What is Fiat Currency?
You might have heard the term “fiat currency” not knowing exactly what it means. Traditional paper bills like the U.S. dollar and euro qualify as fiat currency, which means they are backed by a government body, such as the U.S. government or European Union (E.U.). Most of the money we use today is fiat currency, but it wasn’t always that way. In the past, most people used gold and other tangible goods to purchase goods.
Currency is evolving once again as more investors exchange their government-backed currencies for decentralized commodities like Bitcoin. Learn more about the history and purpose of fiat currency and how it relates to other types of commodities.
What is Fiat Money?
The term fiat money, or fiat currency, refers to paper money that’s backed by local governments. Nearly every country has some form of fiat currency. For example, the U.S. has the dollar, while most of Europe uses the euro. These bills have no intrinsic value, unlike gold, silver, or even a sack of beans. They’re only made of paper, after all. The only reason they have value is because the government tells us that they do. Governments can increase or decrease the number of bills in circulation based on inflation and other conditions, giving them greater control of the economic landscape.
The word fiat comes from Latin. It translates as “let it be done” or “it shall be,” which is a way of saying that the government willed the currency into being.
Fiat currency is a relatively new invention when you look at human history. It wasn’t until the Great Depression in the 20th century that the U.S. decided to implement its own fiat currency. With so many people out of work, the government enacted the Emergency Banking Act (EBA) in 1933 to jump-start the economy and restore the public’s trust in the financial system. Before this bill became law, the U.S. dollar was backed by gold, but the EBA eventually moved the country away from the Gold Standard. The dollar is no longer backed by traditional commodities like gold, making it a fiat currency.
What Determines the Value of Fiat Currency?
The value of fiat currency is always changing. It’s up to the government to control the value of currency. Since the currency isn’t backed by traditional commodities, its value depends on a range of economic factors. The government can always print more money, making it seem as though there’s unlimited supply; however, this can reduce the currency’s value and can lead to inflation. Government regulations and other fiscal policies can affect currency value as well.
The value of one currency compared to other currencies depends on the relationship between the two nations. For example, the U.S. and the E.U. have a strong relationship, which is why the dollar remains close in value to the euro. However, trade imbalances, rising inflation, investor confidence, and the local political climate can disrupt this relationship, causing one currency to rise and the other to fall.
What’s the Difference Between Fiat Currency and Representative Money?
Both fiat currency and representative money are controlled by the government. However, representative money is backed by commodities and goods with intrinsic value, such as gold, silver, or even real estate and other assets. This limits the number of bills that can be produced.
Representative money isn’t like a regular currency. It is usually distributed as a credit card or check, which represents an intent to pay.
What are the Benefits of Fiat Currency?
There’s a reason almost every country uses fiat currency as legal tender. Most nations have a centralized banking system, which puts the government in control of the currency.
This can be beneficial for several reasons. First, it allows the government to adjust the value of the currency as it sees fit. In the U.S., the value of the dollar is largely controlled by the U.S. Treasury Secretary and the Federal Reserve. Government officials can change monetary policies or work to improve international relations to increase the value of the currency. This can help countries avoid a recession or depression.
However, this can be a two-edged sword. Good financial policy increases the value of the currency, but bad financial policies will lower the value as well. There’s always a chance the government could print up too much money or implement reckless lending policies that hurt everyday consumers, as we saw during the 2008 financial crisis or more recently in Turkey, where the lira recently dropped in value.
Is Bitcoin a Fiat Currency?
No, Bitcoin does not qualify as a fiat currency. Bitcoin is a type of cryptocurrency, which means it is decentralized and not controlled by any government. Cryptocurrency lives on the blockchain, which lives exclusively online. Every transaction is recorded on the blockchain in a series of ledgers; however, the system hides the identity of the buyer. Bitcoins need to be mined, which usually requires a lot of computing power. If you want to invest in Bitcoin, you can buy them on various apps and websites. You will then add the coin to your digital wallet.
You can use Bitcoin and other digital tokens to purchase goods and services, but you will likely need to exchange them for a fiat currency first. That’s because most businesses don’t accept cryptocurrency as a form of tender.
The value of cryptocurrency can rise and fall just as quickly as the value of fiat currency. Most Bitcoin users trade their coins for fiat currency, creating a relationship between the two. The value of crypto will rise and fall based on various economic factors, just like fiat currencies.
The Bottom Line
Fiat money isn’t going away anytime soon, despite what some experts may believe. It’s true that Bitcoin and other cryptocurrencies have been gaining popularity over the last few years, but it will likely be a while before they replace paper bills altogether. If you are investing in cryptocurrency, you will still need to use fiat currency at some point. The value of both these currencies will still rise and fall. Keep track of the value of the dollar or whatever currency you use to avoid investing in a currency with little to no value.