Fiat currency or (fiat money) is currency that is issued by governments and central banks and is not backed by a precious commodity, such as gold or silver. Instead of this, the government or central bank that issued it is backing it up. The term fiat derives from the Latin word “fiat”, meaning “let it be done” used in the sense of an order, decree or resolution.
So, the value of fiat money is derived from the balance between supply and demand and importantly, from the stability of the issuing government or trustworthiness of the issuing central bank. The most modern paper currencies are fiat currencies, including the U.S. dollar, the euro, and other major global currencies.
Cons of a FIAT currency
Since it is not tied to a tangible asset, the fiat money’s value is greatly dependent on responsible fiscal policy and regulation by the government. Irresponsible monetary policy can easily lead to inflation or even hyperinflation of a fiat currency.
Additionally, there is greater possibility for bubbles with fiat currency because of an economic cycle in which there is a rapid increase in price before an equally rapid decline in price.
Furthermore the increased prevalence of bubbles is because fiat currencies have a virtually unlimited supply. This means that quantitative easing is an option for governments.
Providing stimulus to an economy and quantitative easing can also cause greater inflation rates. This can potentially impact anything from housing prices to national debt levels, which in turn can impact the financial markets.
A characteristic example
A recent example of “printing” extra money for massive stimulus packages, was the emergency situation with the COVID-19 pandemic. In situations like this, everyone can easily understand the great difference between a FIAT currency and a cryptocurrency like Bitcoin or BitcoinZ with a fixed and stable inflation policy.