Whether it’s the euro, the U.S. dollar, or the Swiss franc, all major paper currencies have lost massive value against the top 5 cryptocurrencies over the past 12 months.
But what is the cause of this development? To answer this question, one must first understand how the current banking system works and where the differences between paper money and cryptocurrencies lie.
- The most noticeable difference between cryptocurrencies and paper money is that cryptocurrencies are only available digitally, while paper money exists in physical form.
- Paper money currencies are centralized, while cryptocurrencies are decentralized. While a central authority (central bank) exists and prints money in the paper money system, there is no such central authority in cryptocurrencies. There is no Bitcoin bank or anything like that.
Instead, cryptocurrencies are based on the blockchain, a decentralized database in which all financial transactions that have ever been carried out are stored.
- With paper money, the central bank ensures an inflationary and thus theoretically unlimited increase in money to supply the economic cycle with liquidity. With cryptocurrencies, the amount of money is usually limited. For example, in the case of bitcoin, the number of digital coins is limited to 21 million bitcoins. Thus, cryptocurrencies have a deflationary character.
- While paper money in the banking system is transferred via account numbers, digital currencies rely on addresses and cryptography. This encrypts private data and mathematically verifies identities.
- While banks create money virtually out of thin air (money creation through lending), cryptocurrencies are calculated (mining) or generated through staking (proof of work vs. proof of stake).
As a result, cryptocurrencies have several advantages. For example, banks do not create the money in the crypto universe and lend it against interest, but users (miners) receive money for processing payment transactions.
- Users can thus mine cryptocurrency themselves, effectively becoming their own bank.
- Cryptocurrencies eliminate the middleman (banks, etc.), allowing money transfers to be made directly from one person to the next. This makes it possible to transfer money across national borders in seconds and for low fees.
- Through cryptography, digital currencies are generally more secure and harder to manipulate than in the paper money system.
- Transparency on the blockchain (transactions are visible to everyone) also makes corruption more difficult, so some countries are now considering using the blockchain in public services.
However, complete digitalization also results in disadvantages for cryptocurrencies.
- If the Internet fails or the user has no access to the global data network, no transactions can be made or forwarded.
- If the cryptocurrency owner loses his private keys or accidentally deletes his wallet from the PC, there is a risk of losing the digital money if there is no backup digital wallet or other protection.
- Payment errors or transfers to the wrong address will result in the loss of the digital money, as there is no central place for the user to turn to in case of errors. Crypto users should, therefore, always check the address carefully when making a transfer.
- Cryptocurrencies are more suitable for computer-savvy users, and acceptance in traditional trading is currently still low.
- The past shows that cryptocurrencies are also not protected against attacks from hackers, whereby accounts can be stolen, or the system itself attacked
Cryptocurrencies are still in their infancy and sometimes suffer from scaling issues. Nevertheless, the advantages that cryptocurrencies offer outweigh the disadvantages compared to paper money.
The reason: cryptocurrencies grant access to financial services to billions of people who otherwise do not have a bank account. In particular, in developing countries, nearly 60% of adults are excluded from the banking system because they do not meet the minimum requirements for an account.
In addition, cryptocurrencies serve to preserve value and exchange in countries with weak currency (Venezuela, Zimbabwe, etc.). Cryptocurrencies are also gaining ground among businesses and banks. IBM estimates that by the end of 2017, around 15% of banks will be using blockchain technologies, as they make financial transactions more effective and cheaper.
But also for the investor, an investment in cryptocurrencies can be worthwhile because while classic banks hardly offer any more interest due to low-interest rates, the crypto world sometimes attracts interest rates that are significantly higher than the overnight and fixed deposit interest rates.
In addition, the investor can, of course, also profit from the possible increase in value of the cryptocurrency. However, it should be noted that cryptocurrencies are very volatile and can fluctuate greatly in price.
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