The Fiat Money System Explained Simply: How Our Money Is Created

Short answer: In the fiat money system, money is backed by nothing but law and trust. The euro, the franc and the dollar have not been exchangeable for gold since 1971. About nine tenths of money does not come from the printing press; it is created mainly when commercial banks make loans. Because the supply keeps growing this way, each unit loses purchasing power over the years.

You work for your money, but where does it actually come from? Most people think of the central bank and its printing presses. In truth, the euro in your account was usually created when someone took out a loan. This article explains the fiat money system without jargon: who makes money, what limits it, why there is always more of it and what that means for you as a saver.

What is the fiat money system?

"Fiat" is Latin for "let it be done". Fiat money is money because an authority has decreed it so. It has no material value of its own, and you cannot exchange it anywhere for a fixed amount of gold or silver.

The fiat money system is the order in which this money is created and circulates. It has three parts: a central bank (the ECB, the Swiss National Bank, the Oesterreichische Nationalbank as part of the Eurosystem), commercial banks, and a law that sets what debts can be paid with.

So why does anyone accept euros or francs at all? For three reasons:

• Legal tender: Everyone in the euro area must accept euro banknotes, and everyone in Switzerland franc banknotes. Coins have limits: 50 per payment for the euro, 100 for the franc.
• Taxes: The state demands taxes in its currency. So everyone needs it.
• Trust: You accept euros because you assume the baker will take them tomorrow too.

If trust disappears, the law doesn't help much either. More on that below under hyperinflation.

From gold to fiat money: the short history

Paper money is old. China already had state paper money in the 11th century, and even then too much of it was printed. Today's system, however, is young: it has existed worldwide for only a little over 50 years.

Since then, no major currency has held out a promise in gold. What limits the supply are rules and decisions of central banks, banks and parliaments.

Who makes our money?

In the fiat money system there are two kinds of money, and most people only know one of them.

Central bank money is made only by the central bank. It consists of the cash in your pocket and the balances banks hold at the central bank (reserves). Banks use it to pay each other. A digital euro would be central bank money for everyone in digital form; what sets it apart from bitcoin is shown in The digital euro and bitcoin.

Bank money is the balance in your account. It is not central bank money but a promise by your bank to give you cash on request or to make transfers for you. This bank money makes up most of the money supply.

Source: ECB statistics (BSI), SNB data portal (money supply M1–M3). M3 includes cash, current accounts, savings deposits and short-term time deposits.

How a bank creates money

The common idea is that the bank collects savings and lends them on. The Bundesbank (Germany's central bank) and the Bank of England describe it differently. When a bank makes a loan, it simply credits the amount to the customer's account. At that moment, new money is created that did not exist before.

What slows money creation

Banks cannot create money at will. Four things set limits:

1. Demand: It takes someone who wants a loan and can repay it.
2. Equity: For every loan, the bank must back part of it with its own capital. More loans need more capital.
3. Interest: The central bank sets what central bank money costs. If this policy rate rises, loans become more expensive and rarer.
4. Minimum reserve: In the euro area a bank must hold 1% of its deposits at the central bank. That is little and hardly slows anything.

The role of the central bank

The central bank creates central bank money and uses the interest rate to steer how much bank money is created. Its goal is stable purchasing power, but not literally: the ECB aims for 2% inflation, the SNB for price increases between 0 and 2%. So prices are meant to rise, only slowly.

On Nov 13, 2026, the ECB pays banks 2.50% on deposits with it (deposit facility rate since Sep 16, 2026). The SNB's policy rate has been 0% since Jun 20, 2025. The lower the rate, the cheaper loans are and the more new bank money is created. How rate decisions affect the bitcoin price is examined in the article Interest rates, central banks and bitcoin.

In crises, a central bank can do even more. It then buys government bonds and other securities and pays for them with newly created central bank money. That happened in the 2008 financial crisis, in the euro crisis and in the pandemic. This tool is the system's real strength and at the same time its risk: it rescues banks and states in the short term and inflates the money supply in the long term.

