What are the economic limitations of crypto overtaking fiat currency? As you may know, there are thousands of different types of crypto coins available out there in the market with a large number of new ones being launched every day by different companies.
Operating on a blockchain, these digital currencies are safe and secure and makes fund transfer an easy affair without needing an intermediary for that.
Add to that, there are lots of CBDCs or Central Bank Digital Currencies being introduced as well which indicates that the central banks across the world are preparing themselves to embrace digital currencies.
A lot of people including crypto analysts and financial market experts think that crypto will take over the current financial system by replacing fiat currency sometime in the future.
It will become a stable and reliable household currency to be used to meet daily expenses.
It is due to the huge growth potential of crypto and the benefits and prospects it has to offer.
Well, whether they are right or wrong is a topic of debate but one thing is certain – there will be a lot of economic limitations to overcome by the crypto industry to achieve this feat.
This is an article that deals with these specific economic challenges faced by the crypto industry in its way to replace cash and take over the current financial system.
After reading this article you will be able to look beyond the hype regarding crypto.
It will make it much simpler for you to find out yourself whether or not the crypto advocates’ claims of it unseating the trusted, established and long-standing institutions are true.
What are the Economic Limitations of Crypto Overtaking Fiat Currency?
When it comes to analyzing the economic limitations of crypto replacing the existing cash system, it will take a lot of research and gaining knowledge on different aspects related to both these financial systems.
You will need to know the economic problems of the existing cash system in the first place.
It is usually very hard to identify such economic problems within any existing monetary system but is essential to know whether or not crypto will be able to solve those issues.
You will also need to know about a few other aspects that may not be directly related to money but may surely affect the fiscal policy of this new digital currency system.
For that matter, you will also need to know the issues and vulnerabilities existing with the crypto landscape as well.
It is only then you will be able to make an accurate analysis of the two polar different financial systems and adjudge the possibilities of a complete crypto takeover.
If you analyze and compare the speed at which the transactions are completed by these two financial systems you will find that as of now both are pretty slow.
It does not need specific mention that the current cash system takes days, and sometimes even weeks, to complete a transaction depending on the location and type.
However, crypto transactions are quite faster in comparison to the current cash system but still needs to improve a lot in order to expedite the transfer process.
For example, as of now as many as 7 transactions can be completed in a minute on the Bitcoin blockchain network, which is pretty slow and far from being called an ‘instant transaction.’
Then it is the cost factor to take into account. Be informed that nothing is free on the blockchain network.
Even if a few crypto exchanges claim to offer transaction service for ‘free,’ you will see that it is not actually free if you look at it closely from a different perspective.
Since cost does not only involve what the consumers pay while making a crypto transaction on a blockchain network, you will need to look at the other allied, direct and indirect costs of it.
As you may know, every transaction made on the blockchain network needs to be verified and confirmed by all other members of a blockchain before it is added into the blockchain as a valid transaction – a process called crypto mining.
Every time a transaction is verified successfully a new block is created by the miner.
They are paid in that particular crypto coin as a reward for their efforts and contribution to the security of the network. This adds to the cost.
Another significant factor is the effect and impact crypto mining process has on the environment as well as the initial investments made by the miners on their mining equipment and recurring expenses of huge electricity bills, both add to the cost.
Therefore, crypto mining needs to be made less costly than what it is now and much faster as well to deal with the incredibly huge surge in the number of transactions that will occur on a blockchain network if crypto replaces the existing cash system.
The next important factor to consider is the congestion in the network that the blockchain networks are so prone to.
This may not be directly related to money but it surely affects the eventual output of the network which reduces its functionality and profits.
There are several different factors of congestion over and above the network speed which the crypto industry needs to look into in order to develop its infrastructure for enhanced functionality.
Otherwise, this will prove to be a serious hindrance in its path to overtake the current financial system.
Consuming energy in huge amounts as well as the environmental impact caused as a result of it is another significant concern.
It is affecting the habitable conditions of the world as well as the economy, having to spend millions of dollars to preserve the environment.
Therefore, to do away with the issues, it is required to focus on finding ways in which the carbon footprints can be reduced significantly.
However, the mining equipment industry is trying their best to produce hardware that consumes much less energy and is highly powerful and fast, but the crypto industry also needs to play its part in it.
It should look for green and renewable energy sources for mining crypto. This will significantly reduce the environmental and economic issues.
One of the most significant issues of the crypto industry is that it cannot scale very easily and according to the demand of the users and the market.
This affects its functionality significantly.
Therefore, the crypto industry should also look into the scalability issue in order to remove the economic limitations related to it and smooth its path to take over the current financial system which is dependent on fiat currencies.
Most importantly, the decentralized consensus as well as the Proof of Work consensus protocol that most blockchain networks operate on, both seem to be pretty fragile.
This is because it needs a lot of trust between the peers and honest participants in the network to ensure its safety and security.
This is very important because they are the ones who control the majority, if not the entire network.
