You’ve probably come across the term fiat while observing features of cryptocurrency exchanges, which can either accept or not accept fiat currency payments on their platforms. Fiat stands for what we call money or the national currency of a certain country.
Fiat currencies against cryptocurrencies have always been an intriguing topic in the sense of whether crypto can eventually replace fiat in the future. Experts’ opinions vary to a great extent since both finance systems are similar and different at the same time.
In this article, we will define fiat on a basic level and discuss how it compares to the decentralized approach that cryptocurrencies represent.
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The Meaning and Etymology Behind the Word Fiat
In the contemporary sense of the term, fiat money or fiat currency denotes a type of currency issued and authorized by a government that isn’t backed up by a material commodity (gold or silver). More specifically, we say fiat for any currency that is:
- Appointed as a legal tender by the government;
- Non-convertible through a central bank into something else or pegged to an objective standard;
- Any currency that went into use with a government decree;
- Fiduciary money — a non-valuable object that serves as a medium of exchange.
Originally, the word fiat (ˈfaɪət) comes from Latin, and it can be directly translated to the phrase “it shall be” or “let it be done.”
The term describes the lack of intrinsic value of fiat money as they’re not valued by their worth against a static commodity but rather, by external factors such as the level of public trust in the government. It’s the government that controls the rate of printing fiat currencies depending on the current demand-vs-supply balance.
This continuous process involves multiple layers of actions, so we’ll try to go through it closely and help you gain a clear understanding of how fiat circulates in our economy.
History of Fiat Money
Throughout history, well-developed countries maintained a commodity backup standard with gold. However, as the cross-countries economy grew in scope, financial interaction with gold became unsustainable due to the limited amount of gold stored in bank vaults and mines.
This created critical disorder and breached the global commerce system. Banknotes and paper money started appearing spontaneously as a form of written promise to pay the debtor a certain amount of gold and silver. The earliest examples of an official government-issued asset include the continental currency and the assignats issued during the American Revolution and French Revolution, respectively, as well as the first paper marks released by the German Government in the 1920s.
However, gold remained a standard in the post-war period leaving behind all bimetallic systems popular in the middle of the 19th century. Based on the Bretton Woods system, the American Dollar (USD) was assigned an international reserve currency, pegged to gold at a fixed rate of $35 an ounce.
However, in the second half of the 20th century, it had become unbearable for the USA to retain gold at a fixed rate so, in 1971, Richard M. Nixon, the President at the time, declared that he would temporarily suspend the convertibility of the dollar into gold or other reserve assets.
Today, each sovereign state has its own fiat representative, whose strength and value rise and fall exponentially to their economic and political power. The American dollar, for example, has ensured its value through the USA being an economic super powerhouse. Thus, most commodities and products, from oil to gold, are denoted in the US Dollar, which gives this fiat currency the status of a reserve.
How Does Fiat Money Work?
Apart from the banknotes and coins in circulation, the most significant part of the fiat supply is “manufactured” digitally. In most regions, central banks convey this process, which is afterward credited to major banks; or banks themselves create money during their regular operations of making loans to individual consumers, institutions, and governments.
Now that fiat money isn’t connected to a physical reserve in the form of a national pile of gold or silver, there is a great risk of it losing value due to inflation or even hyperinflation, which means becoming worthless in total. The worst case of hyperinflation happened in Hungary after the second world war, when the inflation rate doubled in a day. This raises the question of whether governments and central banks could eventually prevent critical recessions by independently regulating the money supply.
Despite all this, the fiat system is deeply rooted in global financial governance. It allows governments sufficient flexibility to manage their own national currency, establish individual monetary policy, and balance international markets. It also opens room for fractional reserve banking, enabling commercial banks to multiply the total amount of circulating money in order to respond to the needs of borrowers. There is even a firmly legit credit theory that suggests that fiat money sustainability is based on an inseparable credit vs debt relation. Hence, it doesn’t make any difference if money is backed by a commodity to maintain value.
Fiat vs Cryptocurrencies
What Is Cryptocurrency?
