Benefits and Drawbacks of asset-backed currencies versus fiat currencies.
Published: 2022-12-08 23:52:11

_What Exactly Is Fiat Money?_

Fiat money is a type of government-issued currency that is not backed by a tangible commodity like gold or silver, but rather by the government that created it. The value of fiat money is determined by the relationship between supply and demand as well as the stability of the issuing government, rather than the value of the underlying commodity. The majority of current paper currencies, including the US dollar, euro, and other major world currencies, are fiat currencies.


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Fiat money is a good currency if it can perform the functions that a country's economy requires of its monetary unit, such as storing value, providing a numerical account, and enabling commerce. It also has great seigniorage, which means it is less expensive to generate than a currency that is directly linked to a product.

Fiat currencies rose to popularity in the twentieth century, in part because governments and central banks sought to protect their economies from the harshest effects of the business cycle's inherent booms and busts.

Because fiat money is not a scarce or fixed resource like gold, central banks have far greater influence over its supply, allowing them to manage economic variables like credit availability, liquidity, interest rates, and money velocity.

_Disadvantages_

_Not a fool-proof way to protect the economy_

But the 2007 housing crisis and the ensuing financial collapse dimmed the idea that controlling the money supply by central banks would definitely avert depressions or severe recessions. Due to the scarcity of gold, a currency backed by it is, for instance, often more stable than fiat money. With fiat money, there are greater chances for bubbles to form due to its endless supply.

_Risk of inflation_

The African nation of Zimbabwe provided an example of the worst-case scenario in the early 2000s. In response to serious economic problems, the country's central bank began to print money at a staggering pace, resulting in hyperinflation.
Experts suggest the currency lost 99.9% of its value during this time. Prices rose rapidly and consumers were forced to carry bags of money just to purchase basic staples. At the height of the crisis, the Zimbabwe government was forced to issue a 100-trillion Zimbabwean dollar note. Eventually, foreign currencies were used more widely than the Zimbabwean dollar.


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**_Asset-Backed Currencies_**

Money that is backed by an asset, such as gold, has inherent worth.A currency backed by an asset can be exchanged for a certain amount of the asset. For instance, following the 1944 Bretton Woods Conference, when nations tied their national currencies to the USD and the USD was backed by gold, the USD was linked to gold. Under this arrangement, any nation that possessed USD may trade it for a certain quantity of gold at the Federal Reserve.Fiat money is currently used by practically all nations, including Canada and the United States.

_Advantage_

Compared to fiat currencies or stablecoins, asset-backed currencies provide a more long-term, stable store of value for the entire world. The economic concepts of supply and demand determine the value of a kilogram of copper, a barrel of oil, a one-carat diamond, etc. Any central authority, such as a government or financial organization, cannot alter their value. Regardless of local politics, the value of asset-backed currencies is determined by global markets.

Asset-backed currencies have huge possibilities for a nation that may be wealthy in assets but has a national currency with a low value.
Think about the African nations that produce diamonds while considering some of the world's poorest nations. It could assist to lessen or perhaps end poverty if these nations can begin to appreciate the worth of their natural resources.

_Conclusion_

Given that asset-backed currencies were the foundation of the world's monetary systems for thousands of years prior to the 20th century, it is hardly surprising that the development of blockchain technology has sparked a resurgence. It won't take long for central banks and governments to start realizing the enormous potential for asset-backed currencies to add new value to national economies once they get over their skepticism toward the new technology.