12/21/2020

Could digital currencies ever replace fiat money?

Earlier this week, El Salvador became the first country in the world to adopt Bitcoin as legal tender. The long-awaited move generated a lot of excitement but got off to a bumpy start when the available technology couldn’t keep up with the demand from users. Given El Salvador’s disappointing experience so far, a natural question to ask is: could digital currencies ever truly replace “fiat” money?

To clarify, it was never illegal to use Bitcoin in El Salvador. However, making this digital asset “legal tender” means businesses are now required to accept Bitcoin as payment for their goods or services. In the wording of the new legislation itself, “every economic agent must accept Bitcoin as payment when offered to him by whoever acquires a good or service”

The move by one of Latin America’s poorest countries to adopt Bitcoin as legal tender seemed promising news for the cryptocurrency industry and for El Salvador itself, with the government harbouring hopes that this could save the country $400 million in transaction fees on funds sent from abroad. The government has encouraged citizens to give the digital currency a try, launching its own wallet called Chivo, and even given citizens $30 each in Bitcoin to encourage its use.

READ: What is the difference between cryptocurrency and banks?

However, the roll-out met with several stumbling blocks this week. To begin with, many platforms such as Apple and Huawei didn’t offer the government wallet, while the wallet itself had to be taken offline for several hours after tens of thousands tried to download the app, overloading the servers. In addition, more than 1,000 Bitcoin skeptics took to the streets in protest against the digital currency, citing fears over financial stability and the use of crypto in illicit transactions. 

It didn’t help, of course, that Bitcoin fell from a high of $52,740 at 10am on Tuesday, September 7, to a low of $46,549 by 11pm - a 12% tumble in a single day. While not unusual for this notoriously jumpy asset, this reinforced the reservations held by many concerning cryptocurrencies: namely, their volatility. Ultimately, it begs the question: can an asset that is so volatile be successfully used as legal tender for everyday transactions?


Bitcoin took a steep tumble as El Salvador implemented it as legal tender
Source: https://www.coingecko.com/ 

The advantages of digital assets

This question as to whether or not digital currencies could replace traditional, fiat currencies such as the US dollar for everyday purchases is frequently raised. Not least because there are strong advantages to using digital assets over currencies that are backed by central banks. 

A 2017 report by Futurism looked at the various advantages of cryptocurrencies over cash. These include the fact that digital assets such as Bitcoin cannot be manipulated as easily as fiat money as a result of their decentralized nature (though regulation of this space is ramping up across the world). 

READ: Cryptocurrency and DeFi use cases: The crypto-curious millennial

In addition, according to the report, digital currencies and blockchain technology are well placed to support the concept of universal basic income, making it more cost-effective, flexible and transparent. This idea has been explored already, for example in a 2018 paper by Imperial College London which touts the use of a government-backed digital currency for universal basic income. However, governments are slow to adopt such technological innovation, so we are yet to see a real-life example of this being implemented.

Last but not least, digital assets eliminate the need for intermediaries in transactions, reducing costs for businesses and making the payment process simpler for consumers. In a world that is just beginning to recover from the impact of the coronavirus pandemic, this would be a welcome saving for businesses struggling to get back on their feet.

So what’s the catch?

However, as El Salvador discovered this week, replacing cash and fiat currencies with digital assets is not as simple as it might seem. 

Firstly, the volatility of digital assets makes it harder for businesses to price their goods and services in these assets, while citizens are reluctant to use legal tender that fluctuates in value sometimes by as much as 20% in a single day. Adopting a stablecoin, such as USDT or USDC, as legal tender instead would eliminate this issue, but since stablecoins are pegged to fiat currencies, this also removes many of the inherent advantages of digital currencies.

READ: How does regulation impact corporate digital asset investments?

Secondly, in order to use digital assets as payment more widely, the technology must be up to scratch and must be able to handle the high demand, especially in the initial roll-out stages. This means digital infrastructure must be developed to match these needs. 

Thirdly, as the transition takes place, some institutions, such as traditional banks, could be left behind. Cash could also quickly become incompatible with new platforms, potentially leaving people with stranded assets. Naturally, this is a consideration for governments whose role includes avoiding a collapse of their established economies.

Will other countries follow El Salvador?

As the debate rages on, other countries across the globe are also looking into making Bitcoin legal tender. This includes Paraguay, which is paving the way for greater adoption of cryptocurrencies; Panama, where Bitcoin is popular among its political parties; and Mexico.

Some countries are already seeing an uptick in the use of cryptocurrencies instead of fiat money such as the US dollar. In Argentina, for example, stablecoins such as DAI are gaining popularity.

A stablecoin issued by MakerDAO, DAI has seen its volumes sky-rocket, and some of this is driven by demand from Argentina. Last year, the country saw its currency, the peso, devalued from $0.02 to $0.006 in just 18 months as the inflation rate soared beyond 30%. Against this backdrop, it is no wonder Argentines are looking for alternatives to safeguard their wealth. However, access to the more stable US dollar is restricted in Argentina, with only $200 permitted to be bought through official channels. The alternative, it seems, is cryptocurrency.

READ: Inflation, shrinking cash and the rise of cryptocurrency

In addition, many countries are considering the creation of their own digital currencies. This includes Vietnam, whose State Bank is conducting research into developing and piloting the use of its own virtual currency based on blockchain technology. 

According to data from Statista, Vietnam is seeing the second highest use of cryptocurrencies globally, with 21.1% of the population saying they owned or used digital currencies in 2020. The country with the highest proportion of digital currency users is in fact Nigeria, with 31.9%. 

Similarly to Argentina, Nigeria’s own currency, the naira, has been losing value in 2021 with an inflation rate of 18%, while US dollars are hard to obtain. This predicament is forcing Nigerians to look for alternatives elsewhere, with many using Bitcoin as a dollar proxy to protect their wealth.

But while there is a lot of interest in the potential for digital currencies to sit alongside fiat money, the path to their adoption is likely to be long and arduous and it is hard to see traditional cash being entirely replaced any time soon. For one thing, governments are reluctant to relinquish the control they have over fiat currencies. However, we could see more countries follow El Salvador’s lead as digital currencies continue to attract supporters across the globe.


Do you want to make up to 20% APY on your USDT, USDC and ETH? Sign up for a YIELD App account today!

Read More

Related Articles

No items found.