Definition

Fiat Money

What is Fiat Money?

Fiat money is the currency issued by the government of a country. It is the national currency, which is backed by the government that issued it. It not based on physical commodities such as silver and gold. The value of fiat currency is derived from the supply and demand, and the creditworthiness of the government.

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Understanding Fiat Money

Fiat money is the money that is used in the economy as the medium of exchange that is issued by the concerned government. Fiat money is issued on the basis of the demand and the supply, and takes the creditworthiness of government into the consideration. Fiat money established by the government for the smooth regulation of economy.

Fiat Money is introduced by China, and after that the concept of fiat money was adopted by other countries. The fiat money is an alternative of commodity money and used as representative money. Commodity money is generated from precious metals includes silver and gold and fiat money, include US dollar, euro, pound, and yen and so on, issued by their respective government of the countries. The government has authority to issue the fiat money and make them legal by giving value. Currently, there are 180+ Fiat currencies in the world.

Frequently Asked Questions (FAQs)

How Fiat Money regulated and works in an economy?

Fiat money refers to the currency that is issued by the government and gives legal value to it. The value of fiat currencies is decided by the government on the basis of demand and supply forces in an economy. Central banks control these forces of marketplace by deciding how much money is needed to flow in the economy and print accordingly. If they print more than what they need, it will lead of hyperinflation in the economy.

Fiat currency is backed by the respective government of the countries; fiat money is not based on the physical commodity. It acts as medium, alternative and representative money to the barter system. With the fiat money, people can buy and sell goods and services without any exchange of goods and services, as it was happened in barter system.

The government takes so many points into consideration while deciding the value of fiat currency including performance of country’s economy, effects on interest rate, creditworthiness, political stability, and an individual’s purchasing power. Fiat money gives the control to the central bank over the economy, and it regulates according to the demand and supply.

What are the merits and demerit of fiat money?

Talking about advantages of fiat money, fiat money has stable or fixed values, unlike other commodity-based currencies are varying depending on a regular business cycle. The government and central bank have a control over the supply and value of fiat currency, and it gives the control to manage the supply and liquidity of an economy.

On the disadvantage side, fiat currency is not based on physical reserves such as gold and silver; it may lead the risk of losing its value at the time of inflation or may become worthless in hyperinflation situation of an economy.

What is the difference between fiat money and commodity money?

Fiat money is just opposite of commodity money. The main difference between the two is its intrinsic value. Commodities money is made from precious metal such as gold and silver, intrinsic value of commodity money is derived of the material it is formed such as intrinsic value of gold coin is derived from the value of gold.

But fiat money has no intrinsic value, government and central bank are the authorities that give value to Fiat money. The value of fiat currency is based on public faith in the government or central bank who establish the fiat currency as legal tender or money representative.

Commodity money is backed by physical reserve such as gold silver but Fiat currency is backed by the government and central bank. Fiat currency is the national currency that is issued by the central bank or government of a country. 

How does fiat currency differ from cryptocurrency?

Fiat currency is the currency issued by central bank and backed by government. It can be in the form of physical money or may in electronical form. Fiat currency is used as legal currency in all countries. It includes Dollar, Rupee, Euro, Pound. Fiat currencies are tangible in nature it can be touched and seen in the form of notes and coins.

On the other side, cryptocurrency is digitally encrypted currency. It is not regulated by government, operates independently. Cryptocurrency is illegal in many countries. It is only used for digital transfer of funds. Crypto currencies are not tangible in appearance as it is digitally encrypted such as Bitcoin, Ethereum, Litecoin.

Fiat currency transactions can be monitored easily and quite safer than cryptocurrency as it can be tracked and backed by the government. In cryptocurrencies, transactions are done anonymously. Supply of fiat currency is regulated by the central bank or government and is regulated by the supply and demand of an economy.

On the other side, cryptocurrencies have digital presence only and act as a medium of trade and not regulated by any government. It is a virtual currency used for trade without any interference of government.

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