The word “fiat” is defined as “an order” or “decree”. So when a government order creates a currency, the expression of “fiat currency” comes about. There are currently some 180 fiat currencies in the world today. This term is now widely used as a means to distinguish regular money from cryptocurrency in today’s context. Commodity money derives its value from its own worth, like with gold, silver, salt, or even shells. Fiat money has attributed value because a government declares it legal tender. There is no underlying store of gold or silver to give fiat currencies material value. Instead, fiat currency is backed by the authority of each government. For example, the US dollar is backed by the “full faith and credit of the US government”, according to the Federal Reserve. To put it plainly, we consider it valuable because the government guarantees it as legal tender, so everyone is willing to accept and use it in economic transactions.
Before fiat money existed, goods were paid by trading other goods. Salt was thought to be valuable as people used it to purchase goods and pay people during certain periods in the Roman empire. As time went on, precious metals like gold and silver also became a form of payment as well.
It is believed that asset-backed coins and paper money could have first emerged centuries ago in China. Eventually, this caught on because people could use it to pay for goods and services, and also redeem it for an underlying commodity. For example.the US currency was redeemable for gold and silver back in the days but ended when the Emergency Banking Act of 1933 came about in the Great Depression, hence stopping citizens from exchanging currency for government gold. The gold standard, which backed US currency with federal gold, fully ended in 1071 when the US also stopped issuing gold to foreign governments in exchange for US currency.
Firstly, fiat money is widely accepted worldwide. You can use it not only for domestic transactions but also for international transactions, for the purpose of purchasing almost any goods or service. Since fiat money is not limited like gold reserves, the government can easily print new money and increase the money supply to stimulate economic growth. This advantage allows greater control over economic variables such as credit supply, liquidity, interest rates and money velocity. Additionally, fiat money is more cost-efficient to produce compared to a currency that is directly tied to a commodity.
Despite all that, fiat money certainly can still go wrong. An example of the limitation of fiat money can be further illustrated through what happened in Zimbabwe in the early 2000s. The country’s central bank printed money at a staggering rate in hopes to combat critical economic problems, which then led to hyperinflation. The currency was believed to have lost 99.9% of its value then. Moreover, the price of fiat money is dependent on government regulations and policies, which could possibly result in a bubble with a rapid increase and decline in prices.
For the past decade, we see the rise of popularity for cryptocurrency and many argue that it could potentially challenge fiat as a store of value and medium of exchange. The key difference between both currencies is that, unlike fiat currency that depends on a central authority, cryptocurrency relies on a decentralised blockchain technology, as transactions are validated through a network of participants.
We know for a fact that money has been evolving throughout the course of history, from using shells to Bitcoin. So for good reasons, cryptocurrency could very well be the next step in this evolution.
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