Bitcoin what is fiat

What Is Fiat Currency?

What is Fiat Currency?

Simply put, fiat currency is legal tender that derives its value from its issuing government rather than a physical good or commodity. The strength of the government that establishes the value of fiat currency is key in this type of money. Most countries around the world use the fiat currency system to purchase goods and services, invest, and save. Fiat currency replaced the gold standard and other commodity-based systems in establishing the value of legal tender.

The Rise of Fiat Currency

Fiat currency originated centuries ago in China. The Szechuan province began issuing paper money during the 11th century. At first, it could be exchanged for silk, gold, or silver. But eventually, Kublai Khan came into power and established a fiat currency system during the 13th century. Historians claim this money was instrumental in the downfall of the Mongol Empire, with excessive spending and hyperinflation at the root of its decline.

Fiat money was also used in Europe during the 17th century, being adopted by Spain, Sweden, and the Netherlands. The system was a failure in Sweden and the government eventually abandoned it for the silver standard. Over the next two centuries, New France in Canada, the American Colonies, and then the U.S. Federal Government also experimented with fiat money with mixed results.

By the 20th century, the U.S. was back to using commodity-based currency on a somewhat limited basis. In 1933, the government ended the practice of exchanging paper money for gold. By 1972, under President Nixon, the U.S. abandoned the gold standard altogether, finalizing its demise on an international scale, switching to the fiat currency system. This led to the use of fiat currency around the globe.

Fiat Currency vs. The Gold Standard

The gold standard system permitted the conversion of paper bills to gold. In fact, all paper money was backed by a finite amount of gold that was held by the government. Under a commodity-based currency system, governments and banks could only introduce new currency into the economy if they held an equal amount in value of gold stores. This system limited the government’s ability to create money and to increase the value of their currency based solely on economic factors.

On the other hand, under the fiat currency system, money may not be converted to anything else. With fiat money, authorities can directly impact the value of their currency and tie it to economic conditions. Governments and their countries’ central banks have far more control of currency systems. They can respond to varying financial events and crises with different tools, like the creation of fractional reserve banking and the implementation of quantitative easing.

Advocates of the gold standard argue that a commodity-based currency system is more stable because it’s backed by something that is physical and valuable. Fiat currency supporters counter that gold prices have been anything but stable. In this context, the value or worth of both commodity-based currency and fiat money can fluctuate. But with a fiat currency system, the government has more flexibility to act when there’s an economic emergency.

Some Pros and Cons of Using Fiat Currency

Economists and other financial experts are not unanimous in their support of fiat currency. Defenders and opposers passionately argue the pros and cons of this currency system.

• Scarcity: Fiat money is not impacted and limited by the scarcity of a physical commodity like gold.
• Cost: Fiat money is more affordable to produce than commodity-based money.
• Responsiveness: Fiat currency gives governments and their central banks the flexibility to address economic crises.
• International Trade: Fiat currency is used in nations around the world, making it an acceptable form of currency for international trade.
• Convenience: Unlike gold, fiat money is not reliant on physical reserves that require storage, protection, monitoring, and other costly demands.
• No Intrinsic Value: Fiat currency holds no intrinsic value. This allows governments to create money from nothing, which could lead to hyperinflation and collapse their economic system.
• Historically risky: Historically, the implementation of fiat currency systems has typically led to financial collapses, which indicates that these systems present some risks.

Fiat Currency vs. Cryptocurrency

Fiat currency and cryptocurrency have a bit of common ground in that neither of them is backed by a physical commodity — but that’s where the similarity ends. While fiat money is controlled by governments and central banks, cryptocurrencies are essentially decentralized, largely due to a distributed digital ledger called Blockchain.

Another notable difference between these two currency systems is how each of these forms of money is generated. Bitcoin, like most cryptocurrencies, has a controlled and limited supply. In contrast, banks can create fiat money out of nothing, according to their judgment of a nation’s economic needs.

As a digital form of money, cryptocurrencies have no physical counterpart and are borderless, making them less restrictive for worldwide transactions. Moreover, the transactions are irreversible, and the nature of cryptocurrencies makes tracking considerably more difficult when compared to the fiat system.

Noteworthy, the cryptocurrency market is much smaller and, thus, way more volatile than traditional markets. This is probably one of the reasons cryptocurrencies are not yet universally accepted, but as the crypto economy grows and matures, volatility will likely decrease.

Closing thoughts

The future of both these forms of currency is in no way certain. While cryptocurrencies still have a long way to go and will certainly face many more challenges, the history of fiat currency demonstrates the vulnerability of this form of money. That’s a big reason many people are exploring the possibilities of moving towards a cryptocurrency system for their financial transactions — at least in some percentage.

