Each country has its own medium of exchange in the form of money. Despite the difference in names and symbols, they follow the same type of currency, which is fiat money.
In this following article, we will discover everything about fiat money and what is so special about it?
What is Fiat Money?
Fiat money (or Fiat currency) is a legal currency issued and backed by a government, not a commodity such as gold and silver. This means the value of the fiat money is tied to the power of the issuing government, not any tangible things. In the past, people often used gold or other commodities to exchange value instead of using a common legal tender.
Money has its evolution road, in which goods from agriculture served as a medium of exchange for people in ancient tribes. Then humans found metal ores, so they used metal coins to exchange value thanks to their rarity. The advent of paper banknotes set an end to metal coins. Banknotes were pegged to commodities like gold. However, the banknote exposed many drawbacks due to its instability. Therefore, the world has adopted fiat money.
China was the first country to use fiat money. Around 1000 AD, they invented it to replace the use of cumbersome rare materials like gold and silver. Fast forward, the U.S dollar is considered to be the most powerful currency in the world at the present.
Some top fiat currencies and their symbols around the world:
- U.S. dollar (USD)
- Euro (EUR)
- British pound (GBP)
- The Chinese Yuan (CNY) and Renminbi (RMB)
- Japanese yen (JPY)
- Korean won (KRW)
Characteristics of Fiat money
Unlimited resource: Fiat money does not have a fixed supply. The central banks can print or hold unlimited money as fiat currencies are not backed by other commodities such as gold. However, the interest rate can be changed by central banks, relying on history and the current market conditions.
Without instinct value: Fiat money is only a piece of paper holding no further value but the underlying faith of the people who accept it. It is bonded to no tangible value. Its value is determined by the issuing country. As a result, it reflects the current status of the country in terms of strength and power.
Cost-efficient: To produce fiat money, the central bank of the country can give orders to set a specific amount of money to be issued and released to the market. It can be a fast deployment or a scheduled one, depending on the purpose of the release, so that the market can absorb a new amount of in-flow money.
Foreign exchange (Forex): Since each country might have its own payment system with different bank notes, it is possible to exchange one fiat money for another for usage in foreign countries. This creates a financial market named Forex, which is for exchanging national currencies. They are traded against others by using exchange rate pairs such as USD/JPY or USD/EUR.
Easy to carry around or transfer: Without a doubt, fiat money is portable to carry around. It is made in the form of paper with high durability. In a long period of hyperinflation, people might have to carry a big pile of money to buy a loaf of bread.
Be a helpful tool to maneuver the country’s economy: Through monetary policies, countries can manage and regulate the economy more efficiently. The interest rate is adjusted by the government, based on the economy’s needs.
Potentially losing control: In history, there have been tons of crises occurring due to bad monetary policies in regressing time. This will be devastating for a country if it applies inappropriate decisions with fiat money. Hyperinflation has been going on in Zimbabwe since 2007, devastating its economy for over a decade.
Bitcoin can be considered a means to exchange value and store value. But how can we use fiat money in the crypto space because Bitcoin and other crypto assets are unstable and too volatile? The notion of stable currencies came into existence.
Stablecoins are now popular among the crypto community. Everyone uses them as the based cryptocurrency to purchase others. Therefore, stablecoins are now one of the most important pillars in the crypto space.
At the time of writing, there are three most popular stablecoins that have been listed on the top crypto leaderboard for a long time. Those notable names are Tether (USDT), USD Coin (USDC), and Binance USD (BUSD). They are all fiat-backed stablecoins that are newly minted on blockchains whenever users deposit fiat money (occasionally USD) into their reserves.
Besides the U.S. dollar-backed stablecoins, there are other stablecoins pegged to other fiat currencies, such as CNHT and EURT by Tether, or Euro Coin by Circle.
Pros and cons of Fiat Currency
Fiat money is a medium of exchange: This is the biggest advantage of fiat money. People can use it for every purchase. It is made in a flexible and lightweight material (often paper) to carry around instead of holding heavyweight materials like gold.
Convenient and cost-efficient to produce: Producing fiat money is a process controlled by the issuing government. Each will have a slightly different formula to produce fiat money. In general, the money printing process is not as complex, labor-intensive, and expensive as panning gold out of mines.
A metric to measure the strength of an economy: By weighing the power of fiat money, experts can determine whether the economy is strong and healthy or not. Comparing fiat money to others is also a way to rank economic growth.
Fiat money has no intrinsic value: As mentioned, fiat money is controlled by the central bank of the issuing country. The supply is centralized and determined by a group of people. This might lead to hyperinflation if the supply drastically rises. For example, in Venezuela, the inflation rate skyrocketed by more than 65,000% in 2017-2018. Uncontrolled inflation can devastate a country.
A financial crisis is possible: It is still a chance that a recession will happen despite the government’s efforts. During challenging times, they might make inappropriate decisions that lead to instability in the economy.
Differences between Fiat currency and Cryptocurrency
Fiat currency and Cryptocurrency have one thing in common: They have no intrinsic value. Unlike gold or other scarce materials, fiat money reflexes the strength of the issuing government. To weigh fiat money and cryptocurrencies, let’s see the differences between these two types of the medium of exchange.
Decentralized vs. Centralized
Fiat currency is issued and controlled by centralized entities such as governments and banks. By contrast, cryptocurrencies are decentralized thanks to blockchain technology. Bitcoin and other cryptocurrencies are programmed before the launch. Therefore, it is impossible to change the predetermined parameters of the blockchain network.
For example, Bitcoin's max supply is 21 million coins, which is immune to be changed.
Blockchain technology can keep data and information transparent and trackable, while fiat money payments are remembered by mind or spreadsheets. Fiat currency relies more on the people who use it and the government that controls it. This feature makes blockchain systems more decentralized than Fiat currency systems.
Global vs. Local
While cryptos can be transferred on the blockchain networks, fiat currency often have to convert to another for usage in foreign countries.
For instance, if you have EUR in your wallet and go to the U.S on a business trip, you will have to exchange your EUR for USD.
Fixed vs. flexible
A big blockchain network with a high level of decentralization is inherently immune to changes and attacks. Therefore, if the blockchain has some flaws or exploits, it is hard to fix them. Fiat currency is more flexible than cryptocurrencies on blockchains. It can be modified by the policies of the issuing country, based on the need for changes.
Even though there is a controversial discussion that cryptocurrencies can potentially replace fiat money, governments still prefer the flexibility of fiat money to manage their economy. In addition, the crypto market is comparatively small when compared to other markets like gold.
FAQs about Fiat money
Is Bitcoin a fiat currency?
Bitcoin is a decentralized currency that is transferable on the P2P (Peer-to-Peer) Bitcoin network. It is newly minted by the network as a reward for block validation. Unlike fiat money, it is not issued by a centralized entity such as a government.
After each block is completed, there is a concrete number of Bitcoin added to the circulation. The number is 6.25 BTC from 2020, and it will decrease by half after each 4-year period. In addition, the maximum supply of Bitcoin is capped at 21 million BTC, which can not be manipulated. Therefore, Bitcoin is inherently not fiat money.
Is the U.S dollar backed by gold?
In the past, the U.S dollar was backed by gold, known as United States Notes, but in the early 1970s, U.S president Richard Nixon gave an order to protect the U.S dollar by removing the gold standard.
Fiat money has been in usage for the time beings. It has both advantages and disadvantages, which might lead to the growth of a country or occur negative impacts on the people. With proper usage, fiat money is a helpful tool for the government to regulate the financial market. Last but not least, crypto is a so-called candidate to replace fiat money. How will this ideal scenario of crypto play out in the future?