Fiat currency is “legal tender” backed by a central government, such as the Federal Reserve, and with its own banking system, such as fractional reserve banking. It can take the form of physical cash, or it can be represented electronically, such as with bank credit.
If you are getting started in the world of crypto, you may hear the term “fiat” thrown around quite often. The definition of fiat money or fiat currency is money a government has deemed or certified as legal tender that they support. The dictionary definition of “fiat” is simply an authoritative or arbitrary order. So, the government issues an order dictating that USD, GBP, INR, EUR, or other world currency is lawful and accepted to pay both public and private debts.
Fiat money is issued by governments’ reserves, treasury and central bank systems to be released into circulation. Fiat money is not backed by gold or silver, but is backed by the governments that mint and distribute the currency. This can be dangerous as countries have a tendency to print too much money to stimulate their economies, resulting in inflation. Fiat currency gives governments the power to implement policies meant to control things like supply, liquidity and interest rates.
There are types of fiat money supply that are denoted as “M’s” in economics. There are four classifications of money supply below from most liquid to least liquid:
Unlike fiat currency, cryptocurrency is decentralized. This means that no monetary authority or country has approved of or has a say in the distribution or use of the currency. Cryptocurrency has no physical bills or coins but is instead completely digital. Cryptocurrency is not legal tender (in all countries except for El Salvador at time of writing) and cannot be used in many places as a means of payment.
The main differences between fiat currency and cryptocurrency are compared here:
In many places around the world, cashless transactions have become the new normal. Digital fiat has become the main way many people do business. Many governments are now considering releasing a totally digital currency that is possibly blockchain-based. These are known as central bank digital currencies or CBDCs. These currencies were inspired by cryptocurrencies like bitcoin, but are very different because they are centralized and their value is still controlled by the government’s monetary policy.
Cryptocurrency can replace fiat currency in all its uses. Crypto can be used as a store of value, medium of exchange and unit of account. Crypto and decentralized finance remove the need for expensive and inefficient intermediaries such as banks. Additionally the value of a cryptocurrency isn’t determined by a government as is the case with fiat. It replaces antiquated record keeping with an immutable and trustless ledger that every user has access to.
However, many cryptocurrencies have issues with things like transaction speed and high energy usage. The new technology is advancing quickly to cover these problems to create a system of finance that is better than fiat in every way.