{“content”:"# Understanding the Nature of Money: From Barter to Cryptocurrencies
Money is a system of value that facilitates the exchange of goods in an economy. Using money allows buyers and sellers to pay less in transaction costs compared to bartering.
The first types of money were commodities whose physical properties made them desirable as a medium of exchange. Today, money includes government-issued legal tender or fiat money, money substitutes, fiduciary media, or electronic cryptocurrencies.
Key Takeaways
- Money is a system of value that facilitates the exchange of goods.
- The use of money eliminates the problem of bartering where both parties must have something the other wants or needs.
- Historically, the first forms of money were agricultural commodities, such as grain or livestock.
- Today, most money systems are based on standardized currencies controlled by central banks.
- Digital cryptocurrencies also possess some properties of money.
How Money Works
Money is a liquid asset used to facilitate transactions of value. It is used as a medium of exchange between individuals and entities. It’s also a store of value and a unit of account that can measure the value of other goods.
Before money, most economies relied on bartering, wherein individuals traded goods directly. This created the problem of the double coincidence of wants\u2014transactions could only occur if both parties had something the other needed. Money solved this issue by acting as an intermediary.
The earliest forms of money were agricultural commodities, like grain or cattle, because traders knew these goods would be in high demand. As economies grew complex, money became standardized into currencies, which made transactions easier. Events like World War II saw non-traditional forms of money\u2014prisoners used cigarettes as currency due to tangible value.
What Are the Properties of Money?
In order to be most useful, money should be fungible, durable, portable, recognizable, and stable. These properties reduce the transaction cost of using money by making it easy to exchange.
Money Should Be Fungible
Fungibility means that units of money should be interchangeable with one another at an equivalent value. Metal coins, for instance, should have a standard weight and purity.
Money Should Be Durable
Money needs to be durable enough to retain its usefulness for many future exchanges. A perishable good isn\u2019t suitable for exchange.
Money Should Be Portable
Money should be easy to carry and divide into smaller units to facilitate transactions. A good that is cumbersome to transport generates high transaction costs.
Money Should Be Recognizable
The authenticity and quantity of money should be apparent to users so that transactions can proceed without much inspection.
Money\u2019s Supply Should Be Stable
The supply should be relatively constant over time to prevent massive fluctuations in value, minimizing risks in holding money.
How Is Money Used?
Money primarily functions as a means for exchanging items of value but also has other crucial roles.
Money as a Unit of Account
Because money is widely accepted, it becomes a unit for accounting. This means that it keeps track of the value of items over time, helping people balance budgets and account for profits and losses.
Money as a Store of Value
Given that money is intended for future transactions, it must retain value over time. This makes it possible to save and engage in long-term exchanges.
Money as a Standard of Deferred Payment
Money allows for transactions over different times via credits and debts. One can borrow a quantity of money and repay it over time with agreed terms.
Different Types of Money
Market-Determined Money
Market-determined money arises out of trading practices where certain goods become more desirable for their exchangeability, like gold or silver in ancient times.
Government-Issued Currency
Governments issue standardized coins or notes to regulate the monetary system. They also may declare money as legal tender, benefiting from seigniorage\u2014the profit from printing currency.
Fiat Currency
Fiat money is not backed by a physical commodity but by the economic stability of the issuing government. It derives value from supply, demand, and government guarantees.
Money Substitutes and Fiduciary Media
Money substitutes, like written IOUs, reduce the burden of carrying large sums. Fiduciary media, such as checks and electronic credits, aren\u2019t fully backed but used as money substitutes.
Cryptocurrencies as Money
Digital currencies like Bitcoin can serve as a medium of exchange, particularly in online and speculative contexts. Some countries, like El Salvador, have recognized cryptocurrencies as legal tender.
What Are the 4 Types of Money?
- Market-determined money: Arises naturally and is traded for its inherent value.
- Government-issued currency: Standardized money controlled by governments.
- Fiat currency: Backed by government authority.
- Money substitutes: Anything exchangeable for money, like a check.
What Is the Difference Between Hard and Soft Money?
Hard money is backed by a valuable commodity, limiting its supply (e.g., gold). Soft money isn\u2019t inherently valuable and can be produced in excess, potentially leading to inflation.
Is Cryptocurrency Money?
Cryptocurrencies have some properties of money and are used for transactions and as investment vehicles. Some jurisdictions recognize them legally, but they aren’t widely accepted as legal tender.
The Bottom Line
Money is an item of value facilitating the exchange of goods and services. It must be exchangeable, portable, durable, recognizable, and stable. Forms of money range from precious metals to cryptocurrencies. Though cryptocurrencies have many properties of money, they\u2019re neither backed by governments nor considered legal tender by many.
Related Terms: liquid asset, medium of exchange, store of value, unit of account, transaction costs.
References
- Exeter University. “A Comparative Chronology of Money”.
- National Institute of Health. “Smoke ‘Em If You Got ‘Em: Cigarette Black Markets in US Prisons and Jails”.
- St. Louis Federal Reserve Bank. “M1 Money Supply”.
- Federal Reserve. “What is the money supply? Is it important?”
- The World Bank. “Economic Monitoring”.
- International Monetary Fund. “IMF Surveillance”.
- Economic History Review. “Your Flexible Friend: The Bill of Exchange in Theory and Practice in the Fifteenth Century”.
- Mises Institute. “There Is Money and Then There Are Money Substitutes”.
- Investor.gov. “Investor Alert: Bitcoin and Other Currency-Related Investments”.