One of the main ideas behind the creation of Bitcoin and cryptocurrencies is to explore a new form of money that is built on a distributed peer-to-peer network. Chances are Bitcoin was not created to replace the whole fiat currency system, but to offer an alternative economic network. Still, it certainly has the potential to create a better financial system for a better society.

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Bitcoin vs Traditional Fiat Currency: Understanding What Is Fiat Money !!

When I hear the word ‘Fiat’, I think of a nice little Italian car brand.

And I believe you also think the same.

But ‘Fiat’ also means something that you wouldn’t like if you understand the meaning of it.

…a meaning that you will regret, you had known earlier.

And by now you must have understood from the title that I am talking about ‘Fiat Currency.’

That’s why in today’s post I am going to share what fiat currency is…why it is bad? And what you could do to opt out of its disadvantages.

So let’s get down to business:

What Is Fiat Currency or Fiat Money?

Apart from Fiat car manufacturer, Fiat also means by a formal authorization or proposition; a decree.

And a currency that comes into existence due to this authority, declaration or decree is called fiat currency or money like USD, EUR, etc.

Yes, fiat currency or fiat money.

But there is a fundamental difference between money and currency but here fiat currency and fiat money are used synonymously.

So you see what does fiat means…but many people are still unaware of this fact and think their paper money or currency like the USD, EUR or GBP are backed by Gold yet!!

But sadly, no it is NOT.

Back in the good old days before 1971 all the paper money or currency of the world was backed by either gold or US dollar (which was in turn backed by gold).

But in 1971, the US president Nixon took off the world from the gold standard and…

Fiat Currency was born.

If you don’t believe me, look at these two US dollar notes shown below:

If you see this above note clearly states that it is a gold certificate and 20 dollars worth of gold coin is payable to bearer on demand.

Whereas in the below US dollar note, it is legal tender only because the federal reserve says so. And it is by the US government’s decree that this paper is worth of 20 US dollar goods and services.

Now, I know if you are not a US citizen, you would ask, how it is related to my country?

Well, frankly it is:

Before 1971, the world’s financial system was governed by the Bretton Woods System which specified that all the currencies of the world will be backed by US dollar and US dollar will be backed by gold reserves.

And all these currencies were convertible in gold via USD dollar, so they were indirectly atleast backed by gold

But when in 1971, President Nixon ended the gold convertibility of the US dollar and other currencies, all the paper currencies of the world became fiat instantly.

So this is how fiat definition of money came into the picture and I hope now you will be able to define fiat to anyone.

But this type of monetary system has its own drawbacks, which I am going to explain in the next section, so stick with me for a while…

Side Effects Of Fiat Currency

Fiat currency has lot many disadvantages and one of the most important is-Inflation or Hyperinflation.

And as I implied before that fiat currency is not backed by anything other than government’s decree so this becomes great news for the government because now they can print any amount as they want for its expenses on wars, social security, or bailouts.

But this is where it gets nasty guys.

Because now as the supply of dollars or paper currency increases its value depreciates over the period of time.

It is so because now you have a lot more paper currency chasing almost the same amount of goods and services. It is the simple economics of demand and supply, the more the supply becomes the less valuable the underlying thing becomes…

And this is what has happened with all the fiat currencies of the world and here is the classical example of US dollar to understand its depreciation:

So here is the reason right in front of your eyes, why fiat currency is bad !!

How Bitcoin Is Different From Fiat Money

I think by now it is clear that fiat money is worthless pieces of paper for which people give-up their whole lives.

But what’s the alternative to fiat currency?

Well, the alternative is, of course, Gold, as I have stated previously. But Gold markets have also been manipulated to a certain degree.

That’s why you need a form of money that is even harder than Gold and that is Bitcoin.

Unlike fiat currencies, Bitcoin cannot be printed or mined as per the needs of any centralized party.

Bitcoin has a fixed schedule and a robust monetary policy built into its system which makes it resilient to any manipulations.

It is also backed by hard and complex energy intensive math problems which take a significant amount of time and resources to be solved. This is the only way through which new bitcoins come into existence every 10 minutes.

Thus it is different from fiat which is backed by nothing more than the hollow promises of governments around the world.

Now, needless to say, when you have learned about the difference between Bitcoin vs Fiat, you should definitely inquire about how bitcoins can be used for a system that is better than fiat.

