What is Fiat Currency vs. Cryptocurrency

Fiat is a centralized currency issued by a government, whereas cryptocurrency is a decentralized currency leveraging blockchain technology.

Most modern currencies are described as fiat—issued by the government. Fiat currencies have risen as a popular monetary instrument in global economies, and while they have worked well, they still have their drawbacks. With the government controlling the money supply through fiat currency, governments have great power. This power and unchecked discretion can lead to economic problems such as inflation. Inflation is caused by overspending and printing of money by governments and continues to be a massive problem with fiat. Many believe cryptocurrencies offer a better exchange option, providing individuals with more control without sacrificing security and value.  

What Is Fiat Currency? 

Fiat currency is a form of tender issued and backed by the sole credibility and faith of a government. Fiat currencies differ from other forms of currency because they are not backed by commodities like gold and silver. It is up to the issuing government’s discretion to assign value, and the public to trust its value. Governments have the authority to print and regulate fiat currency through central banks, giving them great power to influence the money supply in the economy. In the U.S., Fiat currency is everything from a penny to a $100 bill. 

One of the largest concerns with Fiat money is inflation. Inflation occurs when the purchasing power of money decreases relative to the general price level of goods and services. Inflation often follows when the government prints more money, increasing the money supply and outpacing economic growth. If not properly managed, this can reduce the value of savings over time, erode purchasing power, and create economic instability.

The History of Fiat Currency in the U.S. 

In 1690, the Massachusetts Bay Colony issued paper currency to fund military expeditions. At the time, the currency was not recognized as legal tender but as IOUs for certain commodities like cattle and silver. For many years, currency used in the U.S. had some sort of backing. To help finance the war in 1775, the Continental Congress issued paper currency called “Continental.” This quickly deflated due to a lack of backing and the rise of counterfeits. Fast forward to 1791, Alexander Hamilton established the Bank of the United States to create credit with the government and issue private currency to facilitate lending and borrowing. In the following year, 1792, congress passed the Mint Act, establishing a national coin system and cementing the dollar as legal tender nationally. At this time, dollars were backed by silver and gold but the Gold Standard Act of 1834 made gold the standard backing for currency for years.  Gold became the standard backing in 1933 when the federal government passed the Emergency Banking Act. 

The great depression of 1929 led to a host of financial struggles. Unemployment was high, banks were failing, causing individuals and institutions to hold their gold. Since every dollar in circulation was backed by gold, the lack of spending in the economy made it hard for individuals to access credit and spend money. This reduced the money supply and led to a contradictory effect. Prices began to deflate, and debt became expensive. The Emergency Banking Act of 1933 sought to give the government more control over the money supply, helping stabilize prices and increase economic liquidity. The U.S. government could set a standardized dollar value by shifting the currency to Fiat. This laid the groundwork for modern economic management and financial stability. In 1971, President Nixon announced that the U.S. would stop converting dollars to gold at a fixed rate for foreign governments. This marked the end of the Gold Standard. U.S. currencies are backed by full credit and faith in the U.S. government, taking the name Fiat. 

Advantages and Disadvantages of Fiat Currency 

Let's examine some of the advantages and disadvantages of Fiat currency. 

Advantages of Fiat Money

• Cost-efficient to produce: Seignorage refers to the difference between the cost of producing currency and its worth. For example, it costs the government roughly 17 cents to produce a $100 bill. The government makes the difference of $99.83. This is both a pro and a con: it is cost-effective for the government to print money and make revenue, but it can lead to an overprinting of money when not regulated. 
• More flexibility and control: Fiat currency gives the government more control over the money supply. After the great depression, the Emergency Banking Act and subsequent policies enabled the government to influence the money supply. This was a key factor in uplifting and bringing stability back to the economy. Since Fiat money is not backed by a commodity, the government can control more variables like interest rates, credit, liquidity, and money velocity. This gives the government flexibility when dealing with economic conditions.  

Disadvantages of Fiat Money

• Inflation: Arguably, the greatest concern with Fiat money is inflation. Given the government’s discretion when printing money, there is a risk that rapidly increasing the money supply will lead to inflation. When more money is added to circulation, purchasing power decreases, devaluing the currency. Unlike currencies backed by a commodity such as gold, which has a limited supply, the Fiat currency supply can be unlimited. Printing too much money can lead to a lack of confidence in the currency, further disabling the economy. The aftermath of COVID-19 led many governments, especially the U.S., to print more money to stimulate the economy. However, while this did stimulate the economy in the short term it led to inflationary pressures. This inflation increased the cost of living, diminishing savings, and caused other economic issues. 
• Not foolproof: Even if the government can control the money supply, it isn’t perfect at protecting the economy. The 2007 mortgage crisis highlighted this notion, as central banks could not prevent many factors that led to the housing bubble and financial crisis that followed. This spiraled into massive job losses and a global recession, signaling that government control of the monetary supply is not a panacea to economic turmoil. 

Fiat Currency vs. Cryptocurrency 

As discussed, Fiat currency is not backed by commodities or utilities. Its value is determined by the government and supported by the faith and credibility of that government. Fiat currency acts as a legal tender recognized nationally as payment for all forms of debt. Currently, in the U.S., cryptocurrency is not recognized as a legal tender, meaning you can’t use your BTC to pay for groceries. On the other hand, many cryptocurrencies derive their value from the underlying utility. In the case of Bitcoin, the token acts as a medium of peer-to-peer exchange and a hedge against inflation, given its scarce supply. Cryptocurrencies operate on blockchain technology making them decentralized. 

No entity can manipulate cryptocurrencies like the government can do with Fiat. This is a critical difference and is a major factor in the appeal of crypto. The push for decentralization is driven by the desire for increased financial autonomy, transparency, security, and access. Cryptocurrency was born in 2009 with Bitcoin amid the financial crisis, promising an alternative to traditional financial systems that showed significant pitfalls. While cryptocurrencies can provide faster, more secure transactions than the traditional system, they are still very volatile. Cryptocurrency offers a compelling alternative to Fiat currency continuing to evolve daily. Understanding the differences between Fiat and cryptocurrencies is important, as it provides the proper knowledge to make optimal decisions.   

The Bottom Line 

Fiat currency has been the standard tender for nearly a century in the U.S. Emerging from the great depression, the federal government decided it was best to move away from a gold-backed currency to Fiat. This gave the government more control over monetary policy, which can be seen as a pro and a con. In recent years, inflation has become a large concern among the public, particularly about the government’s exorbitant spending and increased money supply, causing a decrease in purchase power and fear of further devaluation of the dollar. These concerns have led to an increase in the popularity of cryptocurrencies. The decentralized nature of crypto has made it a potentially attractive alternative to traditional Fiat. While crypto promises increased transparency, autonomy, and security, a long journey is still ahead. As blockchain technology continues to improve and grow, cryptocurrencies will likely play a large role in the future of economies. 

Frequently Asked Questions