FIAT CURRENCY

Subject : Economy

Context : Reserve Bank of India (RBI) said it was open to exploring the possibility of a digital version of fiat currency.

Concept :

Fiat currency is government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it.
The value of fiat currency is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it as is the case for commodity money.
Most modern paper currencies are fiat currencies, including the U.S. dollar, the euro, and other major global currencies.

Fiat currency vs Legal Tender

Fiat currency has no intrinsic value, while legal tender is any currency declared legal by a government.
Governments can issue fiat currency and make it legal tender by setting it as the standard for debt repayment.
The benefit of fiat currency is that it gives central banks greater control over the economy, but governments can print too much money and create hyperinflation.
The U.S. dollar , Indian Rupee etc are both fiat currency and legal tender.

Digital Fiat currency

The growing popularity of digital currencies (or cryptocurrency) such as Bitcoin, over the last decade, had made most central banks look seriously at launching a digital currency controlled by them that can address the shortcomings of digital currencies while hastening the shift towards a cashless society.
Hence, the RBI is exploring the possibility as to whether there is a need for a digital version of fiat currency and in case there is, then how to operationalise it.

Digitalisation of Fiat Currency vs Digital Currency.

In order to understand the importance of a Digital Rupee, it is required to distinguish the digitalisation of fiat currency from digital currency.
The digitisation of fiat currency stems from the advent of electronic payment and interbank IT systems, allowing commercial banks to more efficiently and independently generate the credit flows that expand the broad money supply.
By contrast, digital currency, enabled by blockchain technology, affects the base currency allowing the central bank to bypass commercial banks and regain control of currency creation and supply end-to-end.