Cryptocurrency has become a popular topic in the financial world over the past few years. Mainstream media organisations started taking more notice after Bitcoin rose from USD $900 to almost USD $20,000 in 2017. Now, you find so many sites online tapping into cryptocurrency and the many industries that it is disrupting.
One popular concern is whether or not cryptocurrency will be able to replace fiat currency, or the national legal tender around the world. But to understand that, we must ask: what is the difference between the two?
Cryptocurrency is a virtual currency that uses cryptography to process and secure transactions. Since cryptocurrency is stored on a public digital ledger known as the blockchain, it’s isn’t controlled by a central authority. Meanwhile, fiat money is currency issued by the government and regulated by a central authority or bank. The important thing to remember is that it’s not supported by a commodity – it is based on the economy’s credit.
Is there a correlation?
Given the basic definitions, it is important to address how the two types of currencies are related, if at all.
Coin Bureau cites a recent statistical study regarding the issue at hand. The results reveal a natural correlation between and among fiat currencies, which are definitely correlated in a number of ways. This is, after all, why currency pairs are the essence of the trillion-dollar forex market, as explained in an article on FXCM. For a forex trader to make a successful trade, they have to make predictions on the exchange rate between a currency pair. The correlation between pairs could be due to a number of reasons. For instance, the AUD is negatively correlated with USD since the latter is the quote currency. This means the AUD can lose value relative to the USD.
However, the same study also found that cryptocurrency pairs had a weak correlation to fiat currencies. The figures reveal that Bitcoin may have had an inverse relationship with CAD/GBP, but the movements are too weak to make a sound conclusion.
What, then, is cryptocurrency correlated with?
While there is a lack of evidence to suggest that cryptocurrency and fiat currency are correlated, there is proof that the price of Bitcoin and equities have a relationship. Forbes contributor Clem Chambers explains that when equity indexes move, Bitcoin prices seemingly move in a new direction roughly 10 minutes later. In this sense, it is safe to say that cryptocurrency is correlated with stocks — at least in the short-term. There is yet to be any study that can determine the long-term relationships between the two, partly because trading cryptocurrency has only recently become mainstream. To establish a better connection, we will have to continue studying the movements between the two over the next few years.
Can cryptocurrency replace fiat?
This is the million-dollar question. In a previous article we explored the pros and cons of crypto vs fiat currencies. Those who believe in the power of cryptocurrencies point out how it is not tied to any traditional economic activity, and therefore have the potential to be global currencies that will overtake fiats in the future. However, government bodies have different views on cryptocurrency. Some see them as stocks and securities rather than currency. Others see them as a property, meaning each cryptocurrency trade should be taxable. Without a clear, uniform regulation on cryptocurrencies, as well as feasible ways to spend them, it seems that the likelihood of cryptocurrencies eventually replacing fiat currencies is a long shot — at least for now.
All in all, although its future is unclear, it’s still a good idea for investors to keep a close watch on cryptocurrency movements. Because it is relatively independent of global currency movements, then it can prove to be a good diversification asset, especially for those of us involved in trading fiat currencies.