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The emergence of cryptocurrencies such as Bitcoin has made people worldwide think about the future of money. Are they going to put an end to paper money, and if so, what would this future look like?
What happens to fiat currencies and will they be worthless?
Digital currency will almost entirely replace paper money in the long term. Unlike traditional money, it’s widely accessible, and cheaper due to the lack of intermediaries. So, it matches better with our new needs. But in the near future, they’ll operate simultaneously.
This article will explore the concept of digital currency and discuss its two distinct types: private cryptocurrencies and central bank digital currencies (CBDCs). You’ll also learn why digital currencies will replace physical money and what advantages they have over paper money and vice versa.
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What is Digital Currency?
Any sort of money or means of payment that exists merely in electronic form is called digital currency, which is supplied, altered, and exchanged on digital systems.
But one thing we should first clarify is the difference between digital currency and electronic money.
Electronic money is regular money or, in other words, fiat currency in electronic form. Paper money can have both physical and electronic formats. But digital currency exclusively exists in digital or electronic format. And this is the main difference between these two.
So, if your question where whether electronic money would replace paper money, the answer would be this has already happened. The overwhelming majority of transactions, especially in more developed countries, are done through electronic means.
However, digital currencies are still in the early stages regarding mass adoption.
Types of Digital Currency
We usually split digital currencies into three groups, including private cryptocurrencies, CBDCs, and virtual currencies.
- Bitcoin is the first and most famous private cryptocurrency. As the name shows, cryptocurrencies are secured through cryptography, and most rely on blockchain technology. Decentralization and not being regulated are their other prominent characteristics.
- CBDCs are digital currencies that central banks offer and regulate. The recent popularity of cryptocurrencies and the cash usage decline have made central banks around the world contemplating and researching this concept. However, CBDCs are still mainly in the trial. Only a few countries like China, Sweden, and The Bahamas have launched their pilot CBDC projects.
- Virtual currencies are traded among online community members and thus have limited usage. They’re primarily in the form of tokens, while some consider cryptocurrencies a subsegment of virtual currency.
Why Will Digital Currency Replace Paper Money?
Digital currency seems that it will inevitably replace paper money, given the pace of technology and the needs of the digital era. Additionally, it can be traded and used for payments better than paper money.
Digital Currency Advantages
Let’s now take a look at some of the advantages of digital currency.
Limited Supply or Resistance to Inflation
One advantage of Bitcoin and many other cryptocurrencies is their limited supply. While Bitcoin’s supply has a cap at 21 million, the amount of fiat money is constantly changing.
Governments and central banks worldwide sometimes increase the money supply. In other words, they print money to cover their deficit, and by doing that, they cause inflation, decreasing the value of people’s money.
However, because of limited supply, many cryptocurrencies are resistant to inflation.
Of course, CBDCs might not have this advantage because central banks can assert their influence on them.
Broader Financial Inclusion
The 2017 Global Findex report shows that 1.7 billion adults around the world still don’t have a bank account. However, digital currencies can change this dynamic because accessing them requires just a mobile phone and internet coverage.
Faster and Cheaper Transactions
Digital currencies can allow us to transfer money faster and cheaper, especially for international transfers. When it comes to international transactions, banks are very slow and expensive, while digital currencies can offer faster transactions with minimal fees.
Of course, this is still mostly hypothetical, and Bitcoin transaction fees are very high due to the network’s low capacity to process transactions. But newer technologies promise higher transaction throughput and thus lower fees.
Decentralization of Power
Unlike fiat currencies, most cryptocurrencies exist in a decentralized form, meaning that no centralized authority oversees or regulates them. So, governments can’t influence them, at least not as much as they want.
Decentralized currencies have other benefits, like being better value stores and more aligned with their users’ interests.
Once again, CBDCs don’t benefit from this advantage.
Elimination of Intermediaries
When you buy something and pay with your credit card, you go through multiple intermediaries like the credit card company, bank, and payment processor.
However, with cryptocurrencies, you can eliminate all of them, saving you a lot of fees.
With CBDCs, central banks can also benefit from this disintermediation and elimination of commercial banks. For example, they can oversee and control the money circulation directly.
Digital Currency Disadvantages
Now let’s look at some digital currency disadvantages to see why they still have a long road to become mainstream and which barriers they must overcome.
Demanding Technical Knowledge
A payment method should be easy-to-use for everyone to reach mass adoption. Unfortunately, cryptocurrencies still lack this feature because using them requires at least some technical knowledge.
But this is not a very difficult barrier to overcome. As technology progresses and people become more tech-savvy, this issue will fade away.
The cryptocurrency market is an emerging market, brimming with speculators and an amateur investor base, which makes this market highly volatile.
Stability is one of the integral features of any successful medium of exchange. So, to become one, cryptocurrencies should mature and become more stable. But, unfortunately, we still can’t consider cryptocurrencies currencies; they’re more of a store of value.
Of course, CBDCs won’t face this issue as much as cryptocurrencies.
Being Inefficient and Unscalable
Bitcoin and other blockchains based on the Proof-of-Work protocol are very inefficient.
Bitcoin Energy Consumption Index currently shows that the Bitcoin network consumes more than 130 TWh annually, nearly as much as the people of Argentina. The carbon footprint for every Bitcoin transaction is equal to watching YouTube videos for more than 130 thousand hours.
Consider this, too: Visa processes around 1,700 transactions per second. Bitcoin processes only 3 to 7. With this much energy consumption, Bitcoin could never become a means of payment.
But aside from Bitcoin, some other newer cryptocurrencies promise lower energy consumption and higher transaction capacity.
For example, Solana can handle around 29,000 transactions per second. The number for Cosmos is 10,000, for EOS is 4,000, and for Ripple is 1,500.
What Happens to Fiat Currencies?
Not many changes will happen to fiat currencies in the near future. As of June 2021, Data from the website FiatMarketCap shows that the global fiat market cap is more than 195 times the Bitcoin market cap.
So, even though Bitcoin and other cryptocurrencies have come a long way, they still haven’t amassed enough traction. However, given the potential of the crypto space to innovate and disrupt, we certainly can’t imagine a future where cryptocurrencies don’t play an important role.
So, as we discussed, regular money still has a long way to go. One of the reasons for this conclusion is that we haven’t seen a viable alternative yet.
However, cryptocurrencies look promising, as they have several advantages over regular money, including broader financial inclusion, faster and cheaper transactions, and the elimination of intermediaries.
They also have problems like high volatility and inefficiency that they need to solve to gain more adoption. Another concept is CBDC which is still too novel for us to predict its future.
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