What Is Fiat Currency?

Fiat currency describes the money used every day across the world by billions of people. This currency lacks intrinsic value as it’s not backed by a physical commodity. Instead, fiat money is backed by the issuing government.

As a result, the value of fiat money depends on the legitimacy and reputation of the issuing government, citizens’ trust in the currency, and supply and demand principles. The vast majority of modern paper currencies, like the Dollar and Euro, are fiat currencies.

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The History Of Fiat Currency

The word fiat comes from the Latin word for “it shall be” or “let it be done.” The first fiat currency was used in China in about 1000 AD and later described by the traveler Marco Polo during the 13th century.

Fiat money became introduced in Europe in the 1600s and slowly began to gain ground in the late 17th and early 18th century across New France, as officials issued a temporary issuance of paper money to pay soldiers. The US Dollar became the global reserve currency, backed by gold, after World War Two until 1971 when the gold standard was removed.

Fiat money not linked to a physical reserve runs the risk of losing its value amid hyperinflation. From the paper marks issued in 1920s Germany, to post-WW2 Hungary, and in recent memory, across Venezuela, history is filled with instances of hyperinflation where fiat currencies remain essentially worthless.

The History Of Fiat Currency In The United States

Classified as both fiat money and legal tender, the U.S. Dollar still rests as the global reserve currency. Early in the nation’s history, the American colonies began to issue bills of credit, promising they would be redeemed in gold or silver after the Revolutionary War. However, confidence in these bills dropped to where they were not even worth a penny by 1780.

In 1934, the Federal Government stopped allowing citizens to swap fiat currency for government gold after the Emergency Banking Act passed. The post-WW2 Bretton Woods agreement pegged the value of an ounce of gold to $35. However, by 1971, President Richard Nixon removed the gold standard from the US Dollar and stopped the government from issuing gold to foreign governments in exchange for US Dollars.

After the collapse of the gold standard, the U.S. Dollar became backed by the “full faith and credit” of the government. Fiat currencies across the world now rise and fall in value based on supply and demand.

The Pros Of Fiat Money

Fiat money has several advantages. It is more cost-efficient to produce than a commodity-backed cryptocurrency, and central banks have a lot more power to manage national economies by managing the supply of bills. Commodity-based currencies can have more volatility as business cycles impact commerce and activity.

Fiat bills also serve as a sound way to store value and facilitate exchange. Monetary policy carried out by actors like the U.S. Federal Reserve can also help mitigate inflation and high unemployment.

The Cons Of Fiat Money

The potential for inflation, or hyperinflation, ranks as one of the biggest disadvantages of fiat currency. An unlimited supply of fiat bills creates more opportunities for bubbles. The global financial crisis of 2008 also proved to many across the world that federal officials are not able to stop every economic crisis even though they control the money supply.

Fiat Money And Hyperinflation

One of the most poignant examples of hyperinflation occurred in the South American nation of Venezuela for several years as the country struggled with political turmoil. From 2018 to August 2019, the International Monetary Fund reported the nation’s hyperinflation rate jumped from 9.02% to 10 million percent.

Annual inflation rates also exceeded 2000% in 2020 as food insecurity became widespread in a country that officially entered hyperinflation at the end of 2017. While the nation technically ‘broke’ a multi-year bout with hyperinflation in January 2022, the dire economic situation for a prolonged period led to millions fleeing the country.

Most developed countries with robust economies do not experience hyperinflation, which has also occurred throughout history even in areas where currency was based on a precious metal. Some argue a low level of inflation is a sign of a healthy economy as people in this environment will ‘put their money to work.’

Modern Economics And Fiat Money

Increased globalization and the limited supply of gold and silver caused massive issues within the global economy. Due to these issues, many started to believe in the benefits of fiat money to give governments more flexibility over managing currency and participating in global finance.

While billions across the world transact with fiat currencies on a daily basis, cryptocurrencies like Bitcoin have also emerged as an alternative to traditional fiat. Crypto supporters claim virtual currencies solve many perceived issues within traditional finance. Skeptics claim cryptocurrencies do not constitute “money” according to the traditional definition.

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Kevin OBrien
Written by Kevin O'Brien verified symbol Web3 & DeFi Writer
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Kevin is a native Texan focusing on DeFi, Web3 & NFT content. He’s written for Bitcoinist, CCN, CryptoGlobe and for a wide range of crypto projects. Kevin also enjoys collecting historical autographs and learning traditional musical instruments. Read more at texandefiwriter .com.

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Reviewed and Fact Checked by Eugene Abungana , Investment Analyst, Financial Analyst, and Institutional Trader