Fiat currency is “legal tender” backed by a central government, such as the Federal Reserve, with its own banking system, such as fractional reserve banking.

What is Fiat Currency?

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. 

The Fiat Money System Explained

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.

Fiat Money Supply Classifications

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: 

  • M1 – These are the physical coins and notes circulating in your countries economy, as well as money ready for use via other mediums like debit cards and checking accounts. 
  • M2 – This includes everything in M1, but adds things like savings deposits and mutual funds that can be converted into cash relatively quickly.
  • M3 – This includes everything from M1&M2, but adds large time deposits, and institutional money market funds that are less liquid. 
  • M4 – M4 encompasses all money in cash as well as all bank accounts.

Fiat Currency vs Cryptocurrency

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. 

Difference Between Fiat Money and Cryptocurrency

The main differences between fiat currency and cryptocurrency are compared here: 

  • Fiat currency is controlled and backed by a central entity (government). It is deemed legal tender for all business and personal transactions. 
  • Cryptocurrency is a completely digital and decentralized asset. It does not belong to any government and is instead a global currency that anyone may use. It is not backed by any government and its supply is instead dictated by an algorithm (like proof-of-work). 

Digital Fiat Currency vs Cryptocurrency

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. 

Is Cryptocurrency Better Than Fiat?

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. 

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