When you buy a cup of coffee, you might pay in cash, with your debit or credit card, or even by scanning a code on your phone. All these transactions, even those that are entirely digital—no bills or coins change hands—are based on fiat currency.

Fiat Currency

A fiat currency—such as dollars, euros, pounds, or yen—is a trusted medium of exchange, or legal tender, that is issued by a recognized government or authority. U.S. dollars, for example, are backed by the “full faith and credit” of the United States government.

Fiat currency works through a system of intermediaries, typically banks. When you write a check or use your credit card, the amount you authorize is debited from your bank account. That same amount is credited to the account of the person receiving the check or the merchant from whom you made the purchase. The transaction is processed and reconciled by the banks, which provide both the buyer and seller with a record of the transaction.

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