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Fiat currency means the same metal coins and cash bills that are used in daily purchases and sales and are known as the common currency of any country. All over the world, fiat currency is used for commercial, economic, investment and buying and selling of goods. This currency is actually a replacement for the gold standard and commodity money (an economic good that is used instead of money). Until the last few years, money existed only in the form of bills and coins and had a physical nature.
But with the advent of digital currency, the form of financial communication has changed. Fiat currency, or the legal and common currencies of countries such as the US dollar, are more reliable and stable among most of the public.
The main factor determining the value of fiat currencies is the power of governments. But in expressing the difference between digital currency and fiat, it should be said that digital currencies are not controlled and valued by any institution, organization or third party. In the rest of this article, I intend to focus more on fiat currencies and the difference between fiat and digital currency.
What is fiat currency?
Fiat currency, or unbacked money, is the currency of countries. Fiat literally means “must be” or “let it be”. A fiat currency is a coin or a piece of paper money without any physical value. These currencies are the same common coins and bills that are used all over the world for transactions.
Fiat currencies are issued and backed by governments. In fact, the value of a fiat currency is obtained from the relationship between supply and demand, as well as the stability of the issuing government, rather than the value of the commodity that supports it. Most paper currencies such as the US dollar, Rial, British pound, Euro and other common world currencies are considered fiat currencies.
One of the important problems of these currencies is the possibility of printing them without restrictions, which has caused excessive production and as a result increased inflation. Unlike digital currencies, fiat currencies have no value because they have no support as physical goods and cannot be redeemed.
Support for fiat currency
Contrary to the common beliefs of people who think that fiat currency is backed by gold and silver in the treasury of each country, it must be said that these currencies have no backing. Their credibility depends on the economic stability of the country as well as the supply and demand of the people. In fact, it can be said that these currencies get their credit from their issuing government. For example, the US dollar, as one of the most prominent examples of fiat currency, has no backing, and if the American people decide not to trade it for any reason, its value will fall.
Another famous example is the devaluation of Zimbabwe’s local currency, resulting in hyperinflation. In the same way that people had to carry bags of bills to buy an ordinary product. Some people even made handicrafts using banknotes and sold them. In the past, people’s needs were met through barter transactions, the progress of societies and the problems of such transactions led to the emergence of money as a medium of exchange.
History of Fiat Currency
It was decided to print paper money for the first time in the 11th century in China and at the time of Sichuan. People at that time used these money to buy gold, silk and silver. After that, in the 13th century, during the period of Kublai Khan, one of the descendants of Genghis the Mongol, the fiat currency system started working in the areas under the dominion of this king. Some historians believe that the reason for the fall of Kublai Khan’s reign was the high costs of setting up this system and the subsequent inflation.
In the 17th century, some European countries such as India, Spain, Sweden and the Netherlands started using fiat currency. But this system could not be successful in Sweden, and as a result, its financial systems switched to using the silver standard.
In the 18th and 19th centuries, the countries of North America, France and all its colonies gradually started using this monetary system. But in the 20th century and some time later, the United States of America switched to commodity money. This process continued until 1933. In this year, the government issued an order to stop the exchange of paper notes with gold and other goods. Finally, in 1971, the President of the United States officially announced fiat money as an alternative to the gold standard. After this decision, the use of the gold standard system was stopped in all countries of the world and the fiat currency was replaced by this traditional system.
The reason for replacing fiat money with the gold standard
In the past, governments used gold as a backing for paper bills. In this system, it was possible to introduce new currency and change its value based on the amount of gold reserves in the national treasury of each country. In other words, governments were only able to produce new currency based on the amount of gold reserves and introduce it into the economic cycle, and they were not able to influence the value of money by other economic factors.
But after the emergence of fiat currency and its entry into the economic cycle of countries, the economic officials were able to have more control over the amount of production of new currency and the method of valuation of the country’s national currency.
During various economic conditions and crises, this process allowed the central banks and statesmen of each country to more easily control the conditions based on the decrease or increase in the value of money. Those experts were in favor of the gold standard, believing that if the banknote has a physical backing, it will be more stable. But the experts against the gold standard believed that the gold metal itself has never had a high price and therefore it will have a negative effect on the value of money.
Advantages of fiat currency
Despite the differences among economists about the characteristics of fiat currency, in general, the following advantages can be considered for fiat currency:
- If fiat money can perform roles such as storing value, facilitating exchange and providing a numerical account, it will perform well as a currency. On the other hand, this currency has good credit and its production is more cost-effective than a currency that is directly dependent on a commodity. Many economists consider it as a store of value despite the inflation and depreciation of fiat currencies over time.
- In the 20th century, fiat money was considered somewhat useful because central banks and governments sought to protect their economies from the natural downturn of the business cycle and the effects of boom and inflation. Some of these currencies that are highly resistant to inflation, such as the Japanese yen and the US dollar, can also be considered safe havens.
- Considering that fiat money, like gold, does not have a fixed and rare source, central banks are able to have more control over its supply; This gives them the power to manage economic variables such as liquidity, credit supply, money velocity and interest rates. For example, the United States Federal Reserve is able to control inflation and unemployment with these tools.
- Printing unbacked paper money and bills is much cheaper than hoarding gold and producing commodity money.
