What Is Fiat Money? How It Works, and Why It Loses Value

Fiat is Latin for “let it be done” (Online Etymology Dictionary). Fiat money is money by decree: a state declares it to be money, makes it legal tender, demands taxes in it, and everyone accepts it because everyone else does. Nothing stands behind it that you can claim. A banknote cannot be swapped for gold, silver or anything else, only for another note.

Every major currency in use today works this way. This guide explains what that means in practice: how fiat money is created, what backs it now, why it is designed to lose value and how much it has lost, the case its supporters make, its costs, and why Bitcoin, which is often lumped in with it, is not fiat money at all.

In short

• What it is: money issued by a central bank, with no claim on any commodity. Its value rests on law, taxes and trust.
• Since when: Federal Reserve notes stopped being redeemable in gold in 1934, and foreign governments lost the right to swap dollars for gold on 15 August 1971.
• Who creates it: mostly commercial banks, when they lend. In 2013, 97% of the money the UK public held was bank deposits.
• What backs it: chiefly government debt, which central banks hold against the money they issue.
• Why it loses value: central banks aim for about 2% inflation a year. A dollar from August 1971 buys about 12 cents' worth today.
• Is bitcoin fiat? No. It has no issuer and no decree, and its supply is fixed by its protocol.

What fiat money means

For most of history, money was a thing with value of its own, or a claim on one. Gold and silver coins are commodity money: the metal is worth something whether or not anyone calls it money. Paper money that can be exchanged for metal on demand is representative money: the note is a receipt, and the gold behind it is the money.

Fiat money is neither. A pound or a dollar is not made of anything valuable and is not a receipt for anything valuable. It is money because the state says so, and because people can pay their taxes and settle their debts with it. Its acceptance rests on three things:

• Law. Legal tender laws let a debtor settle a debt in the national currency, and courts enforce contracts written in it.
• Taxes. Governments demand taxes in their own currency, so everyone who pays tax needs it.
• Habit and trust. Shops price goods in it and employers pay wages in it, so it is the easy thing to accept. That holds for as long as people trust it to keep most of its value.

The difference matters. Commodity money limits how much can be created: gold has to be mined. Fiat money has no such limit. Its supply is whatever the central bank and the banking system create, which makes it a policy decision.

Commodity, currency and money: the difference →

How fiat money works

Fiat money comes in two layers. The central bank issues banknotes and the reserves that commercial banks hold with it. Commercial banks create the money most people actually use: the balances in their accounts. In the Bank of England's words, 97% of the money held by the public in the UK was in the form of bank deposits rather than notes and coins (the figure is from December 2013).

Those deposits are created by lending. “Commercial banks create money, in the form of bank deposits, by making new loans,” the Bank explains, and “the repayment of bank loans destroys money” (Bank of England, 2014). When a bank grants a mortgage, it does not hand over someone else's savings; it adds a new balance to the borrower's account. So the amount of money grows when debt grows.

Central banks create their money in a similar way: by buying assets and paying for them with newly created reserves. Those assets are mostly government bonds. The Federal Reserve says the collateral behind its notes is “chiefly held in the form of U.S. Treasury, federal agency, and government-sponsored enterprise securities” (Federal Reserve). On 23 September 2026, Treasury securities and government-backed mortgage securities made up 96% of everything the Fed owned (H.4.1). In September 2026 the Bank of England said its banknotes “will be backed primarily by UK government bonds”.

Put together, the money in your pocket is a liability of the central bank, the money in your account is a liability of your bank, and the main asset behind both is government debt: a promise to pay, repaid from future taxes or from more borrowing.

Other People's Debt: why your money is backed by government IOUs →

How fiat money is actually created →

Does the US have fiat money?

Yes. The dollar has been fiat money in full since 1971, and for Americans since 1934. The Federal Reserve is plain about it: “Federal Reserve notes are not redeemable in gold, silver, or any other commodity,” and they have not been redeemable in gold since 30 January 1934, when Congress amended the Federal Reserve Act.

For nearly four decades more, a link to gold survived abroad. Under the Bretton Woods system, the United States converted dollars held by foreign governments into gold at $35 an ounce. On the evening of 15 August 1971, President Nixon closed that “gold window”. In the words of the Federal Reserve's history of the episode, “the international monetary system turned into a fiat one”. The IMF's rules caught up on 1 April 1978, when an amendment to its Articles made floating exchange rates legal and ended gold's official role (IMF).

US law makes the dollar legal tender: “United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues” (31 U.S.C. § 5103). That does not oblige anyone to take cash at the till. “There is no federal statute mandating that a private business, a person, or an organization must accept currency or coins as payment,” the Federal Reserve notes, although some states have their own rules.

The history of money debasement, from Rome to the Federal Reserve →

Is the pound fiat money?

Yes. Every Bank of England note still says “I promise to pay the bearer on demand the sum of…”. The wording dates from when notes stood for gold deposits. Today the Bank says it will “only exchange them for other Bank of England notes of the same face value”. The promise is to swap a note for an identical one.

Legal tender also means less than most people think. In the UK it has a narrow legal sense: if you offer to pay a debt in full in legal tender, your creditor cannot sue you for failing to pay. It does not oblige a shop to accept any particular money. Bank of England notes are legal tender in England and Wales; in Scotland and Northern Ireland no banknotes are legal tender at all, only Royal Mint coins. As the Bank puts it, “Scottish notes are not legal tender in England or Scotland.”

Examples of fiat currency

Every major currency in use today is a fiat currency: the US dollar, the euro, the pound sterling, the Japanese yen, the Chinese renminbi, the Swiss franc and the rest. None can be exchanged for a fixed quantity of gold or any other commodity. Some smaller currencies are pegged to a larger one, which only moves the question one step along.

One major currency kept a legal link to gold for decades longer. Switzerland kept a gold parity for the franc, and a rule that a share of its banknotes be backed by gold, until a new currency law came into force on 1 May 2000, nearly three decades after the dollar's gold window closed.

Set side by side, the kinds of money people have used look like this:

• Commodity money: valuable in itself. Gold and silver coins. Supply limited by mining.
• Representative money: a paper claim on a commodity. Gold certificates; the dollar before 1934. Supply limited by the gold behind it.
• Fiat money: money by decree, redeemable for nothing. The dollar, pound and euro today. Supply set by central banks and bank lending.
• Bitcoin: a bearer asset with no issuer. Not a claim on anyone. Supply capped by its protocol at 21 million.

Why fiat money loses value

Fiat money is designed to lose value slowly. Central banks do not aim for stable prices; they aim for prices to rise by about 2% a year. The Federal Reserve targets 2% inflation in personal consumption prices; the Bank of England has a 2% consumer price target set by the government. At 2% a year, money loses half its value in 35 years.

In practice it has lost far more. Here is what has happened since August 1971, the month the dollar's last link to gold was cut:

• The dollar: US consumer prices rose 8.2 times between August 1971 and August 2026 (BLS, CPI-U). A dollar from 1971 buys about 12 cents' worth of goods today: 87.8% of its purchasing power is gone, an average loss of 3.9% a year.
• The pound: UK retail prices rose 20.5 times over the same period (ONS, RPI long-run series), so a 1971 pound buys about 5p's worth: a 95.1% loss. The RPI tends to run above the CPI and is not an accredited official statistic. On the CPI, linked to the ONS's modelled estimates before 1988, prices rose 13.0 times and the loss is 92.3%. Either way, a pound from 1971 buys less than a tenth of what it did.

Decade by decade, a dollar and a pound from August 1971 bought (UK on the RPI):

• August 1981: 44 cents and 27p
• August 1991: 30 cents and 15p
• August 2001: 23 cents and 12p
• August 2011: 18 cents and 9p
• August 2021: 15 cents and 7p
• August 2026: 12 cents and 5p

Prices rise because the amount of money keeps growing. Money is lent into existence, governments borrow every year, and central banks buy government bonds with new money when they want to push interest rates down. More money chasing the same goods makes each unit worth less.

What is inflation, and what causes it? →

Calculate what your money has lost: the fiat debasement calculator →

The case for fiat money

Supporters of fiat money make serious arguments, and they deserve a fair hearing:

• Crisis response. A central bank that can create money can act as lender of last resort, stopping bank runs and cushioning recessions. Under a gold standard, its gold limits how far it can go.
• Avoiding deflation. Most economists think falling prices are dangerous because people put off spending and debts become heavier. A target of 2% inflation keeps a margin above zero.
• Flexibility. Interest rates and the money supply can be adjusted to the economy rather than to the size of a gold hoard.
• Cost. Paper and digital money are cheap to produce and move compared with mining, storing and guarding gold.

The trade-off is that the same flexibility that lets a central bank rescue the system lets a government finance itself without asking anyone. Inflation shrinks the real value of debts, and governments are the largest debtors. Whether flexibility is worth that cost is the real argument about fiat money.

Is deflation actually bad? →

The disadvantages of fiat money

• Savings lose value by design. A 2% target means money is meant to buy less every year. Savers carry the loss; borrowers gain.
• New money is not spread evenly. It reaches banks, governments and asset owners first, before prices adjust: the Cantillon effect. The Bank of England estimated in 2012 that the top 5% of households held about 40% of the financial assets whose prices its quantitative easing had lifted.
• It runs on debt. Because money is created by lending, the money supply grows only if debt grows, and the system needs more borrowing to keep working.
• Booms and busts. Interest rates set by committee, rather than by savers and borrowers, can encourage borrowing for projects the economy cannot sustain.
• Trust can fail. When people stop trusting a fiat currency, it can collapse. In October 1923 German wholesale prices rose 29,500% in a single month. In mid-November 2008, Zimbabwe's monthly inflation peaked at about 79.6 billion per cent, measured from exchange rates once official statistics stopped (Hanke and Krus, 2012).

What is the Cantillon effect? →

Why do governments print money, and why not just print more? →

Is bitcoin fiat money?

No. Fiat money is issued by a state and given force by decree. Bitcoin has neither an issuer nor a decree. New bitcoin is created only by the protocol's fixed schedule, as a reward for adding blocks to the chain, and the total can never exceed 21 million. No government declared its value, no central bank can create more, and it is nobody's liability.

Bitcoin does share one feature with fiat money: you cannot redeem it for anything else. Its value rests on people choosing to hold and use it. The difference is what stands behind that choice. With fiat money it is trust in a committee to limit how much it creates. With bitcoin it is a rule that anyone can check, which no committee can change.

It is also fair to say what bitcoin is not yet. It works as a means of payment and is widely held as a store of value, but few people price goods or wages in it, so for most people it is not yet a unit of account.

How many bitcoins are there? The live count →

What backs bitcoin? →

Questions people ask

What does fiat mean?

Fiat is Latin for “let it be done”. Fiat money is money by decree: it is money because a government declares it to be, not because it is made of, or exchangeable for, anything valuable.

What is an example of fiat money?

The US dollar, the euro, the pound sterling and the Japanese yen are all fiat money, as is every other major currency in use today.

Is the US dollar backed by anything?

Not by gold: Federal Reserve notes have not been redeemable in gold since 1934, and foreign governments lost the right in 1971. The Fed holds collateral against its notes, chiefly US Treasury and government-agency securities, so in practice the dollar is backed mainly by government debt and government-backed securities.

Is fiat money the same as legal tender?

No. Fiat describes money with no commodity behind it. Legal tender is a legal status: money that settles a debt in court. A fiat currency is usually legal tender in its own country, but that does not oblige a shop to accept it.

Is bitcoin a fiat currency?

No. Bitcoin has no issuer and no government decree behind it, and its supply is capped by its protocol at 21 million. It is not backed by anything either, but no one can create more of it.

Money 101: the reading list →

Sources

• Price indices: BLS, CPI-U (CUUR0000SA0); ONS, RPI long-run series (CDKO); ONS, CPI (D7BT) and ONS, modelled CPI 1950–1988 (JFDN). August 1971 to August 2026, fetched 3 October 2026.
• Law and history: 31 U.S.C. § 5103; Federal Reserve, Is U.S. currency still backed by gold?; Federal Reserve, Is it legal for a business to refuse cash?; Federal Reserve History, Nixon ends convertibility; IMF, Silent Revolution, ch. 2; Swiss National Bank, chronicle of monetary events.
• Central banks: Bank of England, banknote FAQs; Bank of England, What is legal tender?; Bank of England, Money in the modern economy (2014); Bank of England, Money creation in the modern economy (2014); Bank of England, What backs banknotes? (2026); Federal Reserve, H.4.1; Federal Reserve, longer-run goals; Bank of England, inflation target; Bank of England, distributional effects of asset purchases (2012).
• Hyperinflation and etymology: Hanke and Krus, World Hyperinflations (Cato, 2012); Online Etymology Dictionary, fiat.