One of the arguments against crypto is that it is backed by speculation and not as stable as fiat currencies, which are backed by governments. However, the recent challenges with the traditional financial system bring us to an inflection point in the crypto vs. fiat debate. If the foundations of fiat are shaking, then crypto has an opportunity to prove its worth as a financial system that doesn’t require users to trust intermediaries that historically have failed them.
Crypto vs. Fiat: A Glance at the Key Differences
Before diving into the crypto vs. fiat debate, let’s first get on the same page and take a moment to define what fiat and crypto are.
Fiat currencies are traditional forms of money issued by governments and central banks. They gain market acceptance from user confidence and trust in the issuing authority rather than any intrinsic value in the currency itself (e.g. using gold pieces as a currency). Fiat is typically in the form of banknotes and coins, and their value is established through legal tender laws that mandate their acceptance for goods and services within a specific jurisdiction.
In contrast, cryptocurrencies operate independently of banks and central authorities. They gain market acceptance from user confidence and trust in the cryptography and mathetmatic principles used to create the currency rather than trust in a government that issued it. Crypto is an entirely digital currency and has no physical counterpoint. It is a decentralized and distributed network that enables peer-to-peer transactions and the store of value, eliminating the need for traditional banking intermediaries and governments.
Now let’s talk about the role of trust in financial systems today.
Trust in Global Banking
The Role of Banks
Central banks play a crucial role in maintaining trust in the banking system. They are responsible for setting monetary policy, which includes issuing new fiat currency, setting interest rates, and removing cash from circulation to maintain the financial system's stability.
Commercial banks act as intermediaries, facilitating the movement and storage of fiat currency within the financial system. Individuals and businesses hold accounts with commercial banks, which allow them to deposit, withdraw, and transfer fiat for various purposes. Banks also serve as custodians of those funds, providing services such as loans, mortgages, and credit facilities.
How the Global Banking System Establishes Trust
The global banking system, as we know it today, has evolved over centuries, shaped by historical events, economic needs, government initiatives, and regulatory frameworks. One way to think about why people trust global banks is that they are backed by governments. People trust the safeguards around banking that protect depositors’ interests and prevent fraudulent practices because those regulations are backed by tangible things like armies and tax dollars.
Those safegaurds include things like deposit insurance, providing depositors some guarantee of protection in the event of bank failure (called FDIC Insurance in the US), as well as regulatory bodies like the Office of the Comptroller of the Currency that oversee the behavior of central banks and other financial authorities. If a financial institution behaves incorrectly, such as tampering with the fiat supply in an unapproved way, in a very real sense the full force of the government is there to course-correct or punish that behavior.
In short, people trust fiat, and by extension the banks, because the government is there behind them to back them up. But sometimes that trust is misplaced.
Bank Failures Break Trust
While banks serve an integral role in the financial system, bank failures happen more often than you think. Between 2001 and 2023, there have been 564 bank failures in the U.S. alone. When a bank fails, it can result in depositors losing their money, eroding confidence in the banking system. This loss of trust can cause depositors to withdraw their money from other banks, creating what is called “a run on the bank” in which all users flock to withdraw their money at once.
Bank failures can also lead to contagion, where the failure of one financial institution triggers the collapse of another, and then another (like a row of dominos falling down). That contagion could be triggered by many reasons, such as a run on the bank or one financial institution having assets tied up in the organization that failed. Regardless, the resulting losses of one failure can ripple through the rest of the economy like a spreading disease (hence “contagion”), as other businesses fail in its wake, which can lead to economic slowdown—even a recession.
Bank Mismanagement Breaks Trust Too
In addition to the potential impact of bank failures in the global banking system, some central bank actions could backfire to further erode user trust and the functioning of the financial system. As mentioned above, central banks adjust and implement monetary policy to stabilize the economy (and ideally trigger growth). This work involves adjusting interest rates as well as managing the money supply. But what happens when banks make the wrong adjustment?
The results can be disastrous, such as the hyperinflation seen in Zimbabwe and Venezuela. Even in developed economies, the mismanagement of monetary policies can have severe implications. For example, the Greek government's fiscal mismanagement led to a debt crisis that contributed to a loss of confidence in the country's economy until the European Central Bank stepped in.
These anecdotes show that while fiat is backed by large resources, those resources still sometimes make mistakes. So what would money look like if you didn’t have to trust a failable foundation? We thought you’d never ask.
Crypto vs. Fiat: How Crypto Eliminates the Need for Users To Trust Banks
Crypto is a "trustless" financial system because unlike fiat it doesn't require users to trust a third party like a bank. There’s no need for a third party because every transaction is publicly verifiable. You don’t need a centralized authority to settle disputes or to determine the state of the ledger (who owns what). That makes crypto “trustless” and puts crypto in a better position than fiat long term because it removes central points of failure.
Mathematics and Code
Cryptocurrencies are dictated by mathematics and code. Everyone knows precisely how much of a particular currency there is, how much there will be in the future, and how quickly new cryptocurrency is minted. This predictability and transparency is in contrast to fiat currencies, in which central banks can decide to print more money whenever they want.
If you trust the code, you trust the crypto.
