- Fiat is a government-issued currency that is backed by a central government.
- Central banks can control how much currency of fiat is printed, which gives them control over the economy. However, if government print too much of fiat money, it will in hyperinflation.
- Cryptocurrency is not backed by a central government or bank. It is global and decentralized.
What is Fiat
Fiat money is a legal tender that is backed by the government that issued it, rather than any physical commodity, such as silver or gold. Majority of the paper currencies in today’s world are fiat currencies, such as the U.S. dollar, the Euro, the Japanese Yen, the British Pound Sterling and various other global currencies.
Since fiat money is backed by the government, its value is based on the and the stability of the issuing government and the relationship between supply and demand. Basically, fiat currency has value only because the issuing government maintains that value, or because the parties involved in a fiat transaction agree on a value.
Fiat money was first used in eleventh century in China. After that, it started to dominate during the twentieth century. The use of fiat currencies on a national level officially started in 1971, after Richard Nixon decoupled the U.S. dollar from gold. This resulted in a transition from representative currency (backed by different assets or financial instruments) to fiat currency.
Fiat currency vs Crypto currency
There is no intrinsic difference between fiat and crypto currency. Both are mediums of exchange that can be used to transfer or store value, both can be used to buy services or goods. The value of both the currencies depends on factors such as supply and demand, scarcity, and overall economic conditions. Fiat and crypto both can be traded on exchanges, however, there are some notable differences between the two.
- Fiat money is a government-issued currency and its value is tied to the stability of the said government, while crypto is a digital currency whose value is based on its native blockchain
- The issuance and governance of fiat currency are dictated by central banks, while blockchain protocols, code, and communities govern cryptocurrency.
- Fiat relies on intermediaries for its distribution, whereas cryptocurrency requires decentralized networks for trust-less transactions.
- The government controls the supply in case of fiat and users can pay their taxes with it. Crypto’s supply is controlled by an algorithm and instead, users are required to pay taxes on it.
Pros of Fiat
The most noticeable feature of fiat currency is the stability of its value, which is the reason it became popular in the first place. Governments started using it to protect their economies from the negative fluctuations of the business cycle since fiat money is able to handle the role of a good monetary unit of a national economy — value storage, numerical account, and facilitation of exchange.
Moreover, fiat money gives control to central banks over the economy - including supply, liquidity and interest rates - as they can print the money as per their need and wants.
Cons of Fiat
Fiat money is not backed by any physical reserves, hence, there is always a risk of it losing its value in case people lose faith in the national currency, or in event of hyperinflation. On the contrary, commodity-based money such as gold has intrinsic value tied to demand of the underlying commodity, so the risk of such currency losing value is far less than fiat.
Commodities have a limited supply; hence critics of fiat money believe that this limited supply makes commodity-based currencies more stable than fiat money, which has an unlimited supply.
For any form of money to be effective, it must be able to store and transfer value, and act as a medium of exchange. Both fiat currency and crypto currency offer this opportunity, but in different ways. Fiat money has no real intrinsic value of its own, and it is the responsibility of the nation’s government and its central bank to preserve its value. Crypto’s value is basically linked to the native blockchain and underlying asset.
Crypto enthusiasts believe that crypto will take over as a primary currency for exchange and value storage instead of fiat. However, that doesn’t seem to be true for common people as of yet. Specially the volatility in the crypto market has made some people argue that digital coins are not a reliable store of value. Only time will tell which currency is more efficient.