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Fiat Currency

Related Term:

Central Bank Digital Currency (CBDC)


Fiat Money, Fiat

Unlike other terms and phrases which are unique to the blockchain industry, fiat currency (aka “fiat” or “fiat money”) is a phrase more widely used across the financial industry (and even beyond) to refer to government-backed national currencies such as the US dollar or the British pound. Even so, the concept of fiat currency is deeply intertwined into multiple aspects of distributed ledger technology (DLT) and cryptocurrency usage. One of those aspects has to do with how individuals and organizations go about onboarding themselves into the worlds of DLT and cryptocurrency.

The individual and organizational use cases for cryptocurrency vary; generally speaking, there’s no getting around the requirement of holding some cryptocurrency in order to engage in DLT or cryptocurrency-related activities. Cryptocurrency usages include but are not limited to paying for a distributed ledger’s transaction and smart contract fees, using cryptocurrency as a form of payment for goods or services, compensating employees, swapping cryptocurrency for other cryptocurrencies, and, of course, swapping cryptocurrencies for fiat currencies.

Among other activities, the aforementioned onboarding typically involves an exchange of some amount of fiat currency for some amount of cryptocurrency. This by itself can present a barrier to DLT for many organizations that prefer to transact with dollars, euros, pounds or other fiat currencies. Strong government-backed fiat currencies (like the US dollar, the Japanese yen, or the Swiss franc) maintain fairly stable value relative to each other and to the costs of goods and services. Cryptocurrencies, on the other hand, are known for their volatility in value relative to fiat currencies. A single unit (a token or coin) of a cryptocurrency that’s worth US$2 today can be worth US$1 tomorrow and US$4 the day after that, and so on.

It’s no surprise that when organizations are engage business, they’re not only transacting with fiat currencies, they’re also tracking their financials and business performance in terms of those fiat currencies. In contrast, one of the challenges when it comes to enterprises working with distributed ledger technology (DLT) as an application platform for digital transformation, business innovation, and industry disruption is that most public distributed ledgers conform to a coin-operated business model whereby the fees for transactions and smart contracts must be paid using a token that’s native to the underlying DLT. In other words, transacting in a way that they’re used to — with fiat currency — may not be an option. For example, transaction and smart contract fees on Ethereum are paid using Ether (the cryptocurrency that’s native to the Ethereum blockchain) whose value, like other cryptocurrencies, is subject to volatility.

Relative to fiat currencies, there are two types of digital currencies that attempt to overcome some volatlity-related challenges by pegging their value to a fiat currency (most often the US dollar); stablecoins and Central Bank Digital Currencies (CBDC). For example, although its name has nothing to do with any US government-backed currency, Circle’s USDC (USD Coin) is a cryptocurrency that pegs itself to the value of the US dollar (a fiat currency). In other words, one USDC token should always be worth US$1 and is therefore considered to be a stablecoin. However, not all stablecoins have been able to maintain their so-called “peg.” Whereas some have slipped off their peg by fractions of a penny but then quickly returned to their pegs, others (most notably some algorithmic stablecoins) like TerraUSD have not only slipped off their peg, never to return, they’ve lost most if not all of their value relative to any fiat currency.

CBDCs are another type of cryptocurrency that, similar to stablecoins, are pegged to the value of a cryptocurrency. But unlike stablecoins, a CBDC will typically have the backing of the same national government that is backing a country’s fiat currency. For that reason, where CBDCs exist, they are invariably pegged to the country’s fiat. For example, if a US government backed CBDC existed (none did at the time this glossary entry was published), it would be pegged to the US dollar. Most of the world’s countries — including the US — are conducting experiments or trials with CBDCs. There are multiple websites that track their progress including CBDCtracker.org and the Atlantic Council.

All this said, for all they do to peg themselves to the value of a fiat currency, neither stablecoins nor CBDCs necessarily make it possible for organizations to completely escape the volatility of cryptocurrency.

Of course, there is so much more, beyond the world of crypto, to understanding the definition of fiat currency. And so, to help you with that understanding, Blockchain Journal offers you this excerpt of Wikipedia’s definition of fiat money.

Fiat Currency in the Wikipedia

Fiat money (from Latin: fiat, "let it be done") is a type of currency that is not backed by any commodity such as gold or silver. It is typically designated by the issuing government to be legal tender. Throughout history, fiat money was sometimes issued by local banks and other institutions. In modern times, fiat money is generally authorized by government regulation.

Fiat money generally does not have intrinsic value and does not have use value. It has value only because the individuals who use it as a unit of account – or, in the case of currency, a medium of exchange – agree on its value. They trust that it will be accepted by merchants and other people.

Fiat money is an alternative to commodity money, which is a currency that has intrinsic value because it contains, for example, a precious metal such as gold or silver which is embedded in the coin. Fiat also differs from representative money, which is money that has intrinsic value because it is backed by and can be converted into a precious metal or another commodity. Fiat money can look similar to representative money (such as paper bills), but the former has no backing, while the latter represents a claim on a commodity (which can be redeemed to a greater or lesser extent).

Government-issued fiat money banknotes were used first during the 11th century in China. Fiat money started to predominate during the 20th century. Since President Richard Nixon's decision to suspend US dollar convertibility to gold in 1971, a system of national fiat currencies has been used globally.

Fiat money can be:

  • Any money that is not backed by a commodity;
  • Money declared by a person, institution or government to be legal tender,[5] meaning that it must be accepted in payment of a debt in specific circumstances;
  • State-issued money which is neither convertible through a central bank to anything else nor fixed in value in terms of any objective standard;
  • Money used because of government decree;
  • An otherwise non-valuable object that serves as a medium of exchange[8] (also known as fiduciary money.);
  • The term fiat derives from the Latin word fiat, meaning "let it be done" used in the sense of an order, decree or resolution.

    This excerpt is based on Wikipedia’s offer of content under the CC BY-SA 3.0 Creative Commons license. All of the content on this web page (and this web page only) is therefore also offered for reuse under the same license. The license to re-use this content does not apply to other web pages on BlockchainJournal.com unless those pages explicilty include a similar Creative Commons disclosure.

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