Traditional Financial System vs. Cryptocurrencies; Which One is Better?
Mostly, Experts in the Fintech industry have had prolonged discussions on how crypto differs/relates to gold. Instead, we should be looking at the broader scope, because that’s what crypto is (broad and still evolving), then evaluate its co-existence with the traditional financial system.
Point in case, if you missed our previous analysis on the traditional financial system, you should know that it is 100% centralization and encompasses five core components; central banks, financial markets, financial institutions, and financial instruments. More or so, the traditional financial system has evolved over the centuries. Ever since the era when we used gold, silver, and paper currencies until now where the modern methods of banking have become a way of life (of course, before the inception of cryptocurrencies). However, throughout that eternity, one thing has remained constant, the tight-locked centralization of the traditional financial system.
Contrary, the primary idea of cryptocurrencies (the virtual currencies we so much adore based on blockchain technology) is supposed to be designed as completely decentralized. But then, the technology is still evolving, and hybrid models, which are partially centralized and decentralized, have been developed to bridge the gap between the two financial systems.
In that rationale, does all that form a robust basis where traditional financial systems can be fairly compared and differentiated from cryptocurrencies? Absolutely yes! Since every financial system has its own complexities, strengths, and weaknesses, it is important to determine whether cryptocurrency technology is part of the evolution of the traditional financial plan or a complete abandonment of the centralized model.
Well, indefinitely, throughout this new decade, crypto innovations are expected to grow inevitably. In fact, some experts predict that 2020 could be the onset of the phasing out of fiat currency.
However, before we conclude that the analysts’ predictions are irrational or for some folks to be highly optimistic of the findings, let’s look at the comparison of various features conveyed in both systems.
Transactions involve payment systems. All the banks in the world operate under centralized servers that give a third party complete access to your financial activities. This means that a compromise in their systems compromises the security of your financial data and funds. Centralized systems also charge high fees for transactions depending on transaction destination and money exchange rates.
The idea behind cryptocurrency is to support global payment systems through seamless transactions. Decentralized systems have a peer-to-peer network model and do not pose such risks to user’s financial data or funds because they do not rely on a third party to send or receive money. This makes it fast and cheap and even free sometimes, to send or receive money anywhere in the world. Decentralized systems are, therefore, faster and more secure as they offer sole access to your money as long as one practices correct safety measures of their private keys.
Ease of Use
The ease of use between centralized and decentralized systems currently depends heavily on the demographics of the user base. There is an increasing number of traditional banks incorporating crypto options to their user interface functionality. Such partnerships between cryptocurrency providers and traditional banks are promoting exposure to cryptocurrencies. However, the younger demographic of more tech-savvy people find it easier to understand and embrace cryptocurrencies than older demographic who have more trust in traditional banking methods.
Cryptocurrencies are still considered to be emerging fintech, and as such, they offer many opportunities and limitations. So far, its deemed as not an easy technology to understand or use. A study was done in 2016 indicated than many non-Bitcoin users felt they were incapable of using it. This, together with financial illiteracy, are the two major setbacks of crypto adoption.
Storage and Volatility
Cryptocurrencies can be used to store value for fiat currency in times of inflation. Bitcoin, the most popular cryptocurrency by market volume, is not subject to change in monetary policies by any central bank or government. As such, people have, in the past, escaped to digital currency to preserve the value of their centralized currency to protect their money from poor regional policies. However, cryptocurrencies are highly volatile and often subject to huge fluctuations in prices. Stable coins are special cryptocurrencies designed to minimize their volatility. They are usually pegged to fiat money, cryptocurrency, or exchange-traded commodities that hold value for money. They offer better options in times of fiat money inflation.
A report by CipherTrace indicated that more than $1.2B worth of cryptocurrency was stolen through crypto hacks and scams mostly from crypto exchanges in the first four months of 2019. In many countries, crypto regulations are lacking or are insufficient, and this opens up many loopholes for illegal activities and theft. Unlike traditional financial systems that are traceable and sufficiently regulated, cryptocurrency transactions are anonymous, and this proves it hard for tracing criminal activities. Governments around the world are working hard to establish legal frameworks that will improve the safety of crypto transactions in exchanges, which are a major weak point. Nevertheless, millions of dollars in crypto transactions are safely transacted every day across the globe. Therefore, traditional financial systems are safer because there are currently more comprehensive ways of diagnosing and managing risks associated with using technology.
Impact on E-Commerce
Traditional methods of online payments include visas, credit cards, debit cards, and mobile transfers. While some of these methods are instantaneous, others take business days to process and are prone to digital scams and high transaction fees. Decentralization is one of the key tools used to secure infrastructure networks by diffusing attack points on the network. E-commerce traffic is growing, and more people are using cryptocurrency to buy and sell goods and services online as a cheaper and more secure option.
Decentralized networks are extremely difficult to hack, and this improves data security and integrity. Retailers who accept payment in crypto also cut operation costs and lengthy administrative processes of dealing with third party financial services providers. For e-commerce, blockchain and cryptocurrency technology will remove redundancies caused by dealing with fiat currencies.
Despite advancements in technology, traditional banking systems have been unable to reach and offer financial services to a lot of people. According to the World Bank statistics, 1.7 billion people in the world are unbanked, and yet more 67% have mobile phones that they can use to access financial services. This presents a significant setback for the global economy, which also presents an opportunity for blockchain and cryptocurrency developers to step in. Social media giant Facebook is one of the companies looking to address this problem with its planned cryptocurrency Libra, a new global payment system. Where traditional methods have failed, cryptocurrencies can include people in global economic development without needing to pass through traditional banking systems.
Verdict: Crypto or Traditional Financial System?
Despite reading this piece in a crypto site, one would expect our verdict to lean towards one side. Of course, crypto is way better, but that’s after assessing all the facts, as explained above. Still, the big players in the crypto industry ought to proceed with caution while working on all the faucets that are leaking out its tech brilliance, benefiting the fintech industry.
In only ten years, blockchain technology, especially cryptocurrencies, has shown a massive potential to accelerate and foster a new digital era in the world. Fintech innovations have ushered in revolutionary changes in banking and financial markets that have forced traditional banking systems to innovate or be phased out. The hybrid models that are bridging the gap between fiat and digital currency transactions seem to be a means to an end.
Cryptocurrencies may be a target for national and international regulators and worse, its also crippled by its volatility nature and cryptography complexities. However, on the bright side, the digital age favours crypto existence. Crypto is viewed as a symbol of giving the power back to the people from central governance and creating inclusive and fair business opportunities globally. For that, it makes sense, forecasting that it is only a matter of time before Cryptocurrencies get the better of the traditional financial system.
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