What is fiat currency?

A person seated at a kitchen table holds their mobile phone while using a laptop to read about fiat currency.Image: A person seated at a kitchen table holds their mobile phone while using a laptop to read about fiat currency.

In a Nutshell

Fiat money is a government-issued legal tender not backed by a physical commodity like gold. It has an unlimited quantity, and its value is based on the general public’s trust in its government. Fiat money is drastically different than most cryptocurrencies, which are usually decentralized and digital.
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Until the early 1900s, many governments backed their money with commodities like gold and silver. Most countries (including the U.S.) now use fiat currency.

There are different types of currencies — some have government backing, like the fiat system of money, and some are decentralized and backed by blockchain technology, like cryptocurrencies. This article will explain fiat currency and how it differs from other types of currency.

What is fiat currency?

Fiat currency, or fiat money, is a government-issued currency that does not have the backing of physical commodities like gold. Instead, the currency’s value is based on the general public’s trust in its government.

Why is it called fiat currency? The fiat currency definition and name originate from a Latin word that translates to “let it be done”. Fiat money only has value because the government gives it value and, therefore, has more control over the currency and how much can be printed.

Pros and cons of fiat currency

Let’s explore the pros and cons of fiat currency.

Pros of fiat money

Unlike gold, Fiat money is not backed by a commodity, meaning it’s not limited or scarce. For this reason, a government has greater control over the currency supply, which can give it the power to manage economic variables such as interest rates, liquidity and credit supply.

Since a government controls the money supply, it may be able to help protect the country from a recession. As the central bank of the United States, the U.S. Federal Reserve has intervened throughout history to reduce the damage from over-expanded markets.

Cons of fiat money

Although fiat currency gives the government control over the money supply, it’s still not guaranteed to prevent a financial crisis. The main issue is that fiat money can lend itself to hyperinflation — an economic state in which inflation increases by more than 50% monthly.

Fiat currency vs. cryptocurrency

Fiat money is a legal tender (a currency declared legal by the government), and its value is backed by the issuer (the government). On the other hand, cryptocurrency is a digital currency backed by decentralized blockchain technology, meaning it’s not backed — or regulated — by a central authority like a government.

Fiat money vs. commodity money

Commodity money has an intrinsic value, which means it derives its value from tangible materials, like gold or silver.

Fiat currency does not have intrinsic value. For example, dollar bills use the same material, but their values can differ depending on what a government decides the price its people should exchange it for (the difference between a $1 bill and a $10 bill, for example).

Fiat currency vs. representative money

Unlike fiat money, representative money is backed by a physical commodity. In the past, consumers kept commodities like gold or silver in the bank and carried a paper certificate to represent that commodity. Checks and credit cards are modern examples of representative money.

While a government backs fiat money, representative money can have backing from many potential assets. In the case of checks and credit cards, they’re backed by the money in a bank account.

FAQs about fiat currency

What are alternatives to fiat money?

Any shared currency that doesn’t rely on government backing is a potential alternative to fiat money. Some examples include commodity money and representative money.

Is the U.S. dollar a fiat currency?

Yes, the U.S. dollar is a fiat currency. This means that its value is not backed by a physical commodity like gold or silver but is based on the government’s guarantee of its value and acceptance as a means of payment for goods and services.

Why is it called fiat currency?

Fiat currency stems from a term that can be translated to “it shall be” in Latin and refers to a type of currency issued by the government and has no backing from physical commodities, such as gold.