By Daniel Archibald | CFA
The recent past has seen a revolution in the world of money: The rise of cryptocurrencies. This new financial innovation, along with it traditional counterparts issued by sovereign nations, are meant to help facilitate trade involving individuals, corporations and governments. Compared to fiat currencies, which are the primary form of global money, cryptocurrencies are issued by non-government entities. Whilst both form of currencies do not have any physical store of wealth backing their value (e.g. gold), fiat currencies issued by a nation's government are backed by the wealth and resources of the respective countries. Cryptocurrencies, on the other hand, have no such guarantor, but instead rely solely upon its value as an alternative and secure means of exchange.
Most cryptocurrencies would be considered 'freely floating'. This implies that that their value is determined purely by market forces; supply and demand. Whilst Bitcoin is the leading cryptocurrency, there are 1000s of cryptocurrency on issue as of 2021 (with Carole Baskin's 'Big Cat Coin' being one of the most recent issues). In regards to fiat currencies, there are currently 180 different currencies issued by governments around the world. Of these 32 are considered to be free-floating, including most of the world's major currencies such as the US dollar, euro, UK pound, Japanese Yen and Australian dollar.
Other forms of currency systems utilised by nations include:
- Managed floating: This is used by smaller or developing countries (e.g. Switzerland, New Zealand) and refers to the practice of government intervention in the foreign exchange (FX) market to provide more stability to the currency or economy
- Conventional pegged arrangement: This is the most common currency system used, mainly by developing nations. This involves the anchoring of the currency to one currency (or a basket of currencies)
- Currency board arrangement: This is a call-back to the gold standard whereby currencies were issued based on gold reserves. Today, countries can use a similar system, but with other currencies instead of gold; for example the Hong Kong is anchored strictly to the US dollar.
Interestingly, countries have had a tendency of looking to devalue their currencies though direct action (selling domestic currency on the foreign exchange market) or indirectly (printing money). This is primarily done to help improve the competitiveness of domestic businesses and economic activity. This is more difficult to accomplish with a free-floating currency, and adverse affects can be severe. This includes bouts of inflation, lower living standards and the rise of alternative modes of currency (e.g. black market activities, cryptocurrencies).