Origin of Fairies

Folk Beliefs

Dead

One popular belief was that they were the dead, or some subclass of the dead. The Irish banshee (Irish Gaelic bean sí or Scottish Gaelic bean shìth, which both mean "fairy woman") is sometimes described as a ghost. The northern English Cauld Lad of Hylton, though described as a murdered boy, is also described as a household sprite like a brownie, much of the time a Barghest or Elf.
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One tale recounted a man caught by the fairies, who found that whenever he looked steadily at one, the fairy was a dead neighbor of his. This was among the most common views expressed by those who believed in fairies, although many of the informants would express the view with some doubts.

Elementals

Another view held that the fairies were an intelligent species, distinct from humans and angels. In alchemy in particular they were regarded as elementals, such as gnomes and sylphs, as described by Paracelsus. This is uncommon in folklore, but accounts describing the fairies as "spirits of the air" have been found popularly.

Demoted Angels

A third belief held that they were a class of "demoted" angels. One popular story held that when the angels revolted, God ordered the gates shut; those still in heaven remained angels, those in hell became devils, and those caught in between became fairies. Others held that they had been thrown out of heaven, not being good enough, but they were not evil enough for hell. This may explain the tradition that they had to pay a "teind" or tithe to Hell. As fallen angels, though not quite devils, they could be seen as subject of the Devil. For a similar concept in Persian mythology, see Peri.

Demons

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A fourth belief was the fairies were devils entirely. This belief became much more popular with the growth of Puritanism. The hobgoblin, once a friendly household spirit, became a wicked goblin. Dealing with fairies was in some cases considered a form of witchcraft and punished as such in this era. Disassociating himself from such evils may be why Oberon, in A Midsummer Night's Dream, carefully observed that neither he nor his court feared the church bells
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The belief in their angelic nature was less common than that they were the dead, but still found popularity, especially in Theosophist circles. Informants who described their nature sometimes held aspects of both the third and the fourth view, or observed that the matter was disputed.

Humans

A less-common belief was that the fairies were actually humans; one folktale recounts how a woman had hidden some of her children from God, and then looked for them in vain, because they had become the hidden people, the fairies. This is parallel to a more developed tale, of the origin of the Scandinavian huldra.

Babies' Laughs
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A story of the origin of fairies appears in a chapter about Peter Pan in J. M. Barrie's 1902 novel The Little White Bird, and was incorporated into his later works about the character. Barrie wrote, "When the first baby laughed for the first time, his laugh broke into a million pieces, and they all went skipping about. That was the beginning of fairies."

Pagan Deities

Many of the Irish tales of the Tuatha Dé Danann refer to these beings as fairies, though in more ancient times they were regarded as Goddesses and Gods. The Tuatha Dé were spoken of as having come from Islands in the north of the world, or, in other sources, from the sky. After being defeated in a series of battles with other Otherworldly beings, and then by the ancestors of the current Irish people, they were said to have withdrawn to the sídhe (fairy mounds), where they lived on in popular imagination as "fairies."
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Sources of Beliefs

A Hidden People.
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One common theme found among the Celtic nations describes a race of diminutive people who had been driven into hiding by invading humans. They came to be seen as another race, or possibly spirits, and were believed to live in an Otherworld that was variously described as existing underground, in hidden hills (many of which were ancient burial mounds), or across the Western Sea.
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In old Celtic fairy lore the sidhe (fairy folk) are immortals living in the ancient barrows and cairns. The Tuatha de Danaan are associated with several Otherworld realms including Mag Mell (the Pleasant Plain), Emain Ablach (the Fortress of Apples or the Land of Promise or the Isle of Women), and the Tir na nÓg (the Land of Youth).
The concept of the Otherworld is also associated with the Isle of Apples, known as Avalon in the Arthurian mythos (often equated with Ablach Emain). Here we find the Silver Bough that allowed a living mortal to enter and withdraw from the Otherworld. According to legend, the Fairy Queen sometimes offered the branch to worthy mortals, granting them safe passage and food during their stay. Some 19th century archaeologists thought they had found underground rooms in the Orkney islands resembling the Elfland in Childe Rowland. In popular folklore, flint arrowheads from the Stone Age were attributed to the fairies as "elf-shot".
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The fairies' fear of iron was attributed to the invaders having iron weapons, whereas the inhabitants had only flint and were therefore easily defeated in physical battle. Their green clothing and underground homes were credited to their need to hide and camouflage themselves from hostile humans, and their use of magic a necessary skill for combating those with superior weaponry. In Victorian beliefs of evolution, cannibalism among "ogres" was attributed to memories of more savage races, still practicing it alongside "superior" races that had abandoned it. Selkies, described in fairy tales as shapeshifting seal people, were attributed to memories of skin-clad "primitive" people traveling in kayaks. African pygmies were put forth as an example of a race that had previously existed over larger stretches of territory, but come to be scarce and semi-mythical with the passage of time and prominence of other tribes and races.
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Christianised Pagan Deities

Another theory is that the fairies were originally worshiped as gods, but with the coming of Christianity, they lived on, in a dwindled state of power, in folk belief. In this particular time, fairies were reputed by the church as being 'evil' beings. Many beings who are described as deities in older tales are described as "fairies" in more recent writings. Victorian explanations of mythology, which accounted for all gods as metaphors for natural events that had come to be taken literally, explained them as metaphors for the night sky and stars. According to this theory, fairies are personified aspects of nature and deified abstract concepts such as ‘love’ and ‘victory’ in the pantheon of the particular form of animistic nature worship reconstructed as the religion of Ancient Western Europe.

Spirits of The Dead

A third theory was that the fairies were a folkloric belief concerning the dead. This noted many common points of belief, such as the same legends being told of ghosts and fairies, the sídhe in actuality being burial mounds, it being dangerous to eat food in both Fairyland and Hades, and both the dead and fairies living underground.

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