What is Fiat Money? How Does it Differ from Cryptocurrency?

The term “money” refers to different things in various historical periods. For example, in traditional West African societies, Crypraea moneta( money cowry), was widely recognised as a medium of exchange and a vestige of West Africa's past. Fast forward to the present day and you have paper money, which has become an integral part of the global trade system.

In this article,the origin and definitions of fiat money is discussed along with its differences from cryptocurrency.

What is Fiat Money?

Fiat money is a legal tender issued by the government of a country. It is not backed by any commodity such as gold or silver, and it has little intrinsic value other than the fact that its value arises from the public trust in the currency’s issuer,which is usually the country’s government. The most common examples of fiat money include Euros, Pounds, Yen, Rupee, dollar, and so on.

History of Fiat Money?

The origin of fiat money can be traced to China's Song Dynasty. According to Wikipedia, it is first issuer of paper money in the world. About the 10th Century C.E, jiaozi paper notes were issued to the public as the earliest form of paper money. 

Then came the era when the gold standard was favoured. After the end of WW2,many countries abandoned the gold standard and adopted flexible monetary policies towards representative fiat money. As a result of this, fiat money gained its value through state control and general recognition. Since then, most of the world’s economies have shifted to fiat money.

How Do Fiat Currencies Work?

Fiat money refers to any type of money that an institution issues and manages using a monetary system that uses a medium of exchange such as paper money. Within any national monetary framework, central banks assume significant roles. They work independently from the government in controlling the level of interest rates, ensuring financial market stability, and immunizing it against political pressure. Its main function is to regulate the monetary supply.

In addition, fiat money depends on how the state’s economy is performing, how the country is being governed, and the outcome of the mentioned issues on interest rates. For instance, during political instability in a country, its currency weakens and commodities become expensive such that buying becomes difficult due to necessity.

However, when fiat money has no intrinsic value, inflation can be triggered. On the contrary, deflation occurs when the money supply shrinks and the price level declines which seems beneficial, but extreme deflation could suffocate economic development and limit consumption.

Nonetheless, fiat currency value lies mostly in the faith citizens have in issuing authority which is usually the state government of a country.

Why is Fiat Money Valuable?

Fiat currencies are valuable because there is confidence and trust in the issuing government from the people. This gives rise to some merits in that the government coerces citizens to pay tax on the fiat money it releases. Citizens must abide by this guideline or else face a heavy penalty, hence improving the currency value.

Ultimately, depending on things such as the strength of the law, the reputation of the ruler, and the ability to pay outstanding debts, currency can be valued either highly or poorly.

What is Cryptocurrency?

Cryptocurrency is a decentralized digital currency built on blockchain and secured using cryptography and unbreakable encryption in electronic forms. There are over nine thousand distinct cryptocurrencies, including Bitcoin, Ethereum, and many more.

Is Cryptocurrency Better Than Fiat?

Both cryptocurrency and fiat money have their advantages and challenges. Cryptocurrencies provide a decentralized system and access from all corners of the world. However, they come with volatility and  are not backed by established assets. Additionally, their strength and wide social acceptability offer privacy and lower transaction costs. However, this preference is based on the individual’s needs and circumstances.

The Difference Between Fiat Currency and Cryptocurrency?

The fiat and cryptocurrency differ in various ways as illustrated:

Centralisation vs Decentralisation 

Governments and central banks centrally regulate and control fiat currencies, overseeing their issuance, monetary policies, and circulation. On the other hand, cryptocurrencies are operated using decentralized blockchain technology and no institution or government controls them. Instead, a consensus mechanism is used to verify transactions using a network of participants.

Backing

The fiat currency value is not tied with either commodities like gold or silver and hence they are used as a medium of exchange. Their strength is based on public trust instead of any material used. Cryptocurrencies on the other hand are not based on physical commodities or promises made by a government entity. They get their worth based on factors such as scarcity, utility, and demand of the consumers in the market.

Issuance

Fiat currencies can only be issued by central authorities like a central bank and can only be controlled legally. Money usually circulates through measures such as changing the interest rates and quantitative easing. On the contrary, the issuance of cryptocurrencies mostly brings about processes such as mining or token generation events controlled through predetermined protocols and algorithms. For instance, it was mentioned that Bitcoin has an upper limit of twenty-one million coins.

Physical Form & Digital Form

Fiat currency comes in physical forms such as coins and notes commonly used in financial transactions. Nonetheless, most of the monetary volume is digital, as it appears on computers’ screens in banks and financial establishments while cryptocurrency is fully electronic(in digital forms). They can even be used in commercial transactions but have no physical equivalence to banknotes or coins.

Regulation

Financial services are required to ensure that transactions involving fiat currency conform to specified laws and regulations.

On the other hand, cryptocurrency regulations include: determining the legal status, registering for exchanges, observing KYC obligations, tax regulations, consumer protection measures, respect for securities regulations, taking cross-border concerns into account, following technical standards, as well as considering central bank digital currencies.

Ultimately, regulation has been very dynamic with regular and numerous changes. Therefore, users and businesses should know the regulations in their areas of operation.

Conclusion

In conclusion, fiat currency can be referred to as traditional non-commodity money whose value is derived from trust and acceptability by law and is governmentally controlled and centralized. On the other side, cryptocurrency is a centralized digital type of currency based on cryptography that uses issues like scarcity and usefulness to calculate its value.

However, they differ in many instances such as issuance, regulations, technology basis, and so on. However, one may opt for fiat or cryptocurrency depending on their preference, application, and the dynamic financial environment.