A Fiat currency (also known as Fiat Money) is a form of money that is not backed by a physical commodity like gold and silver but rather by the government that issues it. US dollar, Euro, Pound, Yen, and other major global currencies are the best examples of fiat currency in the modern day. Despite the fact that the materials comprising fiat money don’t carry much value, they are considered legal tender for paying debts, taxes, and other obligations.
What is Fiat Currency?
The word “Fiat” signifies “an order given by authority or arbitrarily”, and when it comes to “fiat money,” it is an order by the government that gives it value and legitimacy. Fiat currency emerged during the 20th century when countries began moving away from the gold standard, where their currencies were pegged to gold. The global economy currently utilizes 180 fiat currencies.
Currently, the world’s monetary system relies on fiat currency. A fiat currency denoted by a government does not correspond to a physical commodity. Instead, its value depends on how a country’s economy performs and what its leaders do to improve it.
Fiat currency prices fluctuate according to the laws of supply and demand in the marketplace. The central banks regulate the money supply by gauging how much money the economy needs and print it accordingly. Creating too many money prints can lead to hyperinflation — rapid, out-of-control price increases that could cause economic disaster.
The credibility of fiat currencies is directly related to the stability of the government that issued them, as well as the confidence in the central bank supplying them. It is impossible to convert or redeem fiat currency like other traditional commodity-backed currencies. It has no intrinsic value and is regulated by government decree. The government must protect fiat currencies from counterfeiting and manage the money supply responsibly to ensure success.
Read Key Economic Data That Influence Exchange Rates of Fiat Currencies
How do Commodity, Representative, and Cryptocurrencies differ from Fiat Currency?
Over the centuries, several monetary systems have been in use worldwide. While many have failed, some have succeeded, and a few are either poised to fail or succeed in transforming the world’s financial system. Let’s review them one by one.
Commodity Currency vs Fiat Currency
Commodity money is the monetary system that uses physical commodities as currency. Expensive metals like gold and silver are the best examples of commodity currency. Their long and solid track record has made them valuable assets for storing wealth.
The reason why gold and silver never lose their value is that they are scarce. Due to their difficulty finding large quantities of them in the wild, their demand has historically exceeded their supply.
Fiat money and commodity money differ in their intrinsic value. The intrinsic value of commodity money comes from the materials used to make it, such as gold and silver coins. In contrast, fiat money is merely a promise from the government or central bank that its value can be exchanged for goods.
Representative Currency vs Fiat Currency
Representative currency, also known as commodity-based currency, is a monetary system in which items that have no intrinsic value (like paper bills) can serve as currency when backed by something of substantial value.
In the same way that fiat currency gets backed by the government, the representative currency is backed by various assets or financial instruments. Checks, money orders, bank drafts and credit cards, for instance, are backed by the money in a bank account and can be exchanged for the value listed on the instrument.
Cryptocurrency vs Fiat Currency
Fiat currency is a legal tender, one that is recognized as legitimate by the government and has its value guaranteed. In contrast, cryptocurrency is a digital currency powered by blockchain technology and does not have a central authority, such as a government.
In spite of the increasing value of many cryptocurrencies in recent years, they are still very volatile and risky investments due to their lack of regulation. In contrast, fiat currencies like the dollar are more stable, but they are also subject to inflation, which can impair their value significantly over time.
Pros and Cons of Fiat Currency
So, what are the benefits of fiat money? What has led to its survival as a global monetary system for half a century? What are the chances of its long-term endurance? Well, here’s a list of the benefits it has brought and the drawbacks it may face in the future.
Advantages of Fiat Currency:
- Central banks have the ability to control an economy’s money supply by setting interest rates as well, giving them more control over inflation and deflation.
- Similarly, a central bank can devalue its currency to make its exports appear more attractive to other countries, which could boost international trade and the country’s GDP. As a result, the supply of the currency is increased, creating a ‘race to the bottom’ since multiple countries may be doing this simultaneously.
- To maintain the interests of the nation, a governing body controls the money supply of a fiat currency. The value of a currency is not influenced by the amount of gold in circulation or other commodities, for example, new mines and technological advances may affect supply and demand for commodities (and thus, affect the exchange rate).
- A major nation’s fiat currency can easily be exchanged for goods and services, as well as other fiat currencies. If not, transactions would be more complicated.
Disadvantages of Fiat Currency:
- Fiat currencies are valued and trusted by the public based on how they are handled by their governing bodies. Governments and central banks don’t always get it right. Money supply increases faster than the economy grows, leading to inflation. Too much money supply may result in hyperinflation, which quickly erodes the real value of the local currency, as the prices of all goods increase.
- If the money supply is not enough or the people are unwilling to spend what they have, deflation will occur. As a result, prices of goods and the financial markets generally decline, leading to a reduction in wages and wealth.
- When a central bank tries to control a currency’s price, it may not be able to anticipate what the outcome of its actions will be. A central bank may solve a short-term problem, but create a larger problem in the long run. Financial assets, such as the stock market, can experience larger swings as a result.
How to trade Fiat Currency?
Money makes the world go round, as the song says. Almost every person on earth has handled money at some point, and many of them do so on a daily basis. The value of fiat money comes from its ability to act as a medium of trade or exchange in a physical environment.
The EUR/USD currency pair is one of the most popular currency pairs on the market. Following that are the USD/JPY, GBP/USD, USD/CHF, AUD/USD, and USD/CAD. US dollars, Euros, British pounds, Japanese yen, Swiss francs, Australian dollars, and Canadian dollars are among the major fiat currencies traded today.
In order to potentially profit from the price movements of fiat exchange rates, you have to open a forex account and learn how to trade. Before investing your money, it’s crucial to get a forex education. You need to educate yourself and invest in knowledge. To be successful in forex trading, one needs to understand trends and spot opportunities on the market. Therefore, to learn forex trading, the first step is to be patient and believe in self-education.
The forex demo account is ideal for exploring, testing, and learning more about trading in a risk-free environment. Because forex trading provides unlimited possibilities for profiting while involving risks, a demo account offers the comfort of trying and failing with no financial risks.
AximTrade forex accounts offer highly efficient technology so traders can control all their activities through a simple dashboard. Traders may also open more than one account under their main account and set their trading preferences based on their strategy.
Also read How to Open a Forex Account with AximTrade in Easy Steps?
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