Due to its flexibility and stability, the globe has used fiat currency for decades. We use it in our daily transactions. Therefore, fiat currency is comparable to the circulatory system of the economy.
Each nation has its currency as its medium of exchange. Regardless of the differences in names and symbols, they are all fiat money.
In this post, we will learn everything about fiat currency and what makes it distinctive from cryptocurrency.
What is Fiat Currency?
Fiat money, often known as fiat currency, is a sort of currency issued by the sovereign entity of a nation, such as the government or other central authority of the state. Fiat money has no inherent value since it is not backed by a commodity (such as gold or silver).
Agriculture-based items functioned as a means of commerce among ancient cultures as money evolved. Then, when humans discovered metal ores, they began using metal coins to trade value due to their scarcity. The introduction of paper banknotes rendered metal coins obsolete. The value of the currency was tied to commodities like gold. Due to the note’s volatility, however, it revealed several flaws; thus, the globe has thus accepted fiat currency.
China was the first nation to use fiat currency. In the first millennium A.D., it was designed to replace the usage of scarce bulky materials such as gold and silver. CurrentlyIn the current day, the U.S. dollar is the most powerful currency in the world.
Some of the world’s leading fiat currencies and their symbols such as are the U.S. dollar (USD), Euro (EUR), British pound (GBP), The Chinese Yuan (CNY) and Renminbi (RMB), Japanese yen (JPY), Korean won (KRW), etc.
Related article: Crypto to Rival or Replace Fiat Within 10 Years
Characteristics of Fiat money
Unlimited supply
Fiat currency lacks a fixed supply. As commodities like gold do not back fiat currencies, central banks may generate or store a limitless amount of money. However, the interest rate may be altered by central banks based on market history and circumstances.
Without instinctive value
Fiat currency is nothing more than a piece of paper whose only value is the faith of those who accept it. It has no tangible value, and the issuing country defines its value. Consequently, it represents the present strength and might of the nation.
Cost-efficient
To manufacture fiat currency, the country’s central bank can set a specified quantity of money to be printed and placed into the market. Depending on the goal of the release, it can be a rapid or planned deployment so that the market absorbs a fresh quantity of in-flow funds.
Foreign exchange (Forex)
Because each nation may have its payment system with special bank notes, swappingit is possible to swap one fiat currency for another in foreign countries is possible. This results in the formation of the Forex market, which facilitates the exchange of national currencies. They are exchanged against other currencies utilising currency pairings such as USD/JPY and USD/EUR.
Easy to carry around or transfer
Without a question, fiat currency is transportable. It is created in the form of very durable paper. In a prolonged period of hyperinflation, individuals must carry a large amount of money to purchase a loaf of bread.
Be a helpful tool to manage the economy
Through monetary policy, nations more effectively govern and regulate their economies. The government adjusts the interest rate depending on the demands of the economy.
Possibility of losing control
Numerous crises have occurred throughout history due to poor monetary policy in retrograde times. The results will be catastrophic if a nation makes ill-advised choices using fiat currency. Zimbabwe has been experiencing hyperinflation since 2007, wreaking havoc on its economy for over a decade.
Zimbabwe: Inflation Rate. Source: Statista
Fiat-backed Stablecoins
Bitcoin can be seen as a mechanism for exchanging and storing value. However, given that Bitcoin and other crypto-assets are unstable and highly unpredictable, how can we utilise fiat currency in crypto? The concept of stable currencies was introduced.
Stablecoins are now prevalent in the cryptocurrency world. Everyone uses them as the basis for purchasing other cryptocurrencies. Stablecoins are becoming one of the most crucial cornerstones of the cryptocurrency industry.
At the time of writing, three stablecoins have been consistently included on the top crypto leaderboard. Tether (USDT), USD Coin (USDC), and Binance USD (BUSD) are three well-known cryptocurrencies. All of them are fiat-backed stablecoins created on blockchains whenever users deposit fiat currency (sometimes USD) into their reserves.
In addition to stablecoins backed by the U.S. dollar, there are stablecoins tied to other fiat currencies, such as CNHT and EURT by Tether and Euro Coin by Circle.
Pros & Cons of Fiat Currency
Pros
Fiat money is a medium of exchange: This is the most significant benefit of fiat currency. It may be used for all purchases. Instead of retaining hefty things such as gold, it is built from a flexible and lightweight material (typically paper) for portability.