And this brings me to my last section:

Fiat Vs. Bitcoin: Why Bitcoin Is Better Than Fiat

Bitcoin is better than fiat in many ways and believes me I can speak whole night about it. But for now, I will limit my assertions to important ones:

• Bitcoin democratizes the concept of money by taking power back from the governments and banks.
• Bitcoin can help in building more freer capital markets than we have created from fiat.
• Bitcoin is inflation proof which is not the case with fiat.
• Bitcoin moves faster and is quicker than fiat currencies for payments.

Now hang on and imagine for a moment:

If this all happens with Bitcoin, what we would be creating?

Needless to say, we would be creating a fairer world where all can co-exist together without worrying about their wealth and prosperity because whatever value they will be creating, will get captured in a fair form of money or currency, i.e. Bitcoin.

So what do you choose? Bitcoin or Fiat

I will go for Bitcoin, what you will choose? Do share with us in the comments section below.

And don’t forget to follow us on Twitter @themoneymonger

Further Suggested Readings…

Hey there! I am Sudhir Khatwani, an IT bank professional turned into a cryptocurrency and blockchain proponent from Pune, India. Cryptocurrencies and blockchain will change human life in inconceivable ways and I am here to empower people to understand this new ecosystem so that they can use it for their benefit. You will find me reading about cryptonomics and eating if I am not doing anything else.

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What is Fiat Money and How Cryptocurrency Offers a Unique Alternative

The rise of Bitcoin and cryptocurrency in general has elicited passionate debates about the future of money. This genuine spike in interest in how the world’s monetary system works is a positive development. As a result, a genuine understanding of fiat money and its mechanics is necessary to understand why cryptocurrency is appealing to so many.

What Is Fiat Money?

The word “fiat” comes from Latin and means something like «it shall be» or «let it be done.» In modern economics, the definition of fiat money is essentially government-issued currency without the backing of physical assets. Money is printed by the “decree” of central banks.

Most governments rely on supply-demand metrics to print out the desired amounts of fiat money. In essence, central banks rely on market forces to determine the rollout of fiat money. That said, the fiat money is still printed on demand and has a high amount of supply flexibility.

Fiat money has origins in China’s Sichuan province in the 11th century. This was the first incidence of standard paper money in exchange for silk, gold, or silver.

In Europe, fiat money became prominent in the 16th century with a silver or gold standard. By the 20th century, most industrialized nations were already using fiat money.

What Is a Fiat Money System?

Let’s take a journey through the historical origins of money. Back when large, organized governments came about, such as in the Roman Empire, governments would mint coins out of valuable commodities like gold and silver. The scarcity of these precious metals gave the coins intrinsic value. In the event that the economic system collapsed, you would still have redeemable precious metal coins.

Later, a new form of currency came about: paper money. Paper, or fiat, money was essentially a piece of printed paper that had a value ascribed to it by the issuing authority. Ordinary people began to make transactions using the paper, which, for a long time, had gold reserves to back it up.

However, as time went on, governments began to abandon the gold standard and issue printed money that had only the confidence of consumers in the country’s economy to back it up. For example, the US abandoned the gold standard in 1971 and continued on with pure fiat money.

Remarkably, the world has continued to make transactions using fiat money ever since. Now, the world essentially operates using an interconnected global fiat currency system. The most prominent fiat currency is the US dollar, which has solidified its place as the world’s reserve currency due to the international oil trade.

Fiat money works if the central bank or equivalent issuing authority upholds the trust of the ordinary people. An irresponsible government can print excess fiat money, leading to hyperinflation. Since fiat money has no backing in physical assets, such a scenario leaves one essentially holding a piece of paper with low or no value. This is the primary problem with fiat money: An all-powerful centralized agency holds all the cards and can wreck the financial system overnight.

Fiat Currencies

A fiat currency is legal tender that has value based on the issuing government rather than physical assets. In such a monetary system, the strength of the government that issues the currency in terms of its ability to maintain a coherent monetary policy is vital. This explains why most developed countries have stable fiat currencies while the opposite holds true for failed states.

Fiat currency as legal tender is about trust and confidence in the issuer of the currency. A stable fiat currency can support savings, investment, and the purchase of goods and services. This has been the basis of the global economy for decades now.

But is it all rosy? Let’s check out some of the advantages and disadvantages of fiat money.

