Simply put, fiat money is legal tender that derives its value from the issuing government rather than from any commodity or physical object. The soundness of the government ensures the value of fiat money, which is the key to this type of currency. Most countries in the world use a fiat money system to purchase goods and services, as well as to invest and save. Fiat money has replaced the gold standard and other commodity-based systems in determining the value of legal tender.


The rise of fiat currencies

Fiat money originated in China centuries ago. China's Sichuan Province began issuing paper money during the 11th century. Initially, the paper money could be exchanged for goods such as silk, gold or silver. Eventually, after Kublai Khan came to power in the 13th century, a fiat money system was established. And historians claim that excessive spending of this paper money and hyperinflation led to the fall of the Mongol Empire.

In the 17th century, Europe also began to use fiat money (non-convertible paper money), initially in Spain, Sweden, and the Netherlands. However, the fiat money system was not successful in Sweden, and the government eventually decided to abandon it in favor of the silver standard. Over the next two centuries, New France in Canada, the American colonies, and the U.S. federal government all experimented with fiat money, with mixed results.

In the 20th century, the United States began to return to commodity-based currencies on a limited basis. In 1933, the U.S. government ended the practice of redeeming paper money for gold. In 1972, under President Nixon, the United States completely abandoned the gold standard and moved to a fiat currency system. This led to the use of fiat currencies around the world.


Fiat Currency vs. Gold Standard

The gold standard allows paper money to be exchanged for gold. In fact, all paper money is backed by gold held by the government. In a commodity-based monetary system, governments and banks can only introduce new paper money into the economy if they have an equal amount of gold reserves. This system limits the ability of governments to create paper money and increase the value of their currency based on economic factors.

On the other hand, in a fiat currency system, paper money cannot be exchanged for anything else. And the government can directly influence the value of the country's currency through fiat currency and link it to the economic situation. The government and the country's central bank have more control over the monetary system, and they can use different tools to respond to emerging financial events and crises, such as creating a fractional reserve banking system and implementing quantitative easing policies.

Advocates of the gold standard argue that a monetary system based on commodities is more stable because it is backed by real goods and values. Fiat currency advocates counter that the price of gold is far from stable. In this environment, the price and value of both commodities-based and fiat currencies will be affected. However, under a fiat currency system, governments have more flexibility to respond to unexpected economic conditions.


Pros and Cons of Using Fiat Currency

Economists and other financial experts are not all in favor of this type of fiat currency system. Defenders and opponents of this type of currency system have engaged in a heated debate.

  • Shortages: Fiat currencies (non-convertible paper money) are not subject to and limited by shortages of actual commodities like gold.

  • Cost: Fiat money (non-convertible paper money) is easier to produce than commodity money.

  • Responsiveness: Fiat currencies give governments and their central banks greater flexibility when it comes to responding to economic crises.

  • International Trade: Fiat money is used around the world, which also makes it an acceptable form of currency in international trade.

  • Convenience: Unlike gold, fiat currencies do not rely on physical reserves that require storage, protection, monitoring, and other expensive requirements.

  • No intrinsic value: Fiat currencies have no intrinsic value. This allows governments to create money at will, which can lead to hyperinflation and economic collapse.

  • Historical risks: From a historical perspective, the implementation of a fiat currency system can often lead to financial collapse, which shows that the use of fiat currency does have certain risks.

Fiat Currency vs Cryptocurrency

Fiat currencies and cryptocurrencies share one common property: they are not backed by physical commodities, and this is their only similarity. Fiat currencies are controlled by the government and the country’s central bank, while cryptocurrencies are decentralized in nature, and this difference mainly stems from the distributed digital ledger called “blockchain”.

Another significant difference between the two monetary systems is their method of money production. As a representative of cryptocurrency, "Bitcoin" has a limited and controlled supply, while legal currency is completely different. The central bank can issue legal currency out of thin air based on its judgment of the country's economic needs.

As a digital form of currency, cryptocurrency has no physical counterpart and is not owned by any country, so there are few restrictions on global transactions of cryptocurrency. In addition, cryptocurrency transactions are irreversible, which makes it difficult to track cryptocurrency transactions.

It is also worth noting that the current cryptocurrency market is still very small, so the volatility is very high. This may be the main reason why cryptocurrencies have not yet been widely accepted, but it is believed that as the crypto economy grows and matures, volatility will steadily decrease.

  

Summarize

The future of both systems is full of uncertainty. Obviously, cryptocurrencies still have a long way to go and will face more challenges, but they will not disappear. On the other hand, the history of fiat currencies also shows the fragility of this system of currency. And this may be why more and more people are turning to the cryptocurrency system to complete their financial transactions (at least in some aspects).

The main idea behind the creation of Bitcoin and cryptocurrencies is to explore a new form of money built on a distributed P2P network. Bitcoin was not created to completely replace the entire legal currency system, but only to provide an alternative economic network that has the potential to create a better financial system for a better society.