What is FIAT Currency?

Chances are high that you have heard the term fiat numerous times already, but you might wonder what it has to do with our financial system. In fact, when economists and financial analyst talk about fiat, they certainly are not talking about the Italian automobile manufacturer but about the currencies which are commonly used around the globe. To be more specific, fiat money describes a currency without intrinsic value that has been established as a medium of exchange (money), often by government regulation (central banks). Fiat currency does not have intrinsic value and has value only because a government maintains its value (by manipulating the supply), or because parties engaging in exchange agree on its value. In contrast to commodity value such as silver, gold or food, fiat money does not have value by itself (= intrinsic value). 

The circulating money used to be backed by gold, which is commonly known as the gold standard. Consequently, formerly currencies could be seen as representative money, which is similar to fiat money, but it represents a claim on a commodity (which can be redeemed to a greater or lesser extent). However, with the abandonment of the gold standard during World War I, the circulating money wasn’t tied to value anymore, but only to the belief that the money is worth something, although money is, essentially, just a piece of paper. 

Intrinsic Value

And that’s exactly what fiat currencies are – a means of exchange without intrinsic value which is valuable because of the widespread acceptance of such currencies. When people stop accepting dollar, your dollar savings decrease in value because there is no intrinsic value. When currencies become worthless, you might only use it as fuel for your fireplace. 

Money Supply

Money supply is granted and altered by central banks, which results in inflation or deflation. Inflation means that one piece of a given currency is becoming less valuable, meaning you get fewer goods for the same money as you used to. On the contrary, deflation leads to stronger purchase power.

The European Central Bank (ECB) is aiming for two percent inflation annually just as the privately held Federal Reserve of America (America’s Central Bank) because the main target of the central banks is price stability and maximum employment. The governmental official website of the Federal Reserve states “over time, a higher inflation rate would reduce the public’s ability to make accurate longer-term economic and financial decisions. On the other hand, a lower inflation rate would be associated with an elevated probability of falling into deflation, which means prices and perhaps wages, on average, are falling–a phenomenon associated with very weak economic conditions. Having at least a small level of inflation makes it less likely that the economy will experience harmful deflation if economic conditions weaken.”

Moreover, the annual economic growth is around two percent in Europe and close to three percent in America, which makes small inflation reasonable.

Banking System

Ii is important to realize that our whole financial system is built on banks, which are mostly privately held. On top of the pyramid are the central banks, which issue money to the government and smaller private banks. The smaller banks issue money to individuals and companies. 

What’s more, our financial system is built on loans, which are given by central banks to governments and all smaller banks. Those smaller banks give loans to private households and enterprises. The global debt amounted around 233 trillion US Dollar in 2018, according to the Institute of International Finance (IIF). 

Consequently, banks raise interest rates for the loaned capital. Therefore central banks are making money by lending money apart from the fees banks take from its users for their banking services. Due to compound interest and the global indebtedness, banks are gaining more and more capital which negatively affects the global wealth distribution. A world without banks could drastically change our financial system and make individuals and enterprises independent and not in need to take loans. 

Risk Factors

Since loans are deeply integrated into capitalism, everything you buy has factored in the costs for the loans, which means banks are profiting from every transaction that goes through the banking system. And when banks are profiting, somebody has to pay for it, which are usually their customers. As a consequence, a world without banks would ultimately increase global wealth.

Repeated financial crises have led to the expropriation of in-debt individuals because individuals who took a loan for their house are unable to pay for its loan. A financial crisis leads to hyperinflation or a raise of the interest rates, which happened multiple times between 1920 and 2008. Therefore, banks are buying the houses of their insolvent costumes. This is alarming if you think about the fact that the average US citizen is in debt of $67,494.

To make matters worse, banks don’t store your money at their branch locally, they just credit your account with digits, so-called “scriptural money”. In fact, central banks have often no reserve ratio. The highest reserve ratio is in China, which is 13.5 percent, while the European Central Bank has one percent and the Federal Reserve ten percent. Therefore, if every individual who has an account balance would try to get their money out of the bank, it would simply not be possible since the branches don’t store the money and since the gold standard was abolished, your account balance is essentially not backed by anything but belief.

This leads to a permanent risk of a total loss of your capital, which is why a typical hedge against a financial crisis is gold, which has an intrinsic value which was proven over centuries.

Although gold remains a good way to store a fraction of your fortune, there is an even better way to eliminate the risk of a capital loss, and that’s where cryptocurrencies come into play.

Cryptocurrencies

Cryptocurrencies have the potential to eliminate the need of banks, therefore, you don’t need to depend on a bank to safeguard your money.

Cryptocurrencies are digital currencies built on code, using blockchain technology, which allows you to safely store, send and receive money. In addition, the supply of cryptocurrencies is not manipulated by entities and all of the supply is documented and stored on the blockchain. Consequently, the transparency is much higher which eliminates the need for trust. 

Why Cryptocurrencies Are Superior To Fiat Currency

Yet the most significant benefit of the blockchain technology is that it allows you to be your own bank and that the supply is not inflationary. For instance, Bitcoin is the most popular cryptocurrency which has a limited supply of 21 million. Currently, the circulating supply is around 18 million, which means 80 percent of all bitcoins are mined already. The remaining 20 percent will be mined and added to the circulating supply approximately by the year 2140.

Decentralization

The mining process is like the money printing process of fiat currency – both need electricity and induce costs. However, the mining process of Bitcoin is decentralized, meaning everyone can participate in the mining process and you can’t shut it down by eliminating the central power because there is no central power. This, of course, is very different from the centralized money printing process which is done by the government, which is neither transparent nor can you participate in it. 

Transaction Speed And Cross Border Payments

Another huge advantage of cryptocurrencies versus fiat currencies is the transaction speed and availability of the money. For instance, cross border payments are very slow and inefficient, taking three to five working days until they arrive in the bank account. In addition, the costs are very high, as it costs seven percent on average to send money internationally, while Bitcoin transactions need only minutes to hours and cost between $0.13 and $1.64, depending on if you want your Bitcoin to sent within ten minutes or one hour.

Availability And Accessibility

What’s more, when it comes to availability, you can access your cryptocurrency wallet accounts from everywhere around the globe – all you need is an internet-ready device and an online connection. Imagine you want to get your money out of the bank, but the bank closed due to bankruptcy and won’t give you access to your money. Indeed, this happened numerous times throughout banking history, as there were dozens of banking crises in the last five decades.

The bottom line

Cryptocurrencies give the power back from the banks to the ordinary people and allow you to store, transfer and access your own funds by will at any time without the need for approval or surveillance of banks, which are manipulating the money supply with lack of transparency. The lack of transparency ultimately ends up in a lack of control of its users, which are at the banks’ mercy. Cryptocurrencies are the better means of exchange and storage of money than fiat currency and don’t lack transparency and users’ control. 

They enable you to be your own bank, having full control of your own money and access your money anytime from any place in the world. In addition, undertaking financial transactions without banks would tremendously increase the cost-efficiency and alter the global wealth distribution due to the elimination of all costs associated with banks and loans. Another key advantage is that while money is inflationary, cryptocurrencies are deflationary. Therefore cryptocurrencies should be part of everyone’s investment portfolio.