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Fiat currencies are government-issued and universally-recognized legal money, such as the US dollar, the euro, and the pound.
They used to derive their value from gold reserves, but today this is no longer true.
The word “fiat” means a government order or decree.
When applied to money, the word means that a currency's value is largely derived from the trust in the government that issues it.
For example, the US dollar has value because people and institutions have faith that the US will collect taxes, ensure deposits, and continue to function.
But not that long ago, the US dollar was backed by gold.
For most of the 20th century, US dollars could be redeemed for gold through the “gold standard” system.
In 1971, however, the US dollar became a fiat currency in order to combat inflation and meet debt obligations.
Fiat currencies can be created indefinitely, and their benefits include easier control of inflation, unemployment, and economic growth.
However, with fiat money, there is also no theoretical limit on government spending.
The arbitrary nature of fiat currencies makes it easy to devalue them by printing too much money.
In fact, the creation of Bitcoin was partly spurred by excessive government spending during the 2008 recession.
Hint: Fiat currencies do not have reserves in gold or silver.