Why the money supply always grows in the fiat money system

New money is created as long as households, companies and states take out more new loans than they repay. That is almost always the case, because states finance themselves permanently through debt and the central bank wants gently rising prices. If the volume of credit does shrink for once, debtors get into trouble and the central bank cuts rates until more loans are created again. The system is built for growth. How high government debt in the US, Germany, Austria and Switzerland has become and who bears the interest on it is in the article Government debt and why bitcoin benefits.

The numbers show it clearly:

Over the past year, euro M3 grew by 3.5% and franc M3 by 3.9%. Where the extra money flows, into everyday prices or mainly into stocks and property, is shown in the article Inflation and the loss of purchasing power with the figures for Germany, Austria and Switzerland.

Strengths and weaknesses of the fiat money system

The fiat money system is not simply bad. It prevailed because it gives states and central banks room to act. For savers, that room has a price.

That new money arrives unequally is called the Cantillon effect, after an 18th-century economist. Who stands at the front and who at the back, and how this shows up in wages and housing prices, is explained in The Cantillon effect, explained simply.

When trust breaks: the 1923 hyperinflation

Fiat money only holds as long as people trust it. Germany has experienced what happens when a state pays its spending with the printing press. In November 1923, one US dollar cost 4.2 trillion marks. A whole generation's savings were worthless.

The situation was rescued by a new currency with a strict limit: 1 Rentenmark replaced 1 trillion paper marks. Hyperinflations have happened again and again since, most recently in Zimbabwe and Venezuela, for example. In Germany, Austria and Switzerland today, the issue is the slow loss rather than the fast one.

How safe is your money in the bank?

Your account balance is a loan you give your bank. If it goes bust, deposit insurance steps in: in Germany and Austria up to €100’000 per person and bank, in Switzerland through esisuisse up to CHF 100’000. Beyond that, you are a creditor of the bank like any other.

Crypto exchanges offer no such protection. What failures from Mt. Gox to FTX cost customers is shown in the article Exchange collapses from Mt. Gox to FTX.

Fiat money and bitcoin compared

Bitcoin was created in 2009 as an alternative to the fiat money system. Satoshi Nakamoto wrote a newspaper headline about a second bank bailout in Britain into the first block. The idea: money whose rules apply equally to everyone and that no one can increase after the fact. Economists from Vienna such as Mises and Hayek had called for exactly that decades earlier; what they taught and where bitcoin departs from it is shown in The Austrian School and bitcoin.

On Nov 13, 2026, 20.11 million bitcoin existed. How the supply grows block by block and slows with every halving is shown in the chart:

The price of this scarcity is volatility. In euros, bitcoin has lost more than 75% several times. That is why it is no substitute for euros and francs for next week's shopping. It is interesting for money you won't need for many years. All the basics are in the beginner's guide What is Bitcoin? and step by step in the academy under Basics.

What the Power Law model says

The Power Law model describes bitcoin's long-term price trend and a lower bound, the floor, at 42% of the Power Law line. On Nov 12, 2026, one bitcoin cost €64’489 (CHF 59’536). The floor was at €60’515 (CHF 55’867), so the price was 6.6% above it and, at 0.66 × trend, in the "Accumulation" zone.

The model describes the past and is no guarantee. How it is calculated and where its limits are is in the methodology.

What you do with this as a saver

You can't vote the fiat money system out. But you can decide how much of your wealth you keep in a currency whose supply grows every year.

1. Keep what you need soon in euros or francs. For rent, bills and your emergency fund, stable money is right, even if it loses value in real terms.
2. Spread larger balances. More than €100’000 or CHF 100’000 per bank is not protected beyond deposit insurance.
3. Put long-term money into scarce assets. What you won't need for ten years or more loses the most in an account. A bitcoin share is only an option if you can stomach drops of 70%.
4. Buy regularly instead of all at once. A savings plan smooths out the volatility.
5. Hold it yourself. Bitcoin at an exchange is once again a claim on a company. How self-custody works is in the guide How to store bitcoin safely.

How a monthly bitcoin savings plan would have turned out so far, you can work out here for your amount:

More on money, interest rates and central banks is in the category Macro & money.