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A University of Pennsylvania economics professor and an advisor to the Philadelphia Federal Reserve recently released a working paper claiming that Bitcoin is a fiat currency. Their paper investigates a hypothetical economy of privately competing currencies where entrepreneurs “can issue their own fiat currencies in order to maximize their utility.” Jesús Fernández-Villaverde and Daniel Sanches suggest that Bitcoin and other cryptocurrencies are actually more “fiat” than public monies because they cannot be used to pay taxes in most countries.
Bitcoin Doesn’t Need Violence
It’s time to set the record straight: Bitcoin is not a fiat currency. There are not different degrees of “fiatness,” as the authors imply, and privately issued-currencies are the opposite of fiat currencies created by government legislation.
Fiat comes from Latin, and means, “it shall be.”
Bitcoin is an open-source software that allows individuals to trade without an intermediary. Deemed the first “cryptocurrency,” Bitcoin has seen its spot price soar to $750/Bitcoin in recent days. Bitcoin’s market cap of almost $12 billion has garnered interest from investors, academics, and regulators.
Private currencies, such as Bitcoin or the Vodafone mPesa, are not examples of fiat currencies, even if a commodity such as gold or silver does not back them. Several cryptocurrency pundits have accepted the notion that Bitcoin is a fiat currency for this very reason. While it’s true that Bitcoin is not backed by a commodity, this fact only fulfills half the requirements of the definition of fiat. Fiat comes from Latin, and means, “it shall be.” A fiat currency means the government declared the currency to be legal tender even though the currency does not have a commodity backing. Fiat monies include the U.S. dollar, the British pound, the European euro, and the Chinese Renminbi, amongst others.
You Keep Using That Word
Degrees of “fiatness” do not exist. A currency is either enforced by government fiat (decree) or not.
In the paper “Can Currency Competition Work?” Professor Fernández-Villaverde and FED advisor Sanches find that the optimal strategy for entrepreneurs who produce private currencies is to limit currency production to a constant nominal supply. If an entrepreneur prints too much currency, the demand for the entrepreneur’s currency will decrease because the money becomes worthless. The authors mention that the market naturally limits the over-issuance of private currencies because entrepreneurs who produce worthless currencies will eventually go out of business. Unlike private currencies, fiat currencies remain on the market even though central banks overissue. This is because a government can force individuals to use a government-issued currency via a fiat law. If the government creates a cryptocurrency with a “manageable” supply and declares that cryptocurrency to be legal tender via fiat, then that would be an example of a fiat cryptocurrency.
I remember my first credit card vividly. For months, I had been attempting to woo my local bank. “Give me a card,” I begged. “You can trust me.” My pleas fell on deaf ears.
Then one day, after all but giving up, I found myself at Gap. (As I recall, I was there to purchase a pair of skinny jeans.) While fumbling through my wallet at the checkout counter, the cashier asked me if I wanted to apply for a Gap Visa. “Sure!” I replied. After an instant vetting (what the heck did they look up, anyway?), they awarded me an account. The physical card arrived in the mail a few days later. What benevolence! I’ve had the card for years.
Think about that. I am a bastion of trust (trust me on that one). My finances have always been solid. I have a pleasant appearance. The only thing holding me back from getting a credit card was my youth. I had to wait a long time for someone to give me one.
And it’s not just credit cards. Banks often require parental permission to open savings and checking accounts. In general, young people have restricted access to the entire financial system—credit and otherwise.
You can’t blame the banks, though, or the credit card companies. They have to assess risk somehow. And to them, I was risky business. But how could I prove my trustworthiness if I was never given the chance? It’s a classic chicken-and-egg problem.
As a society, we want to lead young people to financial independence. We want to teach young people about financial responsibility. Yet the current financial paradigm fails miserably. Young people have to overcome immense hurdles to build credit and gain access to credit cards and reasonable loans. On the other hand, credit card culture can be detrimental to those who lack financial common sense. Debt entraps millions.
If only there were some way to empower young people to prove their trustworthiness without exposing financial firms to unnecessary risk.
That’s where bitcoin comes in. No trust barriers exist. Young men and women don’t have to bend over backward to prove themselves. Transactions are peer-to-peer and instant. Anyone can download a bitcoin wallet and use it. Forthcoming applications of the blockchain—such as smart property—inject this trustless paradigm with an additional dose of democracy.