For centuries, fiat currencies have provided an accessible and reliable means of financial exchange.
This applies to both basic commercial and retail transactions and the trading of currency pairs through the foreign exchange, which is now governed by a free-floating exchange rate that’s dictated by various market and macroeconomic conditions.
Over time, fiat currencies have become central to the monetary policies enacted by central banks, including the manipulation of a country’s base interest rate. As a result, fiat currencies are now highly influential assets and policy-making tools, in addition to being central when learning how to trade forex for beginners.
More recently, we’ve seen the financial and economic landscape altered markedly by cryptocurrencies. But just how is this asset class continuing to evolve, and will crypto tokens ever supersede or replace fiat currencies?
What are the Most Prominent Fiat Currency Issues?
Despite the prominence and influence of fiat currencies, such entities aren’t as accessible as you may think in certain parts of the world.
Take Africa, for example, whereas much as 57% of the total population is unbanked and doesn’t have reliable access to fiat cash. In sub-Saharan Africa, this percentage increases to 65% of adults, with many citizens lacking the documentation or basic resources to open a personal bank account.
Despite its infancy, cryptocurrency has already evolved to drive greater levels of financial inclusion in the developing world, where crypto adoption rates are rising exponentially.
Even in the developed world, we’re seeing a clear (albeit) slower transition towards the use of electronic cash and transfers, inevitably paving the way for cryptocurrencies to become more mainstream in the near future.
Since 2016, for example, the transactional use of cash and paper money has been in steep decline. By 2019, cash accounted for barely half of all payments in the UK, while this percentage dropped to just 17% during the following year.
Of course, this trend was accelerated rapidly by the coronavirus pandemic, as periods of sustained geopolitical uncertainty tend to create a demand for more flexible and accessible financial solutions. So, it’s no surprise that cash transactions have continued to play second fiddle to debit cards, contactless payments and electronic transfers.
With corporeal money clearly being phased out and replaced gradually, customers are transitioning naturally to digital alternatives including cryptocurrencies.
At the same time, first generation tokens like Bitcoin (BTC) have continued to appreciate in value over time and force their way into the consumer mainstream, providing a transparent and accessible solution to a number of online transactional needs.
Introducing Government-Backed Crypto Assets
The evolution of cryptocurrency has been underpinned by the emergence of government-backed digital assets, from China’s digital yuan to the trailblazing ‘eNaira’ in Nigeria.
While this type of asset is tradeable or available to be bought and sold on exchanges, it leverages the transparency and accountability of blockchain technology to create a de facto digital currency that’s managed by a central bank or authority.
Of course, governments may launch this type of asset for various reasons. In Nigeria, for example, this is part of a move to drive financial inclusion in the region, providing viable resources to unbanked members of the population.
However, China’s digital currency is arguably an evolution of the government’s social credit system, creating significant concerns about affording greater control of personal finances to an authoritarian state.
This mixed bag aside, there’s a fundamental issue with government-backed central currencies. More specifically, such entities are controlled and issued by a central authority, negating the unique selling point of cryptocurrencies which are completely decentralised and backed by immutable ledger technology.
So, although government-backed digital currencies are considered by many to be a formal attempt to replace fiat currencies, there are obvious hurdles and obstacles that will prevent this from becoming a reality.
So, Will Crypto Assets Ever Replace Fiat Currencies?
Ultimately, the precise role and scope of cryptocurrencies in the financial market and wider economy are still being explored, even as the market continues to evolve and third-generation assets (which are inherently more scalable and designed to overcome the issues associated with tokens like BTC) begin to make their mark.
At the same time, crypto assets continue to transcend regulatory frameworks and international borders for the time being, creating a meld of both positive and negative impacts that make it hard to see how such tokens could be scaled and rolled out as a viable alternative to fiat currencies.
Then there’s the issue of volatility. While so-called stablecoins are pegged to established fiat currencies like the USD as a way of curbing price movements, typical cryptocurrencies are incredibly volatile and unusually vulnerable to market sentiment.
Even though assets like BTC have appreciated markedly in value over the course of the last decade, they continue to experience huge peaks and troughs that make it hard to create a reliable store of value.
So, by establishing BTC as a viable alternative to fiat currencies, we’d see a seismic shift in terms of how cash is valued, its management and the ability of holders to plan or organise the finances in real-time.
For these reasons, it’s hard to see any scenario where cryptocurrencies completely replace fiat currencies in the future.
Instead, it’s more likely that governments and central banks will leverage blockchain to enhance fiat currencies and the delivery of associated financial services, while utilising government-backed assets for specific fiscal transactions.