Currency that a government has
declared to be legal tender, but is not backed by a physical commodity. The
value of fiat money is resulting from the relationship between supply and
demand rather than the value of the material that the money is made of.
Historically, most currencies were based on physical commodities such as gold
or silver, but fiat money is based solely on faith. Fiat is the Latin word for
"it shall be".
Because fiat money is not linked to
physical reserves, it risks becoming worthless due to hyperinflation. If people
lose faith in a nation's paper currency, like the dollar bill, the money will
no longer hold any value.
Most modern paper currencies are
fiat currencies, have no basic value and are used solely as a means of payment.
Historically, governments would brand new coins out of a physical commodity
such as gold or silver, or would print paper money that could be redeemed for a
set amount of physical commodity. Fiat money is inconvertible and cannot be
redeemed. Fiat money rose to prominence in the Th century, specifically after the collapse of the “Bretton Woods” system in 1971, when the United States
ceased to allow the conversion of the dollar into gold.
However, since the value of fiat
money lies solely in the trust of those using it, its value can be easily
diminished and result in rapid inflation.
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