What is FIAT currency?

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The term “fiat” is a Latin word that is often translated as “it shall be” or “let it be done” in an authoritative manner. Fiat currencies only have value because the governments maintain that value; there is no utility to fiat money in itself, society creates the value by demanding that currency in order to make day to day transactions.

Simply stated fiat currency is the legal term given by governments when they issue a currency that is not backed by anything as opposed to a physical commodity or a good. The strength and power of the government establishing the currency are key for this type of money. The majority of countries use the fiat currency system for transactions relating to different services and goods, along with investing and saving. The fiat currency replaced the gold standard and the other systems to establish tender value.

The rise of fiat currency

Fiat was established in China and the Szechuan provide began the issue of paper money during the 11th century. At first, the currency has been exchangeable for silk, good etc. However, when Kublai Khan came to power and the fiat currency was established in the 13th century. The historical experts claim that the money was important for falling of the Mongol Empire, along with too much spending and hyperinflation by the end.

The fiat money was used in Europe in the 17th century and adopted by countries including Spain and the Netherlands. The system failed in Sweden and the government abandoned it for the silver standard eventually. Over the next centuries for example Canada’s New France, colonies in America and the US government also experiment with Fiat to mixed results.

By the 20th century, the US was back to commodity-based currency on a limited standard. 1933 saw the government ending the exchange of paper money for gold and 1972 saw President Nixon abandon the gold standard, which led to it falling on a grand scale and switching to the fiat system.

Fiat vs. Gold Standard

The gold standard allowed converting paper bills to gold. The paper money was backed by gold that was held by the government. Under a commodity-based system, the governments and banks can only make new currency if they had the value of gold stored. This system was limited to the ability of the government to create money and increase currency value solely on the basis of the economic factors.

On the other hand, if the fiat system was in place the money cannot be converted. With fiat, authorized people would be allowed to directly influence currency value and connect it to the economy. The governments and central banks can control the currency systems and respond to financial movements and events with tools like fractional reserve banking and implementing quantitative easing.

Those who support the gold standard argue that the system which is commodity based is stable since it is backed through a physical good. Fiat supported state gold has never been stable in price. Within this context, the value of the commodity based and fiat currency can fluctuate but a fiat system is more flexible.

Pros and Cons of Fiat currency

Economists do not unanimously support fiat. Defenders of it argue that there are pros and cons to the system.

· Scarcity: Fiat money is neither impacted nor limited by scare physical products like gold.

· Cost: Fiat money is far more affordable for producing commodity-based currency.

· Responsiveness: The fiat currency gives more leeway and flexibility to authority institutions.

· International Trade: The fiat currency is used in nations all over the world and thus it is acceptable for international trade.

· Convenient: Not like gold, fiat money does not rely on physical commodities to back it and that is good since physical goods get more costs incurred like storing, monitoring etc.

· No internal value: The fiat currency itself is without value. This allows governments to create money from virtually nothing and this has led to hyperinflation and economic collapse before.

· Historical Risk: Previously it has been seen that implementing fiat currency has led financial collapse and this shows risk in the system.

Fiat vs. Cryptocurrency

Both the currencies have common ground in the sense that neither is backed by physical objects but that is all. Fiat is controlled by governments and central banks and are decentralized and run through a ledger also known as the blockchain.

Another big difference between the two currency systems is the way in which each currency is made. Bitcoin like most cryptocurrencies are limited in supply contrasting with fiat which banks make out of nothing according to their judging of the economy.

As a digital currency, there is no physical counter to the cryptocurrencies, and they have fewer restrictions when being used across borders. Also, the transactions are not reversible, and their nature makes them more difficult for tracking.

However, the market for cryptocurrencies is smaller and so more volatile compared to normal markets. This is a reason cryptocurrency are not accepted everyone, though as they develop this volatility will decrease.

Conclusion

The future of the currencies is not certain. While cryptocurrencies have a long time to develop themselves within society and the monetary system, we see that fiat money is showing how vulnerable the form of currency can be. That is a reason people are exploring moving to a system based on cryptocurrencies, at least to an extent.

A major idea behind bitcoin and other cryptocurrencies is exploring new money built on a peer to peer network. Bitcoin was probably not made to replace fiat but just provide an alternative means which is able to create a better financial system for use in society.