This transparency also applies to the record of transactions. All transactions are stored on a public blockchain that is maintained by a network of worldwide users. All of that information is publicly verifiable, removing the need for an arbiter. Instead, that history of transactions is processed and confirmed by the code, using a “consensus mechanism” for this decentralized network to come to an agreement on the order of transactions.
Similarly, smart contracts in DeFi applications further remove trust from the conversation, enabling money to move through various financial instruments autonomously. If you trust the code, you trust the crypto, and the transparency of the ledgers and mathematical proofs ensure there’s no room for fraud or manipulation.
One of the challenges with fiat is that, in general, you don’t have custody of all your money—most people don’t keep all of the money as cash under their mattress. Instead, they keep their money at a bank. But there’s a problem with that, and it’s one we touched on in the beginning of this post: bank failures.
Banks can fail for many reasons, be it a run on the bank, taking on too many risky loans, not diversifying enough, or poor liquidity management. Those failures put people’s money at risk. If you keep money with a custodian, and the custodian fails, there is a non-zero chance you never get that money back.
Crypto takes the opposite approach and focuses on self-sovereignty—users hold all of their funds themselves, removing the risk of another entity misusing their money or failing. This is where one of crypto’s popular taglines, “be your own bank”, comes from.
Crypto is a purely peer-to-peer (P2P) network, meaning all users directly transact with each other. There is no middleman processing transactions. This is true for cash fiat as well, but electronically, fiat moves around through banks and other centralized providers.
With the rise of smart contracts and DeFi, users have access to a fully decentralized financial system where users can interact with each other directly through code and apps, all without intermediaries taking fees or creating central points of failure.
Crypto enables a robust global network where users can cheaply send transactions to each other with fast settlement times, and there are no authorities preventing users interacting with each other or from being able to confiscate their funds.
The Current State of Trust in Crypto
Trust in crypto is a tricky thing, in large part because the space is still young. In theory, trust is absolute: the code is public and behaves a certain way, and that, as they say, is that. However, in practice, there are several challenges with trust in crypto today.
To start with, self-custody is a problem for many users. People often lose the keys to their wallets, and then they are out of luck. You don't have to trust anyone else in crypto, sure, but you do have to trust yourself. That puts a lot of responsibility on the user, and today, they are trained to be able to rely on and trust the bank to look after their funds. This doesn’t make crypto particularly welcoming to new users or make them feel it is trustworthy.
Second, crypto requires users to “trust” the code. Without middlemen or controlling authorities, there is no arbitration when things go wrong. For blockchains that have been around for a long time like Bitcoin and Ethereum, this isn’t a problem—they are battle tested and unlikely to be hacked or compromised—but for many apps and protocols, this is a trust problem.
Hacks in DeFi are common as hackers exploit loopholes found in public DeFi contracts and steal users’ money. The code and data are transparent in crypto, but that’s a double edged sword. Just as it means users can verify their money is there or that a protocol is serving its intended function, it also exposes any bugs to those who may wish to take advantage of them.
Third, just because crypto is decentralized doesn't mean centralized companies aren't built on top of it. To combat the user experience issues described above, many centralized businesses exist on top of crypto. Some of those are reliable; others are not. Recent failures, including the FTX crash, and the contagion that followed were caused by centralized companies mismanaging user funds and making risky investments.
That fallout has damaged the public’s trust in crypto today, and it will take years for that trust to recover. However, crypto’s fundamental properties of transparency, security, and immutability will restore that trust in time. As builders create great products and continue to test and improve DeFi primitives, crypto will win.
Trustlessness Is a Competitive Advantage for Crypto
From an economic standpoint, the current challenges brewing in the global banking system provide an opportunity to strengthen crypto’s position as an alternative to fiat money. According to Edelman's 2023 Trust Barometer, "economic optimism is collapsing around the world, with 24 of 28 countries seeing all-time lows in the number of people who think their families will be better off in five years." The worst part—inflation is one of the top reasons for economic pessimism, on par with existential threats like nuclear war.
Some cryptocurrencies are deflationary, which combats that fear, and their fixed supply makes a hedge against inflation. And generally, the fact that no central authority controls cryptocurrencies means they are not subject to arbitrary changes in monetary policies. That insulates crypto from many of the concerns around inflation and fiat mismanagement, and Web3's transparency makes it easier to win the confidence of the public.
However, even though crypto is a financial system insulated from the fundamental issues of the global monetary system, the global economy has yet to accept crypto as legal tender. The Web3 industry is less than 15 years old and has a long road ahead to convince users that crypto is money and gain widespread adoption as legal tender. As a reminder, the United States government is more than 200 years old—it has guaranteed the U.S. dollar for long enough for users to not worry about the validity of the USD as a medium of exchange.
Today, DeFi apps currently have about $53 billion in TVL (total value locked), and that early success has shown a demand for alternative financial systems across lending, insurance, digital assets, and more. As crypto matures, that success will continue to grow over time.
Start Building Trustless Applications
We are still in the early days of the crypto economy. As Web3 adoption grows, crypto's competitive advantage over fiat will continue to become apparent. That advantage will be rooted in the fact that crypto is trustless money, and Web3 enables developers to put this new form of money to work in a wide range of applications.
If you’re ready to get started, we wrote a guide to Web3 development that accelerates your learning to become one of the earliest builders in the new trustless economy. Ready to get started?