What is Money?

We interact with money all the time, but have you ever slowed down to think about the question: What is money?

We interact with money all the time, but unless you are studying economics or finance, you probably don't stop to think about it any further than the twenty dollar bill in your pocket

In early human civilization, exchange could take place via barter system. For example, a hunter could exchange their meat for the farmer's grain so that each person could focus on what they do best, but allow both to receive a balanced diet. However, what would happen if the farmer decided they didn't want what the hunter had to offer? To get grain, the hunter could swap for a different item that the farmer might want, but this takes lots of energy, especially when societies begin to grow. Instead, if the hunter's village used a form of money, those trying to buy grain don't have to worry about what the seller wants, because money would allow the seller access to anything the society has to offer.

At its core, money is a tool and belief system to help facilitate trade and to convey different information about preferences or needs.

In our highly specialized, global world, we rely on money for almost every transaction we make. Money allows us to avoid the bartering by using a special object to convey value. This allows us to achieve a higher degree of specialization, because we can be rewarded for increasingly more complex tasks. The uses of money can be broken down into three key functions:

1. medium of exchange

2. a unit of account

3. a store of value

This way, every person in society can do tasks in exchange for a standard unit of money, of which they can spend any way they see fit. When this happens on a large scale, the unit of account function allows fair market prices for goods to emerge. Citizens do not have to worry about discovering how much bread they can trade their shoes for, because each has an agreed upon price. Additionally, since money can be traded for any other good or service, there is an inherent value stored in it. Storing value allows people to save for the future.

However, not all money was created equally, and some forms are better than others. Over many years of human history, a myriad of objects have been used as money for different civilizations. Shells, beads, and gold have all served as forms of money in different societies throughout time. However, all have since been replaced by different currencies with superior qualities. There is no guarantee that the most widely accepted form of money in the world today, US Dollars, is a perfect currency that is immune to getting disrupted by something with superior properties.

Other Good Properties of Money

The following qualities make some forms of more effective than others. The following are some of the most important characteristics of any form of Money.

Durability

This refers to something that can be preserved and stable over long periods of time. Due to gold’s unique physical properties, it does not degrade over time, and can be passed down for generations. However, copper oxidizes and erodes more quickly.

Divisibility

A currency that is easily divisible can be broken down into many small pieces to accomodate for many specific prices. UK Coinage allows higher granularity for payments, so vendors can charge with specificity of up to two decimal places, whereas gold bars would have to be cut to pay for items worth less than the bar itself.

Portability

Ease of transfer is a key feature of currency. Something that has a high value to weight ratio can be easily carried around. Imagine how difficult it would be to pay only with coins!

Fungibility*

For a transaction to take place, the buyer and seller must be able to readily identify the integrity and the value of the currency. Dollars can be counterfeited, so some stores will use UV lights to check high valued bills.

Verifiability*

For a transaction to take place, the buyer and seller must be able to readily identify the integrity and the value of the currency. Dollars can be counterfeited, so some stores will use UV lights to check high valued bills.

Scarcity

This is the most important quality of any currency. From Economics 101 we know that as supply increases, price will tend to fall. As the price of gold rises, it becomes more and more profitable to spend time mining it from the ground.

Why is money worth anything?


On it's own, money isn't worth anything! Only when a group of people agree that they will exchange money for goods and services does it become valuable. It is this reason that money can be thought about as a belief system.
Since people need to trust that the money will work, there is usually something backing the value that money carries Most times, a government steps in to validate and maintain the money. Now, we use the government as a proxy for trust in the money. Instead of trusting the money, we trust in the government.

Every step of the process requires trust. You must trust in the government to maintain the value of the money. You must trust the bank to not go out of business. You must trust the payment verification tool to send your money truthfully.

Heading Here

Gold

Dollars

Durability

Doesn't Degrade

Somewhat durable but suseptible to fire

Divisibility

Difficult to divide and measure

Up to two decimal places

Portability

Heavy and costly to transfer

Lightweight paper

Recognizabilty

Atomically verifiable

Distinguishable but prone to counterfeit

Scarcity

No set maximum supply; currently limited to that in earth's crust

No set maximum supply

As mentioned above, one of the key tenets that give money value is scarcity. As supply increases over time, the existing money in circulation becomes less valuable, as some of the value is transferred to the newly created money. A money that is more scarce is more likely to retain its value over time.

While we now have digital representations of gold and dollars so that we can interact with them online, they are not digitally native, which introduces more friction.

When Bitcoin was created in 2009, it was the first digitally native form of money. To learn about what Bitcoin is and what it can do, click on the button below!