Convenient and cost-efficient to produce: The issuing government governs the process of creating fiat currency. Each will have a somewhat unique method for producing fiat currency. In general, printing money is not as complicated, labour-intensive, or costly as the extraction of gold from mines.
A metric to measure an economy’s strength: By analysing the stability of fiat currency, specialists can evaluate whether or not the economy is robust and healthy. Comparing fiat currency to different currencies is another method for ranking economic progress.
Cons
Fiat currency lacks intrinsic value: As previously stated, the central bank of the issuing nation controls fiat money. A group of individuals determines and controls the supply. If the supply increases dramatically, this might cause hyperinflation. In Venezuela, for instance, the inflation rate increased by more than 65,000% between 2017 and 2018. Uncontrolled inflation may ruin a nation.
A potential financial crisis exists: A recession is still possible despite the government’s efforts. During difficult circumstances, people can make poor judgments that contribute to economic instability.
History of the worst cases of Hyperinflation. Source: Investopedia
Fiat currency and Cryptocurrency Differences
Fiat money and cryptocurrencies have a similar characteristic: none has intrinsic value. Unlike gold or other precious resources, fiat currency reflects the power of the government that issues it. To compare fiat currency and cryptocurrencies, let’s examine the distinctions between these two types of the medium of exchange.
Decentralised vs. Centralised
Centralised institutions, such as governments and banks, issue and manage fiat money. Via blockchain technology, Bitcoin and other cryptocurrencies are coded and decentralised. Therefore, it is impossible to alter the blockchain network’s established parameters.
For instance, Bitcoin’s maximum supply of 21 million coins cannot be altered.
Blockchain technology can maintain the transparency and traceability of data, while fiat currency transactions are recalled by memory or spreadsheets. Fiat money is more dependent on its users and the government regulating it. This characteristic makes blockchain systems more decentralised than traditional fiat money systems.
Related article: Bitcoin 101: The Beginner’s Guide & How it Works
Global vs. Local
While cryptocurrencies may be traded over blockchain networks, fiat currencies must often be converted for use in other nations.
For example, if you have EUR in your wallet and are travelling to the United States for work, you will need to convert your EUR to USD.
Fixed vs. Flexible
An extensive blockchain network with a high degree of decentralisation is intrinsically resistant to alterations and attacks. Therefore, it is challenging to address weaknesses or vulnerabilities in the blockchain. On blockchains, fiat money is more flexible than cryptocurrencies. Depending on the necessity for adjustments, the policies of the issuing nation may modify them.
Even if cryptocurrencies might someday replace fiat currency, governments currently prefer the flexibility of fiat currency to control their economies. Moreover, the crypto market is relatively modest compared to other commodities such as gold.
Crypto market cap vs. other metal markets. Source: Ngrave
FAQs about Fiat currency
Bitcoin: Is it a fiat currency?
Bitcoin is decentralised, transferrable money on the Bitcoin P2P (Peer-to-Peer) network. Unlike fiat currency, it is not issued by a centralised institution such as the government. After the completion of each block, a certain amount of Bitcoins are introduced to circulation. The maximum Bitcoin supply is restricted at 21 million BTC, which cannot be altered. Therefore, Bitcoin is not fiat money essentially.
Do modern economies favour fiat money?
Before the 20th century, most nations employed some gold standard or commodity backing. As international trade and finance expanded in size and breadth, the restricted quantity of gold extracted from mines and stored in central bank vaults couldn’t keep up with the newly produced value, creating severe disruptions in world markets and commerce. Governments have more ability to administer their currency, establish monetary policy, and stabilise global markets using fiat currency. It also permits fractional reserve banking, which enables commercial banks to double the cash on hand to satisfy borrowers’ demands.
Does gold support the dollar?
In the past, the U.S. dollar, also known as United States Notes, was backed by gold. However, in the early 1970s, President Richard Nixon issued an order to safeguard the U.S. dollar by eliminating the gold standard.
Does fiat currency cause hyperinflation?
When a government produces its currency, hyperinflation is always possible; yet, most modern nations have only suffered modest inflation. Consistently low inflation is a beneficial driver of economic development and investment because it encourages individuals to spend their money rather than let it lie idle and lose buying power.
Conclusion
Currently, only fiat currency is in circulation. It has both benefits and drawbacks, which contribute to the progress of a nation or have detrimental effects on the population. With correct use, fiat currency is a helpful instrument for government market regulation. Cryptocurrency is a purported contender to replace fiat currency.
