported by the Bitcoin network is Satoshi, which is named after the creator of Bitcoin. Each bitcoin can be further divided into one-hundred-million (100,000,000) satoshis.
- That’s not all - the divisibility of Bitcoin can be increased to 100 billion smaller parts or even more. Similar to Bitcoin, nearly every digital asset offers these same features.
There huge difference between cryptocurrencies and fiat is that you have a two-decimal precision, which means it has a much larger divisibility than any fiat currency.
Deflationary vs Inflationary factor
When it comes to fiat currencies, a central bank can issue new money at any given point in time, and there’s no limit on the amount of money they can create.
Let’s take an example, say in the US, a loaf of bread came at USD 0.09 in 1930, USD 0.36 in 1970, and USD 1.98 in 2013. Even today, it isn’t expensive to bake bread, just that the dollar is less valuable than it was in those decades.
This brings us to the point that fiat currency decreases as it becomes less rare over time, largely because central banks print more money. This makes fiat currencies inflationary.
What about Bitcoin?
When we speak of Bitcoin, there’s no central bank here constantly issuing money and controlling any monetary policy. There’s a different kind of algorithm that runs out, once it hits 21 million coins, which means that any BTC that gets lost is then permanently removed from the money supply. What this translates to is that the total supply will decrease, or deflate over time.
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Centralised vs decentralised
Centralised currency networks rely on third party authorities to control the issuance, supply and transactions while decentralized currency networks are fully operational without any third-party intervention.
This is another differentiator between cryptocurrencies and fiat currencies. Cryptocurrency is traded without intermediaries directly through blocks on the chain, hence the name: blockchain. This means decentralised cryptocurrency exchanges have no access to customer’s assets and information.
Before Blockchain technology was invented, it was impossible to solve an issue which is known as the double-spend problem, meaning that it would be possible to copy the transaction details and rebroadcast it such that the same currency could be spent multiple times by a single owner.
Bitcoin was the first major digital currency to solve the issue of double spending. It made this possible by ensuring that all of the different transactions involving the relevant cryptocurrency are posted to the blockchain, where they are separately verified and protected by a confirmation process.
In the case of Bitcoin and many other cryptocurrencies, transactions that have been confirmed in this way become irreversible; they are posted publicly and maintained in perpetuity.
In essence, cryptocurrencies have an encryption technology that prevents assets from being copied and reused. On the other hand, fiat currencies are regulated by the central bank. Fiat money is regarded to be a legal tender, since it is the official mode of finalising transactions.
