What is fiat currency?

The world of cryptocurrency has a language of its own. And one of the terms that's being thrown around a lot is fiat currency. But what is fiat money?

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With all of the different types of cryptocurrency and terms floating around, the world of cryptocurrency can be easy to get lost in. One of the terms that pops up quite frequently is fiat currency — what are people talking about when they use this term?

What is fiat currency?

Fiat currency is a form of money that’s issued by a government and declared to be legal tender. This type of currency is not linked to any asset of value and can be printed at will by central governments. However, governments must be careful to avoid over-circulation, as this would cause a drop in value.

What determines the value of fiat money?

The value of the currency is based on what it can be used for, not because the coins or cash have any particular value. It’s money that can be used because it’s based on a trust relationship between the issuer, the holder and those that receive it — in turn the supply and demand can be loosely regulated by the government and market.

If trust in the value of a currency is lost, it will lose demand which will lead to a drop in value. The trust of currency is ultimately based on members of the economy believing it’s worth something. The value of fiat money isn’t directly held in a physical asset like a precious metal or an item that’s of use to someone.

For example, when the government of Zimbabwe started issuing more money, the situation eventually snowballed into one where no-one trusted the value of the currency — so, it collapsed as a form of fiat currency.

What can fiat money be used for?

Fiat money is widely accepted all over the world to buy almost any good or service. Fiat currency can come in the form of paper money, coins, credit, loans or bonds. If you apply for a credit card or personal loan and are approved, that credit or amount of money you receive is a form of fiat money because you’re essentially using money on the basis of your creditworthiness and agreement that you’ll pay back the funds — typically with interest.

Fiat money can also be useful for exchanging currency when you’re going on vacation, traveling or sending money around the world. International money transfer services allow people all over the world to take one form of fiat money and send it in the form of a different type of fiat currency for a small fee.

What are the pros and cons of fiat currency

One of the advantages that fiat currency has is that it’s the most accepted form of currency. It’s supported by multiple payments networks and currency exchanges around the world. Fiat money can also help stabilise a country’s economy for two reasons: governments control the money supply and it isn’t based off of a volatile commodity.

But that can also be a disadvantage because if too much money is printed, the currency could experience hyperinflation — severely dropping the value. It could be argued that fiat money has other disadvantages as well. Because fiat money has to continually be printed to keep up with demand and circulation, the value will likely drop over a longer period of time.

Fiat currency vs. cryptocurrency

Here are some of the key differences between fiat currency and cryptocurrency to help you unblur the lines a bit:

Fiat currencyCryptocurrency
Physical or credit currencyDigital currency
Unlimited supplyLimited supply
Government issuedComputer produced
Can come with interestNo interest at all
Government regulation and market control valueSupply and demand control value

At the moment, cryptocurrencies are still evolving and differ from fiat currencies in several ways. Firstly, they’re not minted into physical coins or banknotes. Also, they’re not issued by central governments. This is why many regulators aren’t seeing it as a legitimate currency.

At the moment, the number of exchanges of cryptocurrencies for physical goods and services has been limited, although that appears to be slowly changing with time.

*Cryptocurrencies aren't regulated in the UK and there's no protection from the Financial Ombudsman or the Financial Services Compensation Scheme. Your capital is at risk. Capital gains tax on profits may apply.

Cryptocurrencies are speculative and investing in them involves significant risks - they're highly volatile, vulnerable to hacking and sensitive to secondary activity. The value of investments can fall as well as rise and you may get back less than you invested. Past performance is no guarantee of future results. This content shouldn't be interpreted as a recommendation to invest. Before you invest, you should get advice and decide whether the potential return outweighs the risks. Finder, or the author, may have holdings in the cryptocurrencies discussed.

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