This however is someway against the ‘trustless’ factor this new currency system boasts of.
Looking into all these factors and dealing with all of them effectively and efficiently is therefore the demand of the hour.
Until then the current fiat currency system is safe.
Current Monetary System
If you take a look at the existing monetary and payment system of the world you will have a much better and clearer understanding about its features and strong points.
Then you can tally them with the limitations of crypto and come to know why it will be typically held back from overtaking the current payments systems.
Now, for every growing economy and society, there is a need for reliable, convenient, and stable means that will facilitate making transactions instead of bartering goods.
It is also necessary for the expansion of the economy as well as the economic activities.
Money is needed to fulfill all these needs but that money needs to be both scalable and elastic so that it can grow with the economy as well as address the fluctuating demands of the economy and also those of the consumers most efficiently.
There are lots of instances of failed currencies due to monetary instability that illustrates and substantiates the need for a specific institutional arrangement that will deal with these varying considerations.
This is where the role played by the central banks is so important.
Over the years, these central banks from all over the world have evolved significantly both technically and functionally.
This has paved the path for the central banks to become independent.
This specific aspect of the central banks ensures that the whole financial system operates smoothly.
Apart from that, the features of the current financial systems and the central banks ensure that the supply of money is adequate to respond to the shifting demands of the economy most efficiently and appropriately.
It is all due to the active supervision and participation of the central banks that makes the current monetary system so effective, convenient, and accountable.
This current payment system assures that once a payment is made it is safe, secure, and final.
It is all due to the fact that the existing monetary system comes with all those features that offer a lot of assurance regarding different aspects such as:
- Cost effectiveness
- Scalability and
All these attributes in the current fiat currency systems have made it so efficient and beneficial that most of the people take this system for granted and believe that crypto will have too much to do in order to do away with its characteristics limitations to overtake it.
Crypto and Distributed Ledger Technology
As you already know, crypto and blockchain technology are intertwined.
This technology is basically dependent on collaborative operation which makes it quite efficient but is not devoid of a few significant flaws.
One of the most significant flaws of it is that it allows the malicious actors to compromise it and spend on numerous transactions fraudulently.
Since crypto is decentralized in nature it is easy for the bad actors to duplicate digital transactions, if they can successfully hack into the network that comprises a large number of computers called nodes.
Therefore, as far as cryptocurrencies are concerned, the only probable way to resolve this double spending issue is to have a centralized agent who will be responsible to verify, confirm, and record all transactions.
In order to solve this issue, crypto therefore initiated the use of a distributed ledger.
This ledger is updated in the blockchain in groups of transactions that are commonly referred to as ‘blocks.’
These blocks are sequentially chained with the previous block by using cryptography.
This eventually results in a ‘blockchain.’ This concept is now adapted by myriad other cryptocurrencies.
In this specific process the computer code primarily specifies the way in which a participant in the blockchain network can transact thereby creating a standard protocol.
This is normally designed to ensure that all of the participants in the specific blockchain network follow the specific rules for the sake of the security of the network as well as for their own interest.
This protocol is called the Proof of Work or PoW consensus mechanism.
Every time the distributed ledger needs to be updated, it has to follow this PoW consensus mechanism.
This is fundamentally a kind of mathematical evidence.
It indicates that in order to validate a specific transaction a specific amount of computational work has been carried out by the participants of the network called the miners.
This process, called crypto mining, can be quite costly because it needs both sophisticated mining equipment and a huge amount of electricity.
However, the miners are rewarded with additional tokens or reduction in transaction fees for their efforts, whichever is specified by the consensus protocol.
The good thing about this ledger technology is that if any invalid transaction is updated it is rejected summarily by the network and the reward of the miner is void.
This impels the miners to add valid transactions only.
Moreover, this consensus protocol also specifies the exact ways in which a consensus can be achieved on the order of updates to the distributed ledger.
The miner who solves a mathematical puzzle first and submits it to the pool in the network needs to get it approved by the majority of the miners to get the new block added to the blockchain.
All these aspects of crypto and Distributed Ledger Technology taken together make it a very costly affair for any individual miner and at the same time also make it quite impossible for a bad actor to compromise the system.
This is because they will need to control a large share of the computing power of the mining community.
However, the cost factor of mining will prevent any and every person from taking part in it.
This economic limitation will lower the scale of crypto adoption and thereby reduce its chances to take over the current financial system.
Decentralized Trust Limitations
There are also a few other significant economic limitations that are intrinsic in decentralized crypto technology in terms of trust.
Overall, this decentralized technology of crypto can be easily termed as quite a poor substitute for the current financial system that has a solid institutional backing in the form of fiat money.
Since crypto is expensive and lacks scalability, decentralized trust is also therefore expensive.
Looking at it theoretically, this means that the crypto miners will have to continue competing with each other till their expected profits come down to zero while adding new blocks to the chain.
However, with each passing day, crypto mining is becoming more difficult than ever.
Small-time miners and individuals are finding it very hard to continue competing with the large mining facilities that have come up in large numbers in the past couple of years.
