If FIAT Replaced the Gold Standard, Why Can’t Cryptocurrencies Replace FIAT?

History of “Money”

Just a quick note, we use the word “money” very loosely in this heading as Gold is obviously not money and some argue that cryptocurrency is not as well. It is used only as a means to express the use of something as a means of value to procure something else.

Investopedia’s article What is the gold standard? Goes through the history of Gold and the Gold standard and how it was replaced by what we now use, FIAT currencies. We will give provide you with the definition of the Gold Standard from the article but suggest reading the article in full as it is quite comprehensive. Here is the definition that Investopedia gives for the gold standard:

“The gold standard is a monetary system where a country’s currency or paper money has a value directly linked to gold. With the gold standard, countries agreed to convert paper money into a fixed amount of gold. A country that uses the gold standard sets a fixed price for gold and buys and sells gold at that price. That fixed price is used to determine the value of the currency. For example, if the U.S. sets the price of gold at $500 an ounce, the value of the dollar would be 1/500th of an ounce of gold.”

What is Currency?

One of Wikipedia’s definitions of Currency is:

” Currencies can be classified into two monetary systems: fiat money and commodity money, depending on what guarantees the value (the economy at large vs. the government’s physical metal reserves).”

Wikipedia also defines Commodity Money as:

“A commodity money system is a monetary system in which a commodity such as gold is made the unit of value and physically used as money. The money retains its value because of its physical properties. In some cases, a government may stamp a metal coin with a face, value or mark that indicates its weight or asserts its purity, but the value remains the same even if the coin is melted down.”

Is Gold a Commodity?

Gold became the measure of worth in the past since it was rare and since thousands of years ago captivated the desires and wantings of the world. It was the almighty when it came to “value”. I would concur that if the world accepted this premise then Gold makes sense to have been the first “Commodity Money”. It was the ultimate commodity with physical properties that retained its value partly because of its scarcity.

Gold became the measure of worth in the past since it was rare and since thousands of years ago captivated the desires and wantings of the world. It was the almighty when it came to “value”. I would concur that if the world accepted this premise then Gold makes sense to have been the first “Commodity Money”. It was the ultimate commodity with physical properties that retained its value partly because of its scarcity.

One thing that always has bothered me is that I find it hard to understand the value of gold to the average person of hundreds or thousands of years ago. Let me give you an example:

If I was a farmer and produced various crops, I would want to exchange those crops for something else of value. A barter system that allows me to go to the general store and exchange my crops for others that I need say milk, material and all other goods makes sense to me. The exchange rate would be set by the store based on the quantities available and the demand for such items. Of course, the store owner would leave a little room for himself so he could have what to eat, support his family and keep a bit extra. This is the original barter method. In my opinion, this exchange method would in a way make all commodities a “currency” as they had their own value based on simple supply and demand.

Now we have gold come into the picture. My crops can be exchanged for Gold, which I can now use as currency. The Gold itself is useless to me, as I can not eat it, heat my house or fulfil any other of my needs. I can, however, go to a store and exchange the gold for items that I need. The store owner now can do the same as I did with his gold. So far so good. What happens when there is a scarcity of gold? The answer would actually be the inflation of the gold value which in turn devalues my commodities. I now have less value than before. In a perfect world, this affects everyone and all items come down in cost, in gold terms, and I can move along with my daily activities. We know however that this does not always happen and this can cause poverty. The people that hold the gold become “richer” and many others become “poorer”. The farmer can not purchase what he needs to properly do his work and it has a massive effect on his life.

Now, I’ll give you this, this can happen in any “currency” situation. But the limited supply of gold in the world lends itself to this problem. As the issue of gold and its scarcity became more of an issue, the world switched to the FIAT system and left the Gold Standard behind.

Is FIAT a true Currency?

Wikipedia explains that there is another definition of currency:

“A more general definition is that a currency is a system of money (monetary units) in common use, especially in a nation. Under this definition, US dollars, British pounds, Australian dollars, and European euros are examples of currency. These various currencies are recognised stores of value and are traded between nations in foreign exchange markets, which determine the relative values of the different currencies. Currencies in this sense are defined by governments, and each type has limited boundaries of acceptance.”

I guess the first question to determine the answer to, “Is FIAT a true currency” is to get a definition of FIAT. Once again from Wikipedia:

“Fiat money is a currency established as money by government regulation or law. The term derives from the Latin fiat (“let it become”, “it will become”)[ used in the sense of an order or decree.”

It seems obvious that by the second definition of currency, FIAT is a currency. Once again this confuses me, the government decides to issue currency, on its own and decrees that it is legal tender. There does not have to be anything that backs the currency but it has value by government decree. This is more troublesome than the Gold Standard, at least with the Gold standard we had something backing the value. The understanding of how FIAT retains value is that it is pegged against other currencies from other values. It has become widely accepted that the US dollar is the currency that others are pegged against.

Here I run into more problems. The US Government can print money when it pleases (actually borrowing from the Federal Reserve, but that is a whole different discussion) and distributes it. The problem to me is obvious, printing trillions of dollars with no commodity backing it, how does it have value? This can cause high inflation and the dollar itself loses value over time. From my little understanding, this also contributes to our Federal Deficit. We owe China who knows how much money because they actually produce commodities that have value and we have currency with no commodity behind it. So my question is, is the US dollar (and other FIAT Currencies) truly currency.

Introduction of Cryptocurrency

Let’s stay consistent and take the definition or value proposition again from Wikipedia:

“Decentralized cryptocurrency is produced by the entire cryptocurrency system collectively, at a rate which is defined when the system is created and which is publicly known. In centralized banking and economic systems such as the Federal Reserve System, corporate boards or governments control the supply of currency by printing units of fiat money or demanding additions to digital banking ledgers. In case of decentralized cryptocurrency, companies or governments cannot produce new units, and have not so far provided backing for other firms, banks or corporate entities which hold asset value measured in it. The underlying technical system upon which decentralized cryptocurrencies are based was created by the group or individual known as Satoshi Nakamoto.”

So, cryptocurrency, does not have the downside of the FIAT currencies as in general they are predetermined with no given value (using Bitcoin as an example) and the value is determined by the decentralized community that uses it. It is starting to sound to me like cryptocurrency works more like the barter system than a Gold-Backed, or FIAT currency. I will exchange my cryptocurrency for the value I am comfortable with and will fulfil my needs. We as a community, again based on our needs, will determine the value of the cryptocurrency and not some centralized power, like a government. Seems pretty novel. There are many cryptocurrencies now and they continue to introduce new ones. Some have the characteristics defined above and others are slightly different.

I am not saying that cryptocurrency does not have some of the same issues that the other types of currencies we have discussed but in no way does it seem to me to be worse.So the question remains, will the adoption of cryptocurrencies continue and can Cryptocurrencies Replace FIAT.

Disclaimer: I am not in any way an expert on these topics, nor am I an economist, I am far from it. I am simply a person that does not understand the FIAT and Gold Standard models and is more comfortable with the concept of cryptocurrency.
I would be happy if you commented below, we will publish these comments, but please do not be too harsh on me :-).
Cheers.

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