If you are starting to learn about cryptocurrency, one word you are likely to frequently encounter, always in negative terms, is the word fiat money. It has nothing to do with the Italian car maker, but is a catch-all term for government created money. So why does fiat money have such a bad rap?
There was a great meme circulating in 2017/8 when Bitcoin was experiencing a rapid increase in price, better known as a bull market. It was supposedly a tweet from the official account of the Italian car maker Fiat, simply asking ‘why cryptocurrency people hate us so much?’
Fiat didn’t send that tweet, it was just a clever meme encapsulating the negativity that the world of crypto has toward what fiat money - not the car brand - represents. So what does fiat money represent and why does it play such a key role as the crypto community’s bogeyman?
The word fiat comes from Latin and means an edict or decree, basically an order passed down by those in positions of power which either is enforced by their democratic authority (you elected them to make decisions) or the fact that they have the biggest guns.
So fiat money is money created by the government. It is money by decree because it only has value because the government says so, and because the population - who elected them - either trust them enough to accept the idea or have no alternative.
At this point you may well be scratching your head at the idea of money having no value. Money is what makes the world go round, and gets everyone up in the morning and into their jobs - right? Why would they do that if it had no value?
The difficulty we have with thinking about money is that we forget that it is just means to an end, or to use a more formal description, a medium of exchange. It is a convenient way of exchanging goods and services, but the commodity value of the paper that a banknote is made of, or the metal alloy that a coin is made from, is close to zero.
And physical money has a diminishing role in our digital economy, with most estimates suggesting it accounts for just 3% of bank balances, with the majority, just numbers on a computer.
This wasn’t always the case. Coinciding with the emergence of trade, humans have experimented with many different forms of money going back thousands of year. Initially when people wanted to exchange things - maybe some corn for a pair of moccasins - they would just keep a mental tally of who owed what.
Over time, as exchanges increased, this became increasingly difficult, and pretty-much impossible when dealing with someone just passing through your village that you’re never going to see again.
The solution was a uniform medium of exchange, against which all things were valued - the emergence of money.
Over time many different things have been tried as money, then discarded in favour of something more useful. We've written about the amazing donut-shaped rocks used on the island of Yap. The Romans used salt, which is the root of the word salary (sale is salt in Latin/Italian); Native Americans used wampum, which were shells, the root of the phrase 'shelling out' or referring to money as clams.
Being useful boiled down to six key characteristics which still apply today:
Of the six magical things that make money useful for exchange the last is by far the most crucial, because money isn’t just used for exchanging value, but also for preserving value into the future - a store of value.
To cut a long story short, gold and silver emerged as the best forms of money, and in around 600BCE historians believe the first gold coins were minted. It isn’t long after that we start to get a hint of the dangers that can come from central authorities - kings, emperors, rulers - deciding what is and isn’t allowed as money.
The Romans, for example, were very busy expanding and maintaining their empire, which meant needing a constant supply of gold and silver. Why not just reduce the amount of gold and silver in the coins that were officially authorised by the Emperor?
That became a slippery slope, which ended with basically no silver content in Roman coins, and is believed to have contributed to the eventual collapse of the whole Roman Empire.
Money is essential for trade and the development of society, but the message from history seems to be that if you ignore the basic rules around what makes money useful - or sound - eventually the wheels fall off. You essentially dilute the value of money, and people inevitably ditch it for something better.
Money went through more evolution after the Romans, with plenty of Kings, Queens and dictators trying to avoid that same reality, like King Canute trying to stop the tide coming in. The biggest change being the introduction of banknotes - like I.O.Us - which were more convenient for transportation.
The first actual mention of the idea of fiat money seems to have come from a thought experiment in a book by the English philosopher, John Stuart Mill in 1848. What would happen if the government paid all salaries with paper money not backed by gold? Money’s value “would depend on the fiat of the authority”.
What would happen if the government paid all salaries with paper money not backed by gold? Money’s value “would depend on the fiat of the authority”.
From around 1870 to the early 20th century most money in an increasingly global economy was backed by Gold. In other words, if you wanted to, you could take your notes and coins and redeem them for the actual gold they represented. That gold standard was suspended as countries decided they needed to finance and wage the First Word War, and never really returned.
The Gold Standard was fully abandoned in 1971 by the US President, Richard Nixon, which is when the modern fiat money era began, and set the scene for the eventual emergence of crypto.
There were plenty of attempts to create alternatives to money that exist outside of government control and there have been plenty of illustrations of the dangers - 1.2 billion people now live under crippling inflation - but it wasn’t until Satoshi Nakamoto created Bitcoin that a truly alternative money emerged.
One of Bitcoin’s fundamental characteristics is that it is decentralised - it has no central authority - and has a fixed supply. These are the polar opposites to fiat money, which is why it represents such a bogeyman to Bitcoiners and the whole cryptocurrency community in general.
There are clearly benefits to having a nemesis that a community can rally against, and condense into memes - the most popular being around money printing - but many aren’t entirely accurate, or oversimplify what is the complex relationship between government, business and consumers that results in fiat money.
What is valuable however, is that more people spend time thinking about money and what gives it value. Why can’t the government, as John Stuart Mill suggested, just pay everyone’s salary? Why do we pay tax if money can be created at the push of a button?
Despite being so central to everything we do, we largely take money for granted, not stopping to think that it is nothing but an idea that we all buy into. An idea that has changed many times before and will almost certainly change again in favour of something more useful for humanity. The question is whether crypto is the next iteration.