Fiat money: The currency the world has decided to believe in

Fiat money is the currency we use every day without really questioning what backs it. Unlike gold, it has no tangible value. Its value exists because governments say it does, and because millions of people accept that reality. In short, fiat money is a system of collective beliefs about the value of money, where state authorities determine its actual worth.

Most countries today use this system to buy goods, services, invest, and save. But this is a relatively recent historical development, replacing monetary systems based on physical assets like gold or silver.

Why did fiat money replace gold?

For centuries, the gold standard was the international norm: paper currency could be exchanged for real gold. Governments could only put money into circulation if they held enough gold in their vaults. This system heavily limited countries’ financial decisions.

Fiat money changed everything. Without gold backing it, governments gained the freedom to influence their economies directly. They could create money when needed, adjust interest rates, implement quantitative easing, and respond quickly to crises. This proved more useful during economic emergencies, though it also introduced new risks.

The risk history of fiat money in East and West

The first fiat currency in history appeared in China nearly a thousand years ago. During the 11th century, Sichuan Province began issuing paper money that could be exchanged for silk, gold, or silver. Initially, it worked well.

Then came Kublai Khan in the 13th century and established a fiat money system without backing. Historians warn that excessive spending and resulting hyperinflation significantly contributed to the fall of the Mongol Empire. This was probably the first lesson on the dangers of creating unlimited money.

Europe also experimented with these systems from the 17th century onward. Sweden attempted to implement it but failed, forcing the government back to the silver standard. New France (Canada), American colonies, and later the United States also tested fiat money with mixed results.

The U.S. is particularly instructive. During the 20th century, it maintained a limited gold standard until 1933, when the government banned exchanging paper currency for gold. In 1972, under Nixon’s administration, the U.S. fully abandoned the gold standard and adopted a completely fiat system. This event marked the point of no return: the rest of the world followed suit, and today we live in a global fiat monetary system.

Fiat money vs. gold: A game of flexibility vs. stability

The debate between these two systems is not new. Under the gold standard, governments were handcuffed. With a commodity-based system, they couldn’t introduce new currency without sufficient gold available. The economy was more predictable but also more rigid.

Fiat money offers the opposite: total flexibility. Central banks can influence the currency’s value by tying it to real economic conditions. They have tools like fractional reserve banking and can respond to various economic events. It’s money with purpose.

Gold standard advocates argue that their system was more stable because it was backed by something real and valuable. Fiat money supporters counter that gold prices have never been stable. Both are partly right: gold and fiat money can be volatile, but fiat money allows governments to respond with more tools during economic emergencies.

Advantages of fiat money: Is it really the best?

There are compelling reasons why most economists support fiat systems:

Controlled scarcity. Fiat money isn’t limited by natural resource availability. Governments can create the necessary amount without depending on gold mines.

Lower costs. Producing fiat money is cheaper than extracting, refining, and storing gold. Governments can circulate currency at a much lower cost.

Reactivity. During economic crises, fiat money enables quick and flexible responses that the gold system could never provide.

International trade. Fiat money is universally accepted, facilitating transactions between countries worldwide without needing to convert to gold.

Practicality. Unlike gold, fiat money doesn’t require secure vaults, constant protection, or complex custody systems.

Disadvantages of fiat money that governments don’t always mention

But the system has serious problems:

No intrinsic value. Fiat money has no value by itself. This allows governments to create money without limits, which has historically caused hyperinflation and economic collapses.

History of failures. Implementing fiat systems has led to multiple financial collapses throughout history, from the Mongol Empire to modern monetary crises.

Dependence on government. Fiat money only works if there is trust in the government’s stability. Radical political changes can destroy the system overnight.

Fiat money and cryptocurrencies: Two conflicting monetary systems

In theory, fiat money and cryptocurrencies share a trait: neither has physical backing. But that’s where the similarities end.

Fiat money is centrally controlled by governments and central banks. Cryptocurrencies are decentralized, operating via blockchain—a distributed ledger that requires no central authority.

The way money is generated is radically different. Bitcoin and most cryptocurrencies have a fixed, limited supply (21 million BTC forever). Fiat money, on the other hand, can be created indefinitely based on central banks’ assessment of economic needs.

As a purely digital form, cryptocurrencies have no physical equivalent and no borders, making international transactions less restrictive. Additionally, transactions are irreversible and much harder to trace than traditional fiat transfers.

However, the cryptocurrency market is significantly smaller and thus more volatile than traditional money markets. This volatility is probably the main reason cryptocurrencies haven’t gained widespread acceptance yet. But as the market grows and matures, instability is likely to decrease.

The future: coexistence or domination?

The future of both systems is uncertain. Although cryptocurrencies have come a long way and will face countless challenges, the history of fiat money demonstrates its inherent vulnerability. Rapid inflation, monetary manipulation, and financial collapses are part of its legacy.

This vulnerability is precisely why many people are exploring cryptocurrencies as an alternative. Bitcoin was created with the idea of investigating a new form of money based on peer-to-peer (P2P) distributed networks, without central intermediaries.

Most likely, Bitcoin was not designed to completely replace fiat money but to coexist as an alternative economic network. Its goal is to offer a different option that could help build a more resilient and equitable financial system for the future.

Fiat money will continue to dominate for now, but the existence of cryptocurrencies has raised a question governments cannot ignore: what happens when people stop trusting fiat money?