These super efficient mining firms have an incredible amount of computing power since they use several personal computers often adding up to millions in number.
They also have the ability to pay for using huge amounts of electricity which makes even the mid-sized economies find it difficult to compete with them and decentralized trust is tremendously expensive.
Add to that, there is another problem that they need to deal with. It is the ever-growing blockchain ledger that makes it quite unmanageable and unproductive to keep recording the payments made every day.
If you consider the national retail payment system of today that handles an incredibly large number of digital transactions, it will need an equally large number of supercomputers to verify the incoming transactions.
And, the huge number of these transactions will increase the size of the distributed ledger and may reach to one that will easily cover that of even an outsized server just in a matter of a couple of months.
Another significant limitation, as said earlier, is in terms of its scalability which also affects the updating process of the distributed ledger due to network congestion.
This is caused by the predetermined intervals in which new blocks can be added to the chain which restricts the number of transactions that can be processed at any given point in time.
This means that a lot of transactions will go into a queue and be there for several hours before these are confirmed and added to the chain as a new block.
This will be an inevitable scenario within the blockchain even if new blocks are added to it at the maximum size and rate allowed by the protocol. All these will ultimately interrupt the payment process.
This means that the more people use a specific type of crypto the more unwieldy the payments will become.
This will quite naturally and certainly not help much in the extensive adoption of crypto and offering it a chance to replace fiat currency.
Also, cryptocurrencies are known to have unstable value due to their volatile nature.
This value is ideally determined by the market sentiments and not controlled by any central authority as it is in the case with the fiat currency.
The value of the fiat currency is typically controlled by the government that has the power to adjust the supply and demand by printing new currency notes.
Also, it is expanded or contracted in the balance sheet and may also be traded in opposition to the market as and when required.
This is not the case with crypto. Here, the fluctuations in the demand of a coin results in the change in its value since there is no one to control it.
This makes crypto coins so volatile. This volatility or instability of the cryptocurrencies is further enhanced by the significantly large number of new crypto coins appearing rapidly in the market.
The entire system on which crypto is based and performs is therefore very fragile, if that is the right word to use.
This is pretty opposite of the mainstream payment systems that use fiat currencies.
Typically, the permissionless crypto coins such as Bitcoin and others therefore cannot warrant for payment finality in spite of the fact that the people can see and verify that the particular transaction made by them is included in the distributed ledger.
This is because there may be a rival version of it existing in the blockchain ledger due to simultaneous updates of the same transaction by two different crypto miners.
Ideally, only one of these two versions will survive and the other will be discarded by the network.
This makes the entire payment and transaction process as well as its finality pretty probabilistic.
Add to that, this also means that the trust of people on individual payments will largely remain uncertain and extremely fragile because there will be a chance of the network ‘forking.’
This will generate a new version of the protocol as well as the ledger which some of the holders may choose to use while others may stick to the original chain.
This shows that coordination in the ledger on how it should be updated is lacking or poor.
It can break down at any point of time and eventually result in splitting the particular crypto into two networks.
All these limitations not only make crypto investment quite risky but also proves that it has a lot more to achieve to replace fiat currency which is valuable and stable.
There are also some regulatory measures that limit the crypto industry and make it quite challenging for it to take over the current financial system.
Perhaps, one of the most worrying factors of crypto is that it allows money laundering and funding terrorist activities most easily.
It is all due to the fact that the transactions made with crypto usually remain relatively anonymous. This is one of the major concerns for the regulators.
It is for this reason that the securities regulators are monitoring crypto and crypto related activities very closely, especially the Initial Coin Offerings or ICOs made by the new companies.
Typically, businesses turn towards making ICOs in order to raise money for their projects.
They are therefore determined to create functional tokens that can be easily classified as utility tokens due to its features and functionalities.
These tokens are usually out of the scope of the securities regulators.
However, even if these tokens are out of the reach of securities regulation, it is still likely that consumer protection regulations will be imposed on them.
There is another significant regulatory challenge that crypto needs to overcome in the long term to take over the current financial system.
It is its low overall stability and scalability in comparison to that of the existing financial system.
In short, it should be made more scalable and still be able to abide by the regulations imposed on it.
It will also be unwise to ignore the possibilities of creating systemic risks and financial vulnerabilities due to the extensive use of crypto coins and smart contracts related to it.
These also need to be resolved before crypto is ready to take over the present payment systems all over the world.
Overall, after considering them all, it can be said that the challenges of crypto are significant and there is also a lot of difficulty in regulating the crypto industry with the existing frameworks.
All these call for a much better coordination on the global scale as well as more supple regulatory boundaries.
Typically, it will not be a walk in the park for crypto to take over the current financial system completely.
There will be a lot of economic as well as non-economic limitations in its way for it to overcome and succeed, as pointed out by this article.
I have special interest in crypto and intend to help common people to gain knowledge about the digital asset as well as its potential. Follow Me at Linkedin.