Wonjun Lee and Zaid Khayal
Does fiat currency have an expiry date?
Updated: Jan 17
Before the collapse of FTX, it seemed that everyone was getting into Bitcoin, NFTs, and trading. Now that industry confidence has been shaken to its core, will cryptocurrency ever become as ubiquitous as the conventional ‘Fiat’ currency we have used since escaping the barter system?
Recently, with heightened interest in cryptocurrency, there has been a push towards implementing digital currency into everyday life. For example, in September of 2021, El Salvador became the first country to make Bitcoin legal tender: the country purchased 400 Bitcoin (valued at $20.9 million) in order to both encourage businesses to adopt the change and to increase foreign investments. Bitcoin transactions were not subject to capital gains tax, and to incentivise foreign investors, an investment of 3 Bitcoin would grant them permanent residency.
This change was, however, not successful. Bitcoin plummeted drastically, within a single year, to the point where 400 Bitcoins were worth a relatively measly $6.65 million. This, however, did not discourage El Salvador President Nayib Bukele: he continues to buy more and invest further into the ‘Bitcoin Future’. Bukele even took it to Twitter to dismiss any criticism: he wrote, ‘Stop drinking the elites’ Kool-Aid and take a look at the facts’. The facts, unfortunately, state that the return on the Bitcoin investment is indeed negative and that Bitcoin is indeed not a suitable currency for a nation’s economy to rely on.
Figure 1: A graph comparing the price of Bitcoin and the number of Bitcoin held by the El Salvadorian government. Note the number of held tokens increasing despite their falling value.
With the collapse of the FTX and Bitcoin dipping to all-time lows, El Salvadorian residents have seen their net worth collapse by almost 60% since the introduction of cryptocurrency as legal tender (Figure 1). Even its original currency, derided by the government due to high inflation levels, might have performed better – looking at inflation rates in El Salvador (Figure 2), one can see that the inflation rates were on a steady decline since 1987. But since the introduction of Bitcoin, the inflation rate has risen to 7.29%, the highest since 1993.
Figure 2: Inflation rate of El Salvador from 1987 to 2022. Note the drastic increase in inflation towards 2021.
As cryptocurrency becomes commonplace, the UK government has intervened and has put capital gains tax on any disposable income made from tokens that are sold in the UK. This demonstrates the advancement of cryptocurrency: they have gone from being a handful of decentralised open-source software to an entire industry of more than 9,000 different variants – in just 12 years! Even though crypto-assets are not yet considered money, or equivalent to standard fiat currency (in the UK), the future still looks bright for them as much-needed regulations are introduced. With El Salvador taking the initiative, the future of blockchain is on the horizon: the next step is to learn how to digitise the economy for future growth.
However, there are many dangers to a widespread adaptation of cryptocurrency. Recently, a string of cases and scams related to blockchain tokens have tarnished their reputation: the most famous one being the Terra-Luna case. The value of Terra dropped 99.7% within a week, wiping out investors’ life savings and bankrupting entire companies. Among the biggest problems with the Terra-Luna system was the fact that it was backed by an ‘algorithmic stablecoin’ (a type of stablecoin that is backed not by dollars and other fiat currency and is instead maintained by complex arbitrage systems and algorithms): experts had long deemed these to be inherently unstable.
Another source of controversy stemmed from the so-called ‘Anchor Protocol’: this was a program that allowed users to lend out their coins to acquire a nearly 20 percent return. Sounds familiar? Perhaps because this is an accurate definition of a Ponzi Scheme, more commonly known as a Pyramid Scheme. These accusations against the Terra and Luna coins have made its founder, Do Kwon, an international fugitive. It is also a stark reminder that legislation needs to be introduced on unregulated cryptocurrency markets.
Cryptocurrency has also been plagued by manipulation. The best example would be when Elon Musk was accused of manipulating Dogecoin for his personal gain. Through Twitter, Musk started promoting Dogecoin by allowing consumers to buy specific Tesla merchandise using it. This caused Dogecoin to spike, but a year later, Musk doubled down and rejected Dogecoin, stating the environmental issues of mining.
Possibly the biggest problem that governments have with cryptocurrency is the fact that it allows people to launder money by making use of blockchain’s anonymous nature. This makes it difficult to identify criminal activity – indeed, cryptocurrency is the preferred method of payment when purchasing illegal goods and services from the dark web. The government is also hesitant to implement cryptocurrency as a second means of payment due to the large amount of scams and frauds being conducted using blockchain technology. As companies begin to accept such payments, there is a risk that directors will hide the profit margins from authorities to secretly embezzle the money.
Considering all the drawbacks of cryptocurrency, will these online tokens ever replace the conventional Fiat Currency that is used day to day? Perhaps that will be the case soon - indeed, there has been research done that predicts that digital assets (such as cryptocurrency and NFTs) will either completely replace government-issued currencies or provide a viable alternative to them. Implemented correctly, cryptocurrency could be an incredible weapon towards combating inflation, something which could possibly never be done with conventional currency. However, it is just as likely that cryptocurrencies will diverge entirely from fiat currencies, and that they will serve an entirely separate purpose. Experts believe that while fiat currencies will remain the main paying method, cryptocurrency will become mostly an ‘investment asset class, to the point it would be more correct to call them crypto assets.’
Still, there have been instances of people using blockchain technology on a day-to-day basis. Transactions within the (still fledgling) Metaverse are often done using cryptocurrency and NFT sales, while some musicians are selling their music as NFTs instead of listing the songs on Spotify or Apple Music. Services such as Crypto.com have partnered up with VISA to allow consumers to both store cryptocurrency as credit and spend it in real-life stores. These instances do point towards the fact that crypto assets could indeed be used in lieu of actual money.
As mentioned before, to make cryptocurrency more commonplace than it is today, more regulation needs to be implemented to protect consumers from legal loopholes and fraud. This will become especially more important as methods of payment evolve: with FAANG companies getting into FinTech (Apple Pay, Google Pay, AliPay etc), they could well begin to mint their own currency using blockchain technology. And with governments (such as in the UK) thinking of minting their own cryptocurrency to use instead of conventional currency, perhaps the end of Fiat currency is indeed nigh.