Could you picture having to purchase groceries for the week with gold in your pocket? Earlier in history, instead of the paper money that we are all familiar with now, people used gold to exchange goods and services. In exchange for goods, we now use cash such as the US dollar, the euro, and even cryptocurrency, rather than gold.
There are several sorts of currencies available today: some are backed by a government, such as fiat currencies, while others, such as cryptocurrencies, are decentralised and based on blockchain technology. This page will explain “What is fiat currency?” as well as its benefits and drawbacks, as well as how it varies from other currencies.
What Is Fiat Currency?
Fiat currency, often known as fiat money, is a form of currency issued by the government that is not backed by tangible assets like gold. The public’s faith in the issuer, the government, is what gives fiat money its value.
What is the meaning of the term “fiat currency”? The term “fiat” is derived from a Latin word that means “let it be done” or “it shall be.” Fiat money has value solely because the government assigns it; as a result, the government has more control over the currency and the amount that may be created.
A brief modern history of currencies
Currency used to be made of a tangible thing having an agreed-upon value, most often metals like gold, silver, copper, and bronze in recent centuries. The finest example is the British pound sterling, which started off as a one-troy-pound silver piece.
Scription was literal: One pound of sterling silver was specified in the description. The value of this physical coinage was included within the coin.
Governments began issuing paper money, or notes redeemable for a measure of the supporting standard, from that point forward. Beginning in the 1700s, gold was the solution for the British pound sterling. Until 1933, a single dollar could be exchanged for gold in the United States.
Governments have shifted away from the gold standard throughout the last century. The governments that issue currencies now nearly unanimously back them. The dollar is an example of a fiat currency. In 1976, the United States government formally severed the gold-dollar connection.
Fiat Money vs. Cryptocurrency
Fiat money is a form of legal tender, or a currency that has been deemed legal by the government and whose value is guaranteed by the issuer (the government). Cryptocurrency, on the other hand, is a decentralised digital currency supported by blockchain technology. It is not backed by a central authority such as a government.
In comparison to conventional money, a cryptocurrency is more volatile and provides a better level of information security. Although some individuals believe that cryptocurrencies will eventually replace fiat currencies, fiat money is still used in the majority of transactions throughout the world.
Fiat Money vs. Commodity Money
Commodity money has intrinsic value, which means that it has a real or perceived worth. This sort of cash is made from a valuable commodity like gold or silver. On the other hand, fiat money has no intrinsic value. Consider dollar bills: they’re all made of the same paper, but their value varies based on what a government considers the money to be worth.
Fiat Currency vs. Representative Money
The government also creates representative money, but unlike fiat money, it is backed by a tangible product. There are several types of representational money that signify a desire to pay, such as credit cards and cheques.
Although the government backs fiat money, representational money can be backed by a variety of assets. A check and a credit card, for example, are backed by funds in a bank account.
Understanding Fiat Money in the United States
The national currency of the United States was backed by gold and silver for the majority of its existence. In order to restore public trust in the national banking system, the government established the Emergency Banking Act in 1933. This bill would create a plan to repair banking infrastructure and eventually phase off the gold standard, which allowed residents to swap their cash for gold. The gold standard was totally supplanted by fiat money, the US dollar, from then on.
What Are Central Bank Digital Currencies (CBDC)?
The introduction of central bank digital currencies (CBDC)–virtual currencies generated and supported by a country’s central bank–could be an important development.
CBDCs may appear to be an oxymoron to some because cryptocurrencies are by definition decentralized and have no central authority supporting them, but according to a January 2020 poll by the Bank of International Settlements, 80 percent of central banks were exploring and experimenting with CBDCs.
Pros and Cons of Fiat Money
Fiat money, like other currencies such as cryptocurrencies, has advantages and disadvantages.
Advantages of Fiat Money
Fiat money is not only inexpensive to make, but it is also convenient to use and trade. One of the main advantages is that, unlike gold, fiat money is not backed by a commodity, hence it is not scarce. As a result, a government has more influence over the currency supply, giving it the ability to manipulate economic factors like interest rates, liquidity, and credit availability.
Because the government has control over the money supply, it can safeguard the country from a financial catastrophe. In reality, the Federal Reserve in the United States has a dual duty to keep unemployment and inflation low.
Disadvantages of Fiat Money
Even if a government has control over its currency supply, it isn’t a foolproof approach to shield the economy from a financial crisis like a recession. Another downside of fiat money is that it is prone to inflation, and if a government mismanages and prints too much money, hyperinflation may occur.
Furthermore, the price of fiat money is influenced by government rules and fiscal policies, which might lead to a bubble with fast price rises and falls.
The Future of Fiat Currency
Fiat money is now legal tender in almost every country, so it’s difficult to determine what the future holds. Although cryptocurrencies are gaining popularity and some experts predict they will eventually replace fiat currency, fiat money allows governments greater freedom in managing their economies, so we should anticipate it to remain the dominant means of trade for many years to come.
Fiat currencies have no intrinsic worth in and of themselves. Instead, it is on to a government and its central bank to maintain their value while also ensuring that an economy has a healthy supply. “It is a governmental obligation to protect the value of the money they issue,” former Fed Chairman Paul Volcker famously declared. And when they fail to do so, it endangers a crucial level of faith in government.”
Some think that cryptocurrencies will put fiat money to the test as a store of value and a means of trade. Since 2017, the prices and popularity of cryptocurrencies such as Bitcoin have skyrocketed. They haven’t, however, become a regular method of payment for items. The market’s volatility has led some investors to assume that digital currencies are not a viable store of wealth.