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What Is Fiat Money (Currency)?

What Is Fiat Currency?

There are different types of currencies in existence today. A currency’s value and purchasing power will depend on the country’s economic standing. Internationally, each government has recognized money of its own. Some currencies do not belong to a specific country but rather in the realm of the internet – the cryptocurrency.

Have you ever heard of a currency that doesn’t have any value but is still used and honoured by many governments? If not, then you may want to read on to find out more about Fiat Currency.

Introduction to Fiat currency

Fiat currency, also known as fiat money, is a government-issued currency or a national currency that doesn’t have intrinsic value. It is just a legal tender that governments issue for purchasing goods and services. Unlike commodity money, whose value comes from the price of silver or gold, fiat money’s worth relies solely on trust.

It is like a promise made by a government or a central bank to another government or entity. It is based on the supply and demand and the economic stability of the issuing government. Historically speaking, fiat money was first observed around 1000 A.D. in China and was made popular again in the 20th century. Currently, paper-based fiat currencies are used by many nations as a mode of payment.

How Does Fiat Currency Work? 

Since fiat currency isn’t backed by any physical commodity like gold or silver anymore, its function relies heavily on the people’s faith who agreed to use fiat money. Paper money is a medium or tool to show its purchasing power, a mere token. It allows a purchaser to get goods or services without trading other goods or services. Representing fiat money with paper money also gives it an alternative to a barter system, where goods are traded-off for another good.

Since fiat money relies heavily on faith and trust, its value is gauged on a country’s economic performance and political stability. If a country has proven itself to be of excellent standing in the economic arena, it is more likely that another country will accept fiat money issued by it. On the contrary, if the issuer country is in deep financial turmoil, it isn’t very likely for its fiat money to be honoured by another country or government.

What Are the Pros and Cons of Fiat Currency?

Just like any other currency, fiat money also has its advantages and disadvantages:

Advantage

Since gold, copper, and silver tend to be more volatile for many reasons, commodity-based money is deemed more unstable than fiat money. Fiat money is considered more stable so that central banks or governments can regulate their paper money as they see fit. It gives them more control over the money supply, interest rates, and even liquidity.

If handled properly, fiat money can also build a nation’s economy. Its good seigniorage can help insulate economies from natural outbursts of the business cycle.

Disadvantage

Non-fiat money believers still hold that gold and silver are more stable because of the scarcity of their supply. They also believe that fiat money’s seeming unlimited supply is more likely to create bubble economies, leading to higher inflation rates. Even with its deemed stability, fiat money cannot resolve a global financial crisis, as observed in the recent economic meltdowns that happened within the decade.

How Are Cryptocurrencies Different From Fiat Currencies?

Cryptocurrencies and fiat currencies are different, but they share many similarities. For one, both currencies can be used for purchasing things and have a store of value. They also heavily rely on consumer trust during transactions.

Cryptocurrencies, by their very nature, can be considered as actual money, albeit without physical form. They are online currencies that can be used anytime, anywhere. On the other hand, Fiat money is more of a debt or a promise than actual money. They are legal tender made by governments to be used for purchasing goods and services. They are not readily available like cryptocurrencies.

The main advantage that cryptocurrencies have over fiat money is their accessibility. Since it is digital money, anyone with an Internet connection could have or spend bitcoins. Fiat money isn’t like that. Governments and central banks have primary control over fiat money. In short, cryptocurrencies are more for individual use, while fiat money is for a nation or country’s use.

Both types of currencies are beneficial in their ways. They offer different styles or modes of transaction but ultimately have the same goal – to purchase. Whether digital or on paper, money is made to make economies run in whatever form they are. Without money, people would still be stuck bartering or trading goods and services again. We live in a modern world; it is expected that we also adapt to the means and needs of the times.

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