- Considering that most countries of the world recognize these currencies and carry out all their economic activities through them; It is easier to make international exchanges with them.
- Stocks of gold, silver and commodity money in the gold standard system need a safe place to be kept. Also, storing gold as the support of the country's national currency requires a complex security system. But paper bills require less cost and space than reserves for storage.
Read more: What does store of value mean?
Disadvantages of fiat currency
Below I will discuss two disadvantages of using Fiat Currency:
- Due to the unlimited production and printing of these money, inflation always exists in this way. Opponents of fiat currency see it as the wrong way to protect the economy, the possibility of inflation and an opportunity for bubbles.
- Many governments and governments have suffered economic bankruptcy and loss of power by overproducing these currencies and relying on them (the bankruptcy of the Zimbabwean government in the 21st century).
The difference between digital currency and fiat currency
In the 90s, digital currency came into use with the introduction of several unsuccessful examples such as Razor Liberty and E-Gold. But in 2009, Bitcoin cryptocurrency as the most famous. The most popular digital currency was introduced to the world by Satoshi Nakamoto and created a huge revolution in the cryptocurrency world. Bitcoin and other cryptocurrencies opened a new window to the global economy by eliminating intermediaries with blockchain and other functions. Next, I will discuss the difference between digital currency and fiat:
The difference between digital currency and fiat currency
In the 90s, digital currency came into use with the introduction of several unsuccessful examples such as Razor Liberty and E-Gold. But in 2009, Bitcoin cryptocurrency as the most famous. The most popular digital currency was introduced to the world by Satoshi Nakamoto and created a huge revolution in the cryptocurrency world. Bitcoin and other cryptocurrencies opened a new window to the global economy by eliminating intermediaries with blockchain and other functions. Next, I will discuss the difference between digital currency and fiat:
- Most cryptocurrencies such as Bitcoin have a limited supply and production, and their production is limited based on certain protocols such as Bitcoin Halving . Other cryptocurrencies also use other protocols for this purpose to avoid inflation. This is also the opposite of the excessive production of fiat currencies that lead to inflation.
- Unlike fiat currency, which was mostly controlled by the central bank and government men, cryptocurrencies were created with the aim of decentralization and decontrol. In fact, this issue was also the reason for governments’ opposition to cryptocurrencies .
- Cryptocurrencies are highly secure due to blockchain security and the use of encryption systems, and the possibility of hacking, forgery, and theft is very low. But fiat money is easily counterfeited. Also, bank accounts can be hacked and these funds are always subject to theft.
- The cryptocurrency market is always facing severe fluctuations, and the low volatility of fiat currencies is considered an advantage over cryptocurrencies; Hence, less people trust investing in digital currency .
Is it possible to replace digital currency with currencies?
Although digital currencies have been able to find a suitable place in the global economy in recent years; But fiat currency is still introduced as the most common financial system in the world. money, dollar, euro according to their exporting country, which have strong economies;
They are still one of the important pillars of economic activity all over the world. Although these currencies have caused many problems and do not have a white history, they are more widely accepted than digital currencies. Digital currencies in their current form are beyond regulation, which will have negative effects as well as positive effects.
Cryptocurrencies are not under the control and supervision of the central bank. Central banks use monetary policy tools to influence inflation and employment through interest rates and market operations. This is despite the fact that one of the basic principles of digital currencies is decentralization and thus it intends to eliminate these tools. Due to price fluctuations, the International Monetary Fund (IMF) currently recommends not to use cryptocurrencies as the main national currency. Also, the aforementioned institution emphasizes the lack of consumer protection in the cryptocurrency market and the risks of macroeconomic stability. Based on these cases, the replacement of digital currency with Fiat Currency is still being evaluated and reviewed.
But considering the current applications of digital currencies such as the use of NFT in real estate , trading and investment, yield farming or profit cultivation , voting and election systems, etc., we can be optimistic about its future in the financial world.
The difference between the supply of Bitcoin digital currency and fiat currency
We will often have QUANTITATIVE EASING in fiat currencies that are under the supervision of central banks around the world (such as the dollar that is under the supervision of the Federal Reserve or the Rial that is under the supervision of the Central Bank of the Islamic Republic of Iran). In QUANTITATIVE EASING, these institutions increase liquidity by printing money and in various ways, which will cause the currency to become less valuable (devaluation). This issue is like if we find a mine with an unlimited amount of gold; This discovery of the mine causes the price of gold to drop. In fact, in general, anything that is more than it causes its price and value to decrease, and anything that is less than it and rare causes its value to increase.
In Bitcoin digital currency, we will have QUANTITATIVE HARDENING, unlike common currencies where we had QUANTITATIVE EASING. In fact, Bitcoin halving has reduced the amount of Bitcoin production, and therefore the liquidity or amount of Bitcoin is always a fixed and limited amount; This makes Bitcoin valuable. For example, it is said in history that salt was once scarce. Due to this scarcity, the price of salt at that time was equivalent to gold. The increase in the present time of salt also reduced its value and price
With the increase in production and indiscriminate printing of fiat money, it will be possible to decrease the value of this currency due to inflation.
The only similarity between these two currencies is the lack of physical support for them, while fiat money is controlled by the government and cryptocurrencies are decentralized.
