What is a fiat currency?
Crypto for Beginners
The word "fiat currency" refers to the money you use every day. The United States dollar, like most other modern currencies in circulation, is a fiat currency. The value of fiat currencies is often sustained by a government's economic strength. A distinct type of money is an asset-backed currency, which gets its value from an underlying asset. An asset-backed currency, for example, would be based on the value of gold. Although asset-backed currencies are legal tender, the international monetary system has stressed fiat money since the Great Depression. The phrase "fiat currency" is now widely used to distinguish traditional money from cryptocurrencies. Cryptocurrency is a digitally produced method of payment that does not require the assistance of a central bank to function.
Dollars were backed by reserves of precious assets such as gold and silver for many years. In the 1930s, the United States abandoned the gold standard for internal transactions, and foreign conversions were phased out in 1971. Since the 1960s, dollars have not been redeemable in silver. The Federal Reserve in the United States is now obligated to keep collateral equivalent to the value of the dollars in circulation, which it does using government-issued debt. To summarize, the dollar is valuable for two reasons:
- Because the government of the United States claims it does.
- Because investors and lenders across the globe think the United States will pay its bills.
Difference between fiat and cryptocurrencies
The major difference between fiat money and cryptocurrency is that the former does not require official support, but the latter does. The majority of cryptocurrencies are built utilizing blockchain, a cryptographic computer networking technology that allows them to circulate without the need for a central authority like the Federal Reserve. Many cryptocurrency supporters think that "decentralization," in which currencies are controlled by users rather than central authorities, would result in more efficient and less corrupt monetary systems.
Governments, on the other hand, are free to use cryptocurrencies and related technology in their national currency systems. El Salvador became the first country to accept Bitcoin as legal money in September 2021. China is also working on a digital version of its national money, the yuan. Because most cryptocurrencies aren't backed by governments, their value comes from a variety of places.
The value of Bitcoin, the first and most valuable cryptocurrency, is largely controlled by supply and demand market logic. Bitcoin has a limited quantity that is controlled by its underlying software, so as demand rises, so do prices. Because many cryptocurrency investors speculate on their future value, prices have been highly volatile in relation to the dollar.
Certain stablecoins however, are backed by a reserve of cash or other commodities in order to maintain their value.