What is fiat money? 

Fiat money can be defined as a currency established as legal tender by government regulation. A fiat currency is not backed by a physical commodity such as gold or silver. Fiat money lacks intrinsic value, deriving its value from public trust in the issuing government, and trust between parties engaged in buying and selling. 

Where have you heard of fiat money?

The majority of modern paper-based currencies, such as the US dollar, are classed as ‘fiat currencies’. It’s one of several currency types - others include commodity-backed money and representative money. 

Investors in cryptocurrency often use the term ‘fiat’, from the Latin "it shall be". Cryptocurrency proponents believe the true value of digital assets like bitcoin (BTC) is that they eradicate many of the disadvantages faced by fiat currencies.

What do you need to know about fiat money?

How does fiat money work? While fiat money is backed by government regulation and public trust in its value as a medium of exchange, investors should note the distinctions between fiat money and other forms of currency.

The adoption of fiat currencies has a number of advantages and disadvantages.

Advantages of fiat money

• Easy to store, manage and transport

• Widely accepted

• Provides greater stability in value than a commodity like gold

• Allows for greater control over the money supply, allowing for the infinite creation of new currency in order to stimulate economic growth

Disadvantages of Fiat Money

• Too much currency in circulation can lead to increased inflation and hyperinflation. In Zimbabwe, for example, prices had been rising rapidly - when hyperinflation reached its peak in 2015, $100trn Zimbabwean dollars was equivalent to US$0.40 

• As supply increases, the currency falls in value - consumers can buy less with the same amount of currency. This is demonstrated by the fall in purchasing power of the US dollar – $1 in 1913 has the equivalent purchasing power of $26.98 in 2021

• The value of fiat currencies depends on the stability of the governments that back them