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What Is Fiat Currency: Fiat Vs Crypto Explained

Author: Jeffrey Craig Date: August 11, 2022

Summary

  • 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.

Defining Fiat Currency

The debate over currencies and their future has gained significant traction in recent years as the result of advances in FinTech technology and the proliferation of cryptocurrencies. It has really ignited a heated debate about the future of money and how money will keep its place in the future where the digitalization of finance continues outpacing and out-innovating hard cash.

Moreover, the debate over fiat currencies have hit a crossroads as the world currently is experiencing 40-year highs in inflation as a result of surging global debt, quantitative easing, war, supply chain bottlenecks, and de-globalization.

What Is Fiat Currency?

Fiat currency is legal tender issued, regulated, and controlled by governments. 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.

What Determines The Value Of Fiat Currency?

The value of this money, be it in the form of a paper note or coin, is not tied to any physical commodity. Instead, fiat currency is determined by supply and demand and the stability of the government backing it.

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The History & Rise Of Fiat Currency: When Was Fiat Money Invented?

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).

Commodity Currency

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

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? When Did The US Switch To Fiat Currency?

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.

Why Do Most Nations Use Fiat Money Today?

Most nations use fiat today because it’s become so engrained in the global financial and trading system. As said above, fiat money is easier to transport than hard metals like gold. Therefore, fiat money is easier to trade with (through computers). Originally, this worked out perfectly, as long as the fiat money is tied to the value of gold, then everyone has a somewhat equal base to value the currency on. But things have changed since 1971.

Secondly, nations use fiat because the global economy is so intertwined with trade, finance, investing, and payments, and fiat has become a way of life for people to break out of poverty because it allows people to accept a globally-acknowledged form of payment for their goods or services.

For example, say you are a consumer who has money in the United States and you would like to purchase a clothing item from Southeast Asia. In order to complete the transaction you in the United States would have to send some form of payment to that individual or business, and fiat money is easiest for that purpose (for now).

Fiat Money Pros And Cons

The pros of fiat money are that it allows people from across the globe to exchange goods and services with accepted forms of money , whether that be by accepting the USD, Pound, Euro, Yen, or whatever. The second pro of fiat money is that it’s a worldwide accepted form of payment, which is often overlooked. It’s not easy getting the international community to agree on much. Therefore, fiat money is easy to use to settle transactions in all locations. The third pro of fiat money is that fiat can be used to invest in companies and worldwide stock exchanges and financial institutions.

The cons of fiat money are that they can be stolen, they are susceptible to a failure of government trust, they can be criminally replicated, they are physical and inconvenient to store, and most importantly, over time fiat money tends to inflate.

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Fiat Money System Vs Gold Standard

Comparisons are always used to understand systems, whether it’s fiat vs gold, or the gold standard vs fiat. Generally speaking, the fiat money system is worse than the Gold Standard because of inflation. When the Gold Standard was dropped, global governments began using different forms of monetary policy, which over time have resulted in higher inflation.

However, the fiat system has certain advantages, countries with lower gold stockpiles are no longer tied to their fates, which have also given those respective countries and geographic regions certain flexibility in their economic policymaking. This is the primary argument for why fiat currency is better than gold.

Commodity Vs Fiat Money

However, when it comes to commodities vs fiat money, fiat money clearly comes on top because commodities are even harder to come by and are harder to transfer than gold. Many island countries, landlocked countries, countries in less nature-resourceful areas generally lack in the commodities segment.

Cryptocurrency & Bitcoin Vs Fiat Money

The next step in the evolution of currency is of course Bitcoin, cryptocurrencies, and blockchain! Bitcoin is the first widely recognized decentralized cryptocurrency and has sparked the creation of countless more altcoins and projects.

While the rise of cryptocurrencies and Bitcoin is unlikely to cause massive fiat currency collapse, they are definitely an upgradable alternative to fiat currency. Cryptocurrencies are perfect alternatives to fiat currency because they do everything fiat currencies do but are digital, immutable, and depending on the function, can be programmed to be deflationary.

Is Bitcoin A Fiat Currency?

Interestingly, one train of thought sees Bitcoin as a fiat currency because 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. But generally speaking, Bitcoin is not a fiat currency because it has no central governing body, it’s deflationary, it’s not a physical piece of cash, and it has no nationality. It’s merely money in cyberspace that has garnered the reputation as being “digital gold.”

Can Bitcoin Replace Fiat Currency?

Bitcoin in its current form cannot replace fiat currency. This is because the sheer volume of transactions that occur globally and the scale that fiat currency payments, trade, and finance occupy. This is mainly because of the Bitcoin blockchain’s limitations. However, in principle, Bitcoin can replace fiat currency on its properties alone. Bitcoin was originally meant to be a peer-to-peer payments mechanism, but it has morphed into something different. But the general consensus right now is Bitcoin is unlikely to replace fiat currency, but the process of Bitcoin replacing fiat currency is called hyperbitcoinization, where Bitcoin seemingly becomes the global accepted form of currency.

Can Cryptocurrency Replace Fiat Currency?

So just because Bitcoin cannot or is unlikely to replace fiat doesn’t mean cryptocurrencies can’t. In fact, cryptocurrencies are the most likely alternative to fiat currencies because of their cryptographic innovations, their ability to be transferred worldwide at lower costs than fiat, and because of their potential deflationary characteristics.

Stablecoins are the first up to taking on this task. Interestingly, the largest stablecoins by market cap (USDT & USDT) are stablecoins backed by the US Dollar. USDT and USDC are the favorites for replacing general fiat currencies. However, the US Dollar will likely remain, or be the last domino to fall if fiat currencies were to truly collapse one day.

How To Buy Bitcoin With Fiat Currency?

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.


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