Pros and Cons of Fiat Currencies

Pros	Cons
Flexibility and responsiveness	Elastic supply is great to adjust to the needs of a growing economy.	The ability of fiat money to be printed in infinite amounts can be dangerous. An example is the Zimbabwe government, who printed staggering amounts of money in response to financial issues. This led to punitive hyperinflation, which the country has never recovered from.
Cost	Affordable and convenient to produce compared to gold and commodity money.	The ease of production of paper money is a risk factor when an irresponsible government is leading.
Store of value	Stable fiat currencies like the USD can serve as a store of value.	Fiat money loses value tremendously in the case of hyperinflation.
Control	A single issuing authority such as a central bank can guarantee stability in its monetary policy and has the power to manage variables like liquidity and interest rates. A prime example is the U.S. Federal Reserve, which manages interest rates.	The control of central banks can be catastrophic in creating financial crises like the housing market crash in 2007. The mismanagement of a fiat currency can lead to financial bubbles and devastating crashes.
Risk	Fiat money has a track record of occasional financial collapses. Therefore, there is always the risk that a fiat money system will collapse.

From the above, it is clear that the inherent risk of fiat money is that it is very vulnerable to market shocks. As such, investors have explored alternative financial systems for decades. Gold has been a consistent safe haven globally, but not even gold can address some of the shortcomings of the fiat money model. In 2008, there was a remarkable development in finance. Blockchain technology was a revolutionary invention that is disrupting the world of finance significantly. Though initially low-key with little fanfare, cryptocurrency has risen dramatically to capture the conscious of financial experts across the world.

Bitcoin vs Fiat Currency

Blockchain technology brought with it a remarkable decentralized ledger that could add unprecedented transparency and speed to financial transactions. Bitcoin is a cryptographic digital currency that runs on blockchain technology. Instead of having a central issuing agency, Bitcoin is a peer-to-peer digital currency.

Bitcoin creates a unique financial system that is an independent alternative to fiat. The Bitcoin network eliminates the ability of a central bank to both control and print the currency in unlimited amounts.

In the years since Bitcoin became a global force, many other alternative coins (altcoins) have emerged with a similar decentralized cryptographic model. Examples of such cryptocurrencies include Ethereum, Ripple, Litecoin, and Bitcoin Cash.

Cryptocurrencies are now big financial entities. Bitcoin, for instance, has a market capitalization of over $200 billion. Incredibly, Bitcoin has retained its dominance in the crypto markets despite indications of potential future challenges from the likes of Ethereum.

Why has Bitcoin endeared itself to so many? Let’s compare it to fiat money to understand the distinct advantages of Bitcoin.

The following are some of Bitcoin’s unique characteristics:

1. Cryptocurrencies have a fixed amount from their creation. Bitcoin has a finite ceiling of 21 million Bitcoins, which keeps the volume low. This obviously contrasts fiat money, which has no printing limit, thereby incurring the risk of inflation and hyperinflation. Most altcoins set up higher numbers of available mineable coins after establishment to improve scalability. Regardless, crypto is, in certain respects, similar to the “real asset” value of gold, given the cap on supply.
2. Bitcoin is global and decentralized. Anywhere in the world, people can access and make transactions using Bitcoin. Fiat money normally involves certain procedures for transfers, and different countries have different currencies.
3. Blockchain transactions are transparent. Bitcoin transactions are verifiable and irreversible thanks to the open and decentralized nature of the ledger. This removes the ability of a bank to restrict user accounts and prevent certain users from making transactions.
4. Cryptocurrencies have no transfer limits. Unlike fiat money, with which banks can place artificial limits on transfers, crypto transfers are completely at the discretion of the parties in the transaction. The transfer is instantaneous, without the bottlenecks of approvals and waiting times.
5. Cryptocurrencies are impossible to forge. Regardless of how secure fiat money is, the fact remains that it is paper money, meaning someone out there can counterfeit the currency. However, since Bitcoin is made of cryptographic units secured by mathematics in a blockchain network, it is impossible to counterfeit.
6. Cryptocurrency cuts out excessive charges by banks. Charges such as maintenance fees and overdraft charges are not a feature of crypto transactions. The low fees in crypto transactions cover the network costs.

Bitcoin offers certain distinct features that cover the shortcomings of the fiat currency system. Most significant is the fact that Bitcoin’s supply depends on “market forces” such as fiat money. In fiat, a miscalculation of this supply can lead to inflation, sometimes going to extreme levels like in the case of Zimbabwe.

However, cryptocurrency still has to undergo significant maturity to replace fiat money rather than just being an alternative, as it is now. Nonetheless, the progress crypto has made in its 10 years of existence is astonishing.

Bitcoin is now a household name across the world, making it likely to be a long-term store of value (SOV) and a unit of exchange. Cryptocurrencies that solve the problem of scalability while retaining the immutability of Bitcoin will be the future of finance.

In Summary

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The company is not responsible for any damages or losses that occur in connection with the use of the information contained in this article.

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