As the first product of blockchain technology, Bitcoin was released in 2009 and led the way for around 4,000 different cryptocurrencies, all of which have accumulated a $1 trillion worth of market value together on a global scale. The idea of decentralized finance was envisioned much earlier, in the late nineties but it was materialized with the launch of BTC as an immediate response to the financial crisis in 2008. The public became overwhelmingly concerned about the traditional financial system that was no longer capable of bearing the burden of governments with debts at such a frequent rate. Plus, the blockchain offered a way for cost-efficient and uncompromisable transactions thanks to the basic features of cryptocurrencies: immutability and trustlessness.
To clarify, cryptocurrencies work on a public distributed ledger, independently of central banks and governments. Blockchain transactions are immutable as they can’t be altered, deleted, or manipulated by an external human party, which leads to impeccable transparency. Moreover, they’re trustless since you don’t have to rely on the security measures of a centralized body and live in fear of whether your funds or identity will be compromised during the transaction. Technically, crypto transactions don’t contain any participants’ credentials — just the public address, which is publicly available.
Ironically enough, the largest marketplace for trading crypto nowadays is centralized crypto exchanges (CEXs) that operate in strict compliance with AML and KYC regulations. CEXs may disrupt the idea of decentralized finance, but they’ve turned out to be the main bridge between crypto technology and mainstream audiences.
However, it’s impractical for cryptocurrencies to take the place of fiat money, at least not in the near future, and this is why.
Why Can’t Crypto Replace Fiat?
It’s a fact that the cryptocurrency industry has bloomed faster than expected. Cryptocurrencies turned out to be a great fit in derivatives and CFD markets and a precious store of value (especially Bitcoin and other altcoins with limited supply).
However, cryptocurrencies failed in their role as a medium of exchange, and the main reason behind this is their volatility. Their prices fluctuate on an hourly basis, and it’s simply unreasonable to pay for a product using bitcoins if their price rises by 20% the very next day. This doesn’t mean there aren’t crypto-friendly retailers — crypto coins are unstable yet attractive among well-established businesses like Amazon and Microsoft.
Another serious drawback of cryptocurrencies is the lack of a regulatory framework. Governments across the world were caught unprepared by the crypto revolution and overlooked the risks of crypto transactions being used for facilitating illegal activities such as money laundering, tax evasions, and settlements for illicit goods and services. They have caught up since — countries are tightening the belt around crypto trading — while some governments have totally banned cryptocurrency trading (China and Egypt), others are making efforts to provide highly regulated grounds (Australia and Canada). However, no country where crypto is welcome treats Bitcoin (BTC) or Ethereum (ETH) as a legal tender but rather as a commodity.
Fiat Money vs. Commodity Money
Unlike fiat, commodity money has an intrinsic or perceived value because commodity assets are derived from an actual “product” — from silver and gold to tea, cocoa beans, shark teeth, and tobacco. By their nature, cryptocurrencies can also be classified as commodity money, and this is exactly where Bitcoin’s comparison to gold started.
On the other hand, fiat money doesn’t have intrinsic value — they’re all made of the same paper, but their value depends on how successful the government monetary management is.
Fiat Currency vs. Representative Money
Representative money is issued and controlled by the government, but compared to fiat, it’s backed by a material commodity. There are several types of representative money including checks and credit cards, which denote an intent or promise to pay.
In other words, fiat is supported by the government, but representative money can be backed by other money in your bank account.
A Few Words Before You Go…
We hope that this article gave you a deeper understanding of the word you regularly stumble upon while trying to find the best crypto exchanges available in Australia. Note that all entry-level native crypto marketplaces Down Under do support your local fiat currency, AUD, and most of the overseas exchanges have adjusted their services to suit the payment options of Aussie residents.
With regard to the battle between fiat and crypto, we can conclude that it’s impossible to predict the further behaviour and development of both types of assets. At this point, it’s unreasonable to talk about replacement but rather coexistence and balance between real and virtual forms of money. Both come with large luggage of advantages and disadvantages, but fiat is definitely here to stay in the role of a moving force of the global economy and political governance.