What is FIAT?
FIAT is a currency with no intrinsic value which has been established as ''money'', usually issued by governments. The value of money is maintained by the government, the strength of the government is key in the FIAT value compared to other FIAT currencies. Most countries use the FIAT currency system, to trade goods and services, invest, and save.
The Rise of Fiat Currency
During the 11th century, the Szechuan province in China began to issue paper money, FIAT. In the beginning, it could be traded for silver, silk, and gold.
In the 17th century, FIAT was also used in Europe, adopted by the Netherlands, Spain, and Sweden. In Sweden, the FIAT system failed and therefore was changed to a currency based on the silver standard. During the 18th & 19th centuries several countries, such as Canada and the American Colonies also experimented with FIAT (with mixed results).
The United States of America, headed by President Nixon abandoned the gold standard in 1972. This led to the usage of the current FIAT system around the world.
FIAT vs. the Gold Standard
The gold standard system authorized the exchange of paper money to gold. So, all paper money was backed by an amount of gold, held by the governments. With this gold standard governments and banks could only introduce new paper money if they would hold an equal amount of gold. This system restricted the government of creating money without the capability of backing it with gold.
With fiat money, governments can instantly change the value of their currency and match it to economic conditions. So, governments and Central Banks have a lot more power and control with the current FIAT system. They can react in case of certain events or crises, for example by the so-called fractional reserve.
Pros & Cons
- Flexibility: FIAT gives governments and their central banks the flexibility to address economic crises.
- Intrinsic Value: FIAT holds no intrinsic value. This allows governments to create money out of the air (nothing), which could result in hyperinflation and collapse their economic system.
- Rarity: FIAT is not affected and restricted by the rarity of a physical commodity like gold.
- Trade: FIAT is used in countries around the globe, making it an easy currency for international trade.
- Practicality: Unlike commodities (gold), FIAT does not rely on physical reserves that require security, storage, monitoring, and other costly demands.
- Expense: FIAT is more affordable to produce than commodity-based currencies.
FIAT vs. cryptocurrency
Cryptocurrency has a bit of common ground compared to FIAT, as both aren't backed by any physical commodity. But, FIAT is controlled by governments and Central Banks. Cryptocurrency
is essentially decentralized
, due to the distributed digital ledger, so-called blockchain
Besides, a huge difference between the two systems is the generation of new money/coins. For example, Bitcoin
has a pre-programmed, limited and controlled supply. On the other side, governments and banks can create money out of nothing. As cryptocurrencies are digital, they are borderless, making them less restrictive for global transactions.
But, the cryptocurrency
market is very small and therefore, very volatile compared to traditional markets. This is most likely one of the causes cryptocurrencies are not yet globally accepted.