Fiat money is currency issued by a government and designated as legal tender, but not backed by a physical commodity like gold or silver. Instead, its value comes from government backing and public trust in the issuing authority. The term "fiat" comes from Latin meaning "let it be done," referring to government decree.
Most currencies today are fiat currencies, including the US dollar, euro, British pound, and Japanese yen. Unlike commodity money, fiat money has no intrinsic value. Its purchasing power is maintained through government regulation and monetary policy controlled by central banks.
The stability of fiat currencies makes them practical for everyday transactions, international trade, and financial planning. Central banks can adjust money supply to manage economic conditions, helping control inflation and support economic growth.
The history of fiat money
Fiat money became the global standard in the 20th century, but paper currency has existed for over a thousand years.
China issued the first paper money between the 10th and 13th centuries during the Song, Tang, Yuan, and Ming dynasties. This was initially created to address shortages of metal coins. By the Yuan dynasty under Kublai Khan, paper currency had become the main form of money.
In Europe, the Bank of Amsterdam introduced early forms of fiat currency in 1683, while Sweden issued the first regular paper money in the West through the Bank of Stockholm in 1661.
Throughout the 19th and early 20th centuries, most currencies were backed by gold. Paper money could be exchanged for specific amounts of the precious metal. This changed in the United States with the Emergency Banking Act of 1933, which stopped citizens from exchanging currency for gold.
The modern fiat system was established in 1971 when President Nixon ended the convertibility of the US dollar into gold, officially ending the gold standard. By 1976, the Bretton Woods system was formally dissolved, and fiat currencies became the global standard.
How does fiat money compare to commodity money and cryptocurrency?
Fiat money differs from both historical commodity-backed currencies and modern cryptocurrencies in how value is created and maintained.
Fiat vs. commodity money:
Commodity money (like gold or silver coins) has inherent value from the material itself. A gold coin is valuable because gold is valuable. Fiat money has no intrinsic value. A dollar bill is only valuable because the government says it is and people trust that declaration.
Commodity money has a naturally limited supply based on how much of the commodity exists. Fiat money supply is controlled by central banks and can be adjusted based on economic needs. This flexibility allows governments to respond to recessions and inflation, but also creates risk of overprinting and currency devaluation.
Fiat vs. cryptocurrency:
Fiat is government-issued and considered legal tender for all transactions. Cryptocurrency is decentralized with no governing body controlling its value. For most cryptocurrencies, there is a set supply limit (like Bitcoin's 21 million coins), while fiat can theoretically be printed in unlimited quantities.
Fiat is represented by both physical bills and coins and digital representations in bank accounts. Cryptocurrency exists only digitally on blockchain networks. Fiat currencies are generally stable in value, making them practical for everyday purchases and business operations. Cryptocurrencies tend to be highly volatile.
Stablecoins represent a hybrid approach, using cryptocurrency infrastructure while maintaining 1:1 backing with fiat currencies like the US dollar to provide stability.
