Fiat money is currency that a government has declared to be legal tender, but is not backed by a physical commodity.
The value of fiat money is derived 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”.
What is the Fiat System
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 intrinsic value and are used solely as a means of payment. Historically, governments would mint 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 20th 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.