Fiat vs Representative Money: What’s the Difference?

Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications. Yet, with great power comes great responsibility; mismanagement can lead to economic woes. This volatility https://www.1investing.in/ can cause both inflation and bubbles in the economy. The cryptocurrencies on the strongest, most secure, and most capable blockchain networks could grow more valuable for another important reason, too — the innovation in uses happening on the blockchain.

Fiat Money vs Commodity Money

American colonies, France, and the Continental Congress started issuing bills of credit that were used to make payments. The provincial governments issued notes that the holders would use to pay taxes to the authorities. The issuing of too many bills of credit generated some controversy due to the dangers of inflation.

Legal Tender

Cryptocurrencies such as Bitcoin have emerged as a challenge to the inflationary nature of fiat currencies. These virtual assets don’t seem to approach being “money” in the traditional sense, however, despite increased interest and adoption. There are also more opportunities for the creation of bubbles with fiat money because of its unlimited supply. The term “fiat” is a Latin word that’s often translated as “it shall be” or “let it be done.” Fiat currencies only have value because the government maintains that value.

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Unlike fiat currency, it operates on a decentralized system typically via a technology called blockchain. Fiat money obtains value through government which decrees it as legal tender. In other words, businesses must accept it as a medium of exchange.

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Investors and users of cryptocurrencies must navigate a complex landscape of taxation where the rules are often new, unclear, or in flux. With features like smart contracts, cryptocurrencies could redefine contractual transactions. They facilitate not only immediate transfers but also complex programmed agreements, offering promising advancements in efficiency and security over traditional contracts. Cryptocurrencies excel in making money accessible to anyone with internet access, without needing an intermediary like a bank. Fiat systems, being more opaque, can sometimes be susceptible to corruption.

Digital currencies and fiat money

The government may respond by printing too much paper money, which leads to hyperinflation. The U.S. severed its ties with the gold standard in 1971, turning its currency into demand pull inflation meaning fiat money. As a result, all other national currencies came to be valued against the U.S. dollar. Cryptocurrencies—Bitcoin, for example—are not as manipulable by governments.

1. “Like with any incumbent technology for an existing system, it kind of mostly works most of the time,” says Andy Edstrom, CFA and financial advisor at WESCAP Group.
2. The value of fiat money is determined by economic factors, but cryptocurrencies are valued by supply and demand, which may be affected by economic factors.
3. Plus, it’s cost-efficient to produce the currency — known as seigniorage.
4. We are an independent, advertising-supported comparison service.
5. Tether (USDT 0.01%), which is “tethered” to the U.S. dollar, is the largest.

Legal tender is any currency that a government declares to be legal. Many governments issue a fiat currency and then make it legal tender by setting it as the standard for debt repayment. Historically, it was printed, but today, it is created digitally.

Representative money is a kind of IOU but it is backed by more than a promise to pay. It is backed by a deposit of cash or some other commodity that is stored by the payer and ready to be handed over to the payee. The country eventually turned to the U.S. dollar as its base currency. Other theories of money such as the credit theory suggest that all money has a credit-debt relation so it doesn’t matter if money is backed by anything to maintain value.

All these pieces of paper are issued with as much solemnity and authority as if they were of pure gold or silver… The main disadvantage of fiat money is the risk of inflation if it is overprinted. Overprinting can cause a potential loss of value due to its lack of intrinsic worth and dependence on government stability. It began to see widespread use in the 20th century when the US dollar was decoupled from the price of gold.

The main advantage of fiat money is that it allows the government to have greater control of its own currency and economic stability. Fiat money is also cheaper and easier to make than commodity-backed currencies. Some cryptocurrencies, called stablecoins, can be pegged to commodities or fiat money, intended to make them less volatile. Some cryptocurrencies have utility, such as transferring payments or powering decentralized networks and applications.