06 Dez What is a Fiat Currency and How Do You Trade It?

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We all accept fiat currencies because we know that the government has officially promised to maintain their value and function. For decades, gold-pegged and fiat currencies formed the backbone of the global economy. But with bitcoin and altcoins, an alternative financial system is emerging, also known as decentralised finance.

What Is Fiat Money?

They were either pegged to the US dollar (i.e. side A), following the Bretton Woods System (i.e. side C), or free-floating (i.e. side B). The gold and silver standards are monetary systems in which the standard economic unit of account is based on a fixed quantity of gold or silver. Gold is still traded today for fiat currency as a way to store wealth or speculate on the changing value of both. Learn more about gold and silver and how they are traded with fiat currencies.

The European Central Bank controls the supply of the euro common currency. Because fiat currencies are not backed by a physical commodity, they are at risk of collapsing during an economic bubble. An economic bubble occurs when fiat currencies rapidly increase in value until the heightened price becomes unsustainable. When a currency becomes too highly valued, other countries cannot afford it, and in turn, the overvalued currency rapidly loses value.

A volatile history: the gold standard’s rise and fall

And the list could go on and on; think back to yourself as a kid, and you used to swap toys, books, games, or baseball cards. These create a form of commodity money because you placed a value on that item and used it to trade with your friends. Some confusion around money exists in terms of money and currency. Currency, some argue, remains physical such as coins, notes, and credit cards. And money equals an intangible concept denoting the value we place in a currency as having a value.

The recent rise of Bitcoin has recently brought all of these doubts into focus. As we decide whether Bitcoin creates “money” or not, we need to understand the difference between fiat money and commodity money. The African nation of Zimbabwe provided an example of the worst-case scenario in the early 2000s.

Either the farmer finds someone else to fiat currency vs commodity currency with, or the fruit rots. This is a specific example of a general problem with barter called the lack of double coincidence of wants. Two people in the same place rarely have wants that result in a timely and satisfactory trade.

Its value is derived from its official recognition as a medium of exchange from government legislation. Furthermore, if individuals lose confidence in a country’s currency, the money will no longer have any purchasing power. Furs and agricultural commodities such as maize were employed in trade transactions throughout the 17th and early 18th centuries. For example, during World War II, prisoners were using cigarettes as commodity money, and they were exchanging them for other goods and services. A cigarette’s value was attached to a certain portion of bread.

Why Choose Decentralized Cryptocurrencies?

Since it does not have an intrinsic value per se, it can be more prone to this kind of inflation as more can be printed at will. Monetarist theory suggests that inflation is alternatively the reduction in the purchasing power of a unit of currency in an economy. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison WAVES in sociology.

If policy is ineffective or misguided, there can be significant economic damage, including inflation that destroys the value of citizens’ savings. The use of commodity money has been common throughout history. Coins made from precious metals like silver and gold were the standard for thousands of years. By the 18th and 19th centuries, paper currencies began to take hold, although many of them served as promissory notes to pay specific quantities of gold and silver.

Even those who didn’t smoke were using cigarettes as a means to conduct trade. The number one advantage of commodity money equals the ability to serve more than one purpose. For example, gold can become jewelry and also used as wiring in computers. The rise of fiat currencies over the last fifty years is also tied to creating more credit in our system, but not historically so, which I find interesting. The gold standard performed the function of the monetary system of choice for much of the world until the early 1970s, when the U.S. moved away from the currency. The gold standard has a long and complicated history in the U.S. and worldwide and will stay a subject for another day.

Explain the role played by the state in the public acceptance of fiat currency as money. A) The supply of fiat money is controlled by the government, b) Fiat money is also a commodity, c) Fiat money is backed by gold, d) Fiat money is the same as Treasury bonds. C. All money is commodity money, as it has to be exchanged for gold by the central bank.

The world has been out of the gold standard for 50 years now. But representative money is still in use in the form of financial instruments like checks. Holders of representative money could exchange it for the commodity supporting it on demand.