What is money? It is a medium of exchange to facilitate transactions in an economic ecosystem. Historically, money has taken many unusual forms, ultimately evolving into the current form. Money serves many other functions than just serving as a medium. It poses specific characteristics to perform its functions. Based on those characteristics and functions, it is categorized into four primary types.
A Brief History of Money
The exchange of goods started with the development of human civilization. Initially, the Barter exchange system was in place. Still, with the growing needs and complexities, human civilization needed a system of exchange that simplifies trade, hence developing the concept of money. Money provided a medium of exchange and helped evaluate the value of goods and services. People have used many common goods as money in the past, but with changing needs, money has evolved into its current form. Even today, the market uses four types of money. Although cryptocurrencies pass major characteristics to become money, there is still a long way to go.
What is Money?
Money is a medium of exchange where an item or good is accepted as a payment in exchange for goods and services. Initially, humans