Fiat money is a government-issued currency that is not backed by a physical commodity and includes the likes of the US dollar, Euros, Great British Pounds, etc.
What Is Fiat Money Used For?
Fiat money is used as a legal tender and is typically confined to the borders of a country (the Euro being an exception to this). Fiat money comes in the form of notes and coins, as well as electronic versions which are handled by the bank and reflect the physical money on a 1:1 ratio. People can then use fiat money to pay for goods and services, both physically and online.
How Is Fiat Money Valued?
Fiat money is not backed by a commodity like gold or silver, instead, the value is determined by the government and fluctuates due to supply and demand. It is also influenced by the stability of the government issuing it, with socio-political factors causing the value to increase or decrease according to the associated reactions.
As there is no commodity backing it, fiat currencies run the risk of losing value when inflation sets in, or worse, hyperinflation.
Inflation is the falling value of a currency resulting in the increased cost of goods and services, while hyperinflation is when the inflation rate rises at a rapid speed, over 50% in a month.
The most recent case of hyperinflation is in Venezuela, where the central bank estimated that inflation rates rose over 50,000,000% between 2016 and 2019. At one stage, Bitcoin was more stable than the Venezuelan fiat currency.
The Downside To Fiat Currency
As governments are in control of fiat money, they have greater control over the economy. The ability to print more money should they wish can cause the value of a fiat currency to decrease and send inflation rates rising.
This was witnessed during the Covid-19 pandemic where governments around the world printed new money to stabilize the economy, however, the long-term effects of this are increased inflation rates and a devalued currency, leading to an increased cost of living and increased debt for the government.
Another downside to fiat is that it can be counterfeited. These illegal notes then enter circulation and can cause the real currency to lose value and send the cost of goods and services to rise.
Counterfeiting money has been around since the beginning of time, and remains a costly illegal activity for governments today.
Fiat Money vs Cryptocurrency
While fiat currencies have been around for centuries, cryptocurrencies were only introduced to the world a little over a decade ago. Following the global financial crisis caused by a downturn in the US housing market in 2007, an anonymous entity Satoshi Nakamoto created a digital currency that did not rely on the government or banks to operate.
Instead, users remain in complete control over their funds and can send them directly to another user without needing to go through a third party.
Since cryptocurrencies came onto the scene, fiat money is often compared to the new-age payment system. Observing their differences, we explore the benefits and downfalls of both fiat and cryptocurrencies below.
Fiat currencies are centralized, meaning that they are controlled by an entity in charge (in this case, the government and central banks). Cryptocurrency on the other hand is decentralized, meaning that no one has control of your account or has a say in your transactional activity.
Cryptocurrencies cannot be counterfeited. Unlike its fiat counterpart, Bitcoin and other cryptocurrencies cannot be forged. As they exist online in a digital ledger, it is impossible to create a “fake version” or duplicate a coin.
We’ve mentioned the inflationary nature of fiat currencies and the long-term effects, however, Bitcoin (and most other cryptocurrencies) were designed to be deflationary in nature. This was implemented by creating a maximum number of coins that could ever be created.