We often read that cryptocurrencies are in competition with fiat currencies. Some nations, such as China or Turkey, are therefore declaring “war” on digital currencies. Correspondingly, CBDCs, i.e. digital central bank money, are being promoted. Why we can only speak of a competitive relationship to a limited extent and why the US dollar benefits from rising prices on the crypto market.
The term cryptocurrency suggests that the digital placeholders on a blockchain have the same purpose as, for example, euros or US dollars. However, this is not the case, as 90 percent and more of all cryptocurrencies have an application reference that stands above the function, as a universal payment and value storage medium. There is no logical reason why you should use Cardano, Solana, or Polkadot to pay for your rolls at the bakery. After all, you don’t pay for your coffee with a tokenized Tesla share either.
Store of value yes, currency no
In terms of a currency, Bitcoin is therefore unlikely to pose a threat to any currency area that does not have massive economic problems. The situation is different for the value storage function, which has been Bitcoin’s actual primary function over the past few years. The narrative that Bitcoin benefits from the loss of confidence in fiat currencies and their inflation is quite convincing in the sense of digital gold. This thesis cannot be contradicted in principle.
However, the motivation is more akin to investing in gold rather than fleeing to another currency. Gold is basically not used for payment either. After all, it makes a difference whether one invests in precious metals to own a limited tangible asset or another currency like the Swiss franc. This does not yet justify a danger that Bitcoin could replace another fiat currency.
Better central bank policy thanks to Bitcoin?
But what is not, can still become. Cautious attempts to use Bitcoin as a payment currency, such as in El Salvador, nevertheless give rise to the hope that Bitcoin could increasingly become a fiat currency alternative as its volatility decreases over the next few years. Based on this, it can theoretically be concluded that cryptocurrencies can play an educationally important function for monetary policy.
Unless digital currencies will not be banned, they can theoretically compete with the respective fiat currency. Consequently, this increases the motivation for the central bank to pay more attention to monetary stability. However, the competition has a catch here as well: It only works as long as the fiat currency dominates. Should things turn out differently and people turn to private cryptocurrencies for payment, then a ban, as already given in some countries, would quickly spread.
When rampant inflation began in Turkey a few months ago, one of Erdogan’s first reactions was to ban cryptocurrency payments. There can therefore never be any talk of free competition between fiat currencies and cryptocurrencies, not even in the eurozone or the US dollar area.
That is how much the US dollar benefits from cryptocurrencies
The extent to which Bitcoin and Altcoins can even contribute to strengthening a fiat currency can be seen when looking at the US dollar. While the state US dollar “only” makes up around 60 percent of the world’s reserve currency, this share is over 90 percent for tokenized fiat currencies, or more precisely for stablecoins. Of the 20 largest stablecoins, 18 are based on the U.S. dollar. In terms of trading volume, the largest USD derivatives, Tether (USDT), USD Coin (USDC) and Binance USD (BUSD), also account for well over 90 percent of total stablecoin turnover.
This additional demand for U.S. dollars – driven by stablecoin coverage – in turn strengthens U.S. monetary policy. The more U.S. dollars demanded by foreign demand, the more the U.S. government can borrow. Or put another way: The more USD stablecoins in circulation, the more likely it is that the Fed can print money without any negative consequences. The mechanism of action is comparable to oil, which is settled in U.S. dollars by default.
Leading cryptocurrency: Tether instead of Bitcoin
Anyone who is active in the crypto sector can tell you a thing or two about it. Hardly anyone is likely to have a foreign currency account in US dollars at their house bank. However, most of those who are active in the crypto market have already held USDT or USDC.
To put it somewhat exaggeratedly, Bitcoin is not the cryptocurrency of choice, but Tether USDT is. After all, its daily trading volume is the highest of all cryptocurrencies. Its daily volume accounts for more than 50 percent of the total crypto market turnover on some days.
As the crypto sector grows, so does the demand for stable, tokenized fiat currencies in the crypto market. The flight from the volatility of cryptocurrencies is therefore also an opportunity for fiat currencies.
Do not disregard interdependence
Breaking away from the competitive notion of cryptocurrencies vs. fiat currencies, a stronger Bitcoin while fiat currencies remain stable is not mutually exclusive. Crypto adoption is driven by far more than just distrust of fiat currencies.
Stable fiat currencies are the basic prerequisite for investment and growth in this regard. The capital that flows into cryptocurrencies must be generated within an economy, unless it is diverted from other assets – as seen with gold.
If we want to see a rising market capitalization of the numerous digital currencies, then this also requires a stable US dollar, euro, etc. Without stable currencies, in turn, there will be no strong economies, and without strong economies, there will be no strong crypto-economy.
More opinion than science
It is difficult to deny that Bitcoin is in part in a competitive relationship with fiat currencies. Nevertheless, it would be too simplistic to place Bitcoin’s value proposition solely in dependence on fiat currencies. Especially since the bulk of cryptocurrencies are more like decentralized tech companies, ergo stocks, than currencies.
Due to the short history of cryptocurrencies, many of these assumptions are based merely on conjecture or only short periods of observation. For example, how Bitcoin will react to the U.S. dollar’s planned interest rate hikes is something we can only guess based on our assumptions, but cannot scientifically prove. Finally, there is a lack of comparable precedents from the past in which Bitcoin already existed as well as possessed a comparable macroeconomic relevance.
