What it is:
How it works (Example):
As valid currency solely by virtue of a government declaration, fiat money is not backed by any commodity, such as gold, but only by the faith of the bearer. In this respect, unlike currencies backed by gold or silver, fiat money does not have any intrinsic value (e.g., paper money and much coinage). The U.S. dollar is an example of fiat money.
Why it Matters:
Fiat money allows the declaring government to employ virtually any material, such as paper (which is lightweight and convenient for carrying), as a medium of exchange. However, since the value of fiat money lies solely in the faith of those using it, its value can be easily diminished and result in rapid inflation.