What is Fiat Currency: Fiat vs. Crypto Explained
- What is Fiat Currency: Fiat currency is legal tender issued, regulated, and controlled by governments.
- Examples of fiat currencies: The most dominant fiat currencies are the US dollar, the Chinese Yuan, the Euro, the Japanese Yen, and the British Pound Sterling.
- Pro of Fiat: fiat currency holds no intrinsic value of its own aside from the value that its issuing government confers on it.
- Con of Fiat: A major downside to fiat currencies is the inflation that arises through the mismanagement or overprinting of money.
What is Fiat Currency?
Fiat currency is legal tender issued, regulated, and controlled by governments. The value of this money, be it in the form of a paper note or coin, is not tied to any physical commodity. Instead, it is determined by supply and demand and the stability of the government backing it. The most dominant fiat currencies are the US dollar, the Euro, the Japanese Yen, and the British Pound Sterling. However, this wasn’t always the case; money evolved through multiple stages before taking the form it has today.
The History and Rise of Fiat Currency
The three types of money explained
The need for money essentially arose from the need to have things. Once man realized that they couldn’t hunt/gather all the things they needed, they began to trade or barter. Soon, they also realized that different items or services had different values. A trade could only be completed if both parties had an item that each wanted (of similar value).
So came about commodity currency, or items being used as money. This relies on the idea that some things held a certain level of intrinsic value to everyone. Depending on where you were in the world, various commodities were used as currency. In colder regions, furs and pelts were the standards, while in warmer areas, these were less likely to be as valuable as food or other minerals. It wasn’t an exact science, and value tended to be mostly based on the necessity and availability of certain items.
The Drawbacks of Commodity Money
One of the biggest problems with commodity money was maintaining its value long-term. As a merchant with many high valued goods, you may have received a lot of barley as payment. Unfortunately, the barley’s value is lost in a relatively short time if it spoils before usage. This feature of commodity currency made it practically impossible to store wealth. Even if barley had been turned into a product with a longer shelf life, such modification might have lead to its loss of value as a currency anyway.
Not all commodity money was perishable of course. Precious metals are the most well known and long standing commodity currencies, with some developing nations still using gold and silver to back their national currencies today. An issue with using metals is the inconvenience of having to carry bulky and heavy materials around. Instead, banks began using paper vouchers to represent a certain amount of gold being officially stored in their accounts. This is what gave birth to representative money.
Representative money is a government-issued note that is backed by an actual commodity, like gold or silver.
Representative Money vs. Fiat money
One of the key differences between representative currency and fiat currency is that governments could only print money according to the amount of actual gold they had in their vaults. Technically, each one of these notes was at one point redeemable for the amount of gold they represented. This Gold Standard soon became accepted globally. Each country had a different currency with a value that was determined based on their own gold reserves and their prices for the metal.
When did Fiat Currency emerge?
In 1971, President Richard Nixon made it illegal to hoard privately owned gold. This led to the end of the Gold Standard, a transition from representative currency to fiat currency. Circling back to the beginning of this article, recall that fiat currency holds no intrinsic value of its own aside from the value that its issuing government confers on it. In other words, fiat currency derives its value not from a commodity but from the government’s power. If the government backs this currency as a reliable payment method, then most people will accept it as such. A major downside to this is the inflation that arises through the mismanagement or overprinting of money. In Venezuela, for example, their local Venezuelan Bolivar must be immediately exchanged for USD to avoid losing value given the hyper-inflation plaguing the country.
Cryptocurrency vs Fiat
The next step in the evolution of currency is of course, crypto! Bitcoin is the first widely recognized decentralized cryptocurrency and has sparked the creation of countless more altcoins and projects.
Is Bitcoin a Fiat Currency?
Interestingly, one train of thought sees Bitcoin as a fiat currency, as it’s not backed by any commodity and instead derives its value from investors’ faith and, to some level, governments. The accuracy of this statement remains highly debatable.
Understanding Central Bank Digital Currencies: What is a CBDC?
Can You Buy Bitcoin With Fiat Currency?
Yes. The easiest way to buy Bitcoin is through an exchange. For example, Phemex is a secure crypto exchange where you can buy Bitcoin using your credit or debit card. You can also buy directly with your Bank account.