Fiat Money
Fiat money is currency that is not backed by a commodity such as gold. It works mainly because people accept and trust it and because a government declares it legal tender.
How fiat money works
The word fiat comes from Latin for let it be done: the money has value because an authority says it is the official currency, and because people expect others to keep accepting it. Governments usually require taxes to be paid in it and make it legal tender for settling debts, which helps anchor demand.
Most fiat money today is not physical cash but digital balances held at commercial banks. Central banks issue banknotes and reserves, while commercial banks create most deposits when they make loans. The euro, the US dollar and the Swiss franc are all fiat currencies.
A short history
Paper money that could not be exchanged for metal has appeared many times, for example in medieval China. The modern global fiat system took shape on 15 August 1971, when US President Nixon suspended the convertibility of dollars into gold for foreign governments, ending the Bretton Woods arrangement that had linked major currencies to the dollar and the dollar to gold.
Strengths and weaknesses
Because supply is not tied to a metal, central banks can expand or tighten money in response to crises, which can soften recessions and stabilize banks. The flip side is that supply can be expanded too far. Most fiat currencies lose purchasing power gradually through inflation, and in extreme cases, such as Zimbabwe in 2008, mismanagement has led to hyperinflation.
Fiat money and crypto
Bitcoin was created partly as an alternative: a currency with rules enforced by software and a fixed supply rather than by an issuing authority. Meanwhile, most stablecoins are built on fiat money. A fiat-backed stablecoin holds dollar or euro reserves and aims to stay worth one unit of that currency, so it inherits fiat money's properties and adds the risk of the issuer.
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Frequently asked questions
Is fiat money backed by anything?
Not by a commodity. It is backed by the issuing state's authority, its ability to tax, the central bank's policies and public trust.
Is the euro fiat money?
Yes. The euro, the US dollar, the Swiss franc and virtually all national currencies in use today are fiat currencies.
Is Bitcoin fiat money?
No. Bitcoin is not issued or declared legal tender by a government in most countries, and its supply follows protocol rules. Like fiat, however, it has no commodity backing; its value rests on demand.
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