Can you imagine having to carry gold when buying your food for the week? Earlier in history, people used gold in exchange for goods and services, instead of the paper money we are all used to today. but now, instead of gold, we use currency like the American one. the dollar, the euro and even cryptocurrencies in exchange for products.
Today, there are different types of currencies: some may be backed by a government, such as fiat currencies, and others are decentralized and backed by blockchain technology, such as cryptocurrencies. This article will go over the answer to “what is fiat currency?”, its advantages and disadvantages, as well as how it differs from other currencies.
Reading: Is bitcoin a fiat currency
what is fiat money?
Fiat currency, or fiat money, is a type of currency issued by the government and is not backed by physical commodities, such as gold. instead, the value of fiat money comes from the public’s trust in the issuer, the government.
why is it called fiat currency? The fiduciary definition comes from a Latin word that can be translated as “let it be done” or “it will be done”. fiat money only has value because the government gives it value and therefore has more control over the currency and how much can be printed.
fiat money versus cryptocurrency
Fiat money is legal tender, which is currency declared legal by the government, and its value is backed by the issuer (the government). On the other hand, cryptocurrency is a digital currency that is backed by blockchain technology and is decentralized, meaning that it is not backed by a central authority like a government.
Unlike fiat currency, a cryptocurrency is more volatile and provides a higher level of information security compared to fiat money. Although some people believe that cryptocurrencies may replace fiat currencies in the future, most transactions around the world are still done with fiat money.
fiat money vs. commodity money
Commodity money has intrinsic value, meaning it has a real or perceived value associated with it. This type of currency is derived from a material that has value, such as gold or silver. fiat money, on the other hand, has no intrinsic value. consider dollar bills: they’re all cut from the same paper, but their values can differ depending on what the government deems the currency can be exchanged for.
fiat currency vs representative money
The government also produces representative money, but unlike fiat money, it is backed by a physical commodity. There are different forms of representative money, such as credit cards and checks, that represent an intention to pay.
Although fiat money is backed by the government, representative money can be backed by different assets. in the case of checks and credit cards, they are backed by money in a bank account.
understanding fiat money in the united states
For most of US history, the national currency was backed by gold and silver. In 1933, the government passed the Emergency Banking Act in hopes of restoring public confidence in the national financial system. this law would develop a program to rehabilitate banking facilities and then abandon the gold standard, which allowed citizens to exchange currency for gold. From there, the gold standard was completely replaced by fiat money: the US dollar. dollar.
pros and cons of fiat money
Like other currencies, such as cryptocurrencies, fiat money has some advantages and disadvantages.
advantages of fiat money
Fiat money is not only profitable to produce, but also easy to transport and exchange. But one of the biggest benefits is that fiat money is not backed by a commodity, which means it is not scarce, unlike gold. for this reason, a government has greater control over the supply of foreign exchange, giving it the power to manage economic variables such as interest rates, liquidity, and the supply of credit.
Since a government has control over the money supply, it also has the power to protect the country from a financial crisis. in fact, the us The Federal Reserve has a dual mandate to keep the unemployment rate and the inflation rate low.
disadvantages of fiat money
Although a government has control over its supply of foreign exchange, it is still not a guaranteed way to protect the economy from a financial crisis, such as a recession. Another disadvantage of fiat money is that it is subject to inflation and a government could mismanage it and print too much money which could result in hyperinflation.
Furthermore, the price of fiat money depends on government regulations and fiscal policy, which could result in a bubble with rapidly rising and falling prices.
the future of fiat currency
Almost every country now has fiat money as legal tender, so it’s hard to say what’s in store for the future. Although there is a rapid rise in cryptocurrency, and some experts believe it could eventually replace fiat currency entirely, fiat money gives governments more flexibility in managing a country’s economy, therefore we can expect it to remain the main medium of exchange for years to come. .
sources: gobakingrates | history of the federal reserve
fiat currency frequently asked questions
Here are some frequently asked questions about fiat currency.