Fiat

November 21, 2023 - Around 4 mins mins to read

Understanding Fiat Currency

If you are new to the world of crypto, you may frequently come across the term “Fiat.” Fiat money or fiat currency refers to money that a government has declared as legal tender and supports. The dictionary definition of “Fiat” is simply an authoritative or arbitrary order. Therefore, the government issues an order stating that currencies like USD, GBP, INR, EUR, or any other world currency are lawful and accepted for both public and private debts.

Explaining the Fiat Money System

Fiat money is released into circulation by the government’s reserves, treasury, and central bank systems. Unlike gold or silver-backed money, fiat money is not backed by any precious metal. Instead, it is supported by the governments that mint and distribute the currency. However, this can be risky as countries tend to print excessive amounts of money to stimulate their economies, leading to inflation. Fiat currency grants governments the authority to implement policies aimed at controlling factors such as supply, liquidity, and interest rates.

Classifications of Fiat Money Supply

In economics, there are different classifications of fiat money supply denoted as “M’s.” These classifications range from the most liquid to the least liquid:

M1 – This category includes physical coins and notes in circulation within a country’s economy, as well as money available for use through mediums like debit cards and checking accounts.
M2 – In addition to everything in M1, M2 includes savings deposits and mutual funds that can be converted into cash relatively quickly.
M3 – This category encompasses everything from M1 and M2, but also includes large time deposits and institutional money market funds that are less liquid.
M4 – M4 covers all money in cash as well as all bank accounts.

Fiat Currency vs Cryptocurrency

Unlike fiat currency, cryptocurrency operates in a decentralized manner. This means that no monetary authority or country has approved or has control over the distribution or use of cryptocurrency. Cryptocurrency exists solely in digital form and does not have physical bills or coins. While fiat currency is legal tender in most countries (except for El Salvador at the time of writing), cryptocurrency cannot be used as a means of payment in many places.

Difference Between Fiat Money and Cryptocurrency

The main distinctions between fiat currency and cryptocurrency are as follows:

Fiat currency is controlled and backed by a central entity, typically a government. It is considered legal tender for all business and personal transactions.
Cryptocurrency is a completely digital and decentralized asset. It does not belong to any government and serves as a global currency that anyone can use. It is not backed by any government and its supply is determined by an algorithm, such as proof-of-work.

Digital Fiat Currency vs Cryptocurrency

In many parts of the world, cashless transactions have become the norm. Digital fiat has emerged as the primary method of conducting business for many individuals. Several governments are now contemplating the release of fully digital currencies, potentially based on blockchain technology. These currencies are known as central bank digital currencies or CBDCs. While inspired by cryptocurrencies like bitcoin, CBDCs differ significantly as they are centralized and their value is still controlled by the government’s monetary policy.

Is Cryptocurrency Better Than Fiat?

Cryptocurrency has the potential to replace fiat currency in all its applications. It can serve as a store of value, medium of exchange, and unit of account. Cryptocurrency and decentralized finance eliminate the need for costly and inefficient intermediaries like banks. Additionally, the value of a cryptocurrency is not determined by a government, unlike fiat currency. It replaces outdated record-keeping systems with an immutable and trustless ledger accessible to all users.

However, many cryptocurrencies face challenges such as transaction speed and high energy consumption. Nevertheless, technology is rapidly advancing to address these issues and create a financial system that surpasses fiat currency in every aspect.

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