The Truth About Fiat Currency: The Secret Behind Government-Supported Value

Do you ever deeply consider the essence of the money we use every day? Why does a coin in your pocket or a banknote in your wallet hold value? The answer to this fundamental question lies in the system of “fiat currency.” Fiat currency is a type of money whose value is not backed by physical assets like gold or silver but is established through the credit and enforcement power of the issuing government. Almost all countries worldwide currently adopt this fiat currency system, which underpins all economic activities, from buying and selling goods to investing and saving.

The True Nature of the Money We Use—Basic Concepts of Fiat Currency

The most prominent feature of fiat currency is that its value depends on the trust in the government and central bank. Unlike the gold standard era, today’s fiat money is not guaranteed by gold stored in vaults. Instead, the government’s declaration that “this banknote is legally valid” defines its value.

In this system, fiat currency does not have intrinsic value. The metal value of coins or the paper value of banknotes is almost negligible compared to their face value. However, society accepts this value because the government declares “this has a value of 100 yen” and recognizes it as a legal means of payment. This collective trust is the only condition that makes fiat currency valid.

A Millennium of History: How Fiat Currency Came to Dominate the World

The concept of paper money surprisingly dates back to the 11th century in China. Sichuan Province became the first place in Asia to issue paper currency, initially exchangeable for silk, gold, and silver. As time progressed, during the era of Kublai Khan of the Mongol Empire—13th century—a true fiat paper currency system (not backed by any physical assets) was established for the first time.

According to historians, the excessive issuance of paper money and the low backing standards introduced by Kublai Khan significantly contributed to the collapse and decline of the Mongol Empire’s economy. Uncontrolled issuance of currency inevitably led to hyperinflation and the destruction of the empire.

Similar experiments were attempted in Europe. In the 17th century, Spain, Sweden, and the Netherlands introduced fiat paper money. However, the results were disastrous; especially in Sweden, this system caused severe economic turmoil, forcing the government to rapidly revert to the gold and silver standard.

Later, in North America, regions such as New France, American colonies, and the U.S. government conducted various experiments with paper currency. The outcomes varied depending on the scale and stability of the society and economy, with some successes and some failures.

Until the 20th century, many developed countries used commodity-backed currencies—particularly gold standard currencies. The turning point came in 1933 when the U.S. government could no longer honor gold redemption requests from citizens and stopped exchanging paper money for gold. Nearly four decades later, in 1972, under President Nixon’s directive, the U.S. completely severed the last ties to the gold standard and declared a full transition to a fiat currency system. This historic decision marked the end of the gold standard worldwide, establishing fiat currency as the standard monetary system for all countries.

From Gold Standard to Fiat Currency—The Path of System Innovation

Gold standard and fiat currency systems originated from fundamentally different worldviews. Under the gold standard, the amount of gold held by the government strictly limited the amount of currency issued. Anyone holding banknotes could always go to the issuing bank and demand to exchange them for gold. This mechanism imposed a constraint on governments and central banks: “You cannot introduce new currency into the economy unless you hold gold.”

This restriction significantly limited government fiscal policy. During economic crises, governments could not support beyond their gold reserves. Theoretically, they could not even print more money to stimulate the economy.

In contrast, the fiat currency system freed governments from these “physical chains.” In theory, governments and central banks can create “something from nothing” and generate unlimited new fiat money. They can operate fractional reserve banking, implement quantitative easing policies, and provide large-scale financial bailouts during crises.

The 2008 global financial crisis demonstrated the value of this flexibility. Central banks around the world quickly injected massive funds into markets, avoiding economic collapse. Under the gold standard, such responses would have been impossible.

The Pros and Cons of Fiat Currency: Debates Among Supporters and Opponents

Among economists and financial experts, deep debates continue regarding fiat currency.

Arguments supporting fiat currency:

From the perspective of scarcity and production costs, fiat currency is free from the constraints of physical commodities like gold. Central banks no longer need to worry about gold reserves, enabling them to supply currency according to actual economic demand. Production costs are also vastly lower compared to commodity-based money.

Fiat currency has given governments and central banks the ability to respond to economic crises. Even faced with unemployment, deflation, or financial panics, policymakers can respond flexibly.

In international trade, fiat currency is also superior to the gold standard. Countries worldwide following the same rules (such as a system based on the US dollar) have enabled unprecedented scale in cross-border trade of goods and services.

Unlike gold, paper bills and digital currencies do not require enormous costs for storage, security, or authentication. This allows more resources to be allocated to economic growth.

Arguments opposing fiat currency:

Opponents first point out that fiat currency has no intrinsic value. The ability to create money “out of nothing” inevitably leads to excessive printing. The resulting hyperinflation can wipe out citizens’ savings and threaten the entire economic system.

Historical data supports this concern. Many countries that adopted fiat or non-backed paper money experienced significant inflation and economic instability. Examples include Zimbabwe, Venezuela, and Argentina—cases of economic collapse caused by excessive money printing.

Furthermore, the combination of political control and economic dominance is problematic. Under fiat systems, governments can monopolize monetary policy, potentially restricting citizens’ economic freedom.

The Impact of the Digital Revolution: Fiat Currency vs. Cryptocurrencies

In the 21st century, new competitors have emerged: cryptocurrencies like Bitcoin. At first glance, cryptocurrencies and fiat currencies share some similarities—they are not backed by physical assets.

However, fundamentally, they differ. Fiat currency is managed by centralized authorities—governments and central banks—while cryptocurrencies are inherently decentralized. Blockchain technology, a distributed digital ledger, enables transactions without third-party intermediaries.

There are also decisive differences in issuance mechanisms. The total supply of Bitcoin is strictly limited to 21 million coins, and no authority can change this. Conversely, central banks can unlimitedly supply fiat currency based on economic decisions. This difference creates the dichotomy of “hard currency” versus “soft currency.”

Another characteristic of cryptocurrencies is the difficulty in tracing transactions. In the fiat system, banks record all transactions, and governments can track them. Cryptocurrencies, by their nature, can serve as a way to evade traditional financial surveillance.

Currently, the cryptocurrency market remains vastly smaller than the fiat market in terms of market capitalization and trading volume, leading to high volatility. This is why cryptocurrencies are not yet widely accepted; as the market expands and ecosystems mature, volatility may decrease.

The Future of Monetary Systems: Coexistence of Fiat and Cryptocurrencies

The future of these two forms of currency is not straightforward. Cryptocurrencies are still in growth stages, facing regulatory, technological, and market maturity challenges. Meanwhile, fiat currencies, with centuries of history, are also vulnerable—overissuance by governments, inflation, and devaluation are ongoing concerns.

The emergence of Bitcoin and modern cryptocurrencies is driven not merely by speculative interest but by more fundamental ideas: “A new monetary system built on a decentralized peer-to-peer network that escapes central authority.” Bitcoin was not created to replace the entire fiat system but to offer an alternative.

In the coming decades, it is highly likely that fiat and cryptocurrencies will coexist. Governments will continue issuing digital central bank currencies (CBDCs), while citizens will seek access to decentralized finance through cryptocurrencies.

In conclusion, there is indeed potential to build a more stable, fairer, and more democratic monetary system. Whether through fiat, cryptocurrencies, or a hybrid of both, the future financial system will undoubtedly become more complex and layered than we currently imagine. Both fiat and cryptocurrencies will be continually evaluated for their contribution to a better socio-economic system during their evolution.