Fiat Money: Definition, Operation, Examples, Advantages & Drawbacks

Everyone uses fiat money. Essentially, these are ordinary coins and bills in a wallet or numbers in your bank account. In general, this is money with which you can buy food, clothes, or a home, and pay a hairdresser, taxi driver, or dentist.

Fiat Money: What Is It?

Fiat money is the currency of a country, which is issued only by the Central Bank. It also counts how much it has already issued and predicts how much money will need to be issued in the near future.

Today, fiat money is not backed by precious metals or any other assets. You can use them to buy the currency of other countries, but at a free exchange rate, which is determined by a complex set of influencing factors.

Fiat Money Examples

In the modern world economy, not a single state issues money according to the state’s gold reserves. Based on this, any national currency is fiat, even global currency such as the American dollar. The most common fiat currencies are the US dollar, euro, Japanese yen, and British pound sterling. There are close to two hundred of them, though. 

The Positive and Negative Sides of Fiat Currency

Advantages:

• Convenience;
• Less risky;
• A liquid asset.

Disadvantages:

• Not a scarce asset;
• Easy to counterfeit;
• Not backed by anything.

Pros Described

Fiat currencies have become a vital part of our daily lives and brought many advantages with them.

• Fiat money is easy to use, easy to store, and easy to travel with, especially if they exist in digital form. This money is used all over the world and is a convenient form of currency for international trade.
• It allows fiat money holders to earn interest. Although the amount of return is low compared to investing in the stock market, this method can be used to manage inflation with little to no risk. During a recession, the value of fiat money does not fluctuate in the short term compared to a volatile stock market. 
• They can be easily exchanged while maintaining market value. People can easily withdraw or deposit fiat money in a bank or use it for everyday transactions. Having sufficient fiat funds allows the investor to quickly and flexibly respond to changing market conditions.

Cons Described

It is important to be aware of some of the problems associated with holding too much fiat currency.

• If there is too much fiat money in circulation, its value may decrease over time due to inflation. The American dollar, for example, can be printed by the government with virtually no restrictions.
• They are easy to forge. In electronic form, complete security is also not guaranteed.
• Another disadvantage of fiat money is that it is not a “real asset.” Their value depends on the fiscal and monetary policies formed by the authorities and the Central Bank. If these policies are ineffective, inflation or hyperinflation will result.

In the event of an economic crisis, fiat currencies may fall in value, which will lead to a loss of faith in them. It would be like finding yourself in possession of fake gold.

What Makes Fiat Money Valuable?

Each of us probably has fiat money in our pocket or wallet. How much can they really cost? In response to this question, a number is presented. However, no matter how many banknotes you have in your hands, they are just pieces of paper. 

The value of this money is not tied to any physical product. Instead, it is determined by supply and demand, as well as the stability of the government supporting it. It is formed by government promises and our belief that these promises can provide it with the declared purchasing power. Mistrust of market participants can quickly collapse any national monetary system. 

Why Do Fiat Money-Based Economies Prefer It?

A monetary system in which the value of money is set by the state has been tried to be introduced in many European countries since the 17th century. However, the attempts were unsuccessful: trade and industry developed exclusively at the expense of gold, as the gold standard system was stable. For example, one dollar was guaranteed to be exchanged for 31 grams of gold, and vice versa

Stability, though, became a disadvantage: development requires inflation, albeit small and controlled. In addition, the more countries tuned their economies to the “gold” system, the more acutely it was felt that there would not be enough precious metal. The fiat monetary model helped solve at least these two problems and brought other advantages.

Fiat money is also beneficial to the state. Compared to the gold standard system, the government can influence them more during a crisis. Compared to cryptocurrencies, the state can control electronic money.

Cryptocurrency and Fiat Money: Similarities and Differences

Cryptocurrency is virtual, digital money, the value of which does not depend on the state. They are the result of computer calculations. 

At the same time, cryptocurrency and fiat money are both not backed by precious metals. Their value is based on general recognition throughout the world. In addition, they have a similar scope of application. They are used as a medium of exchange and can be given, stored, sent, received, etc.

Payment using cryptocurrency occurs thanks to blockchain technology - a chain of information blocks that contains all the information about the transactions of network participants. It eliminates fraud: transaction information cannot be falsified, since the system is controlled by all network participants.

Conclusion

Fiat or fiduciary money is issued by the government. They are not backed by precious metals and have no intrinsic value. Their value is based on the authority of the government. Fiat money can be used to pay for goods and services, investments, and other financial transactions.

Cryptocurrency has a number of advantages over fiat currency: anonymity, speed, low commission, and availability all over the world. It might take a strong position as a fiat alternative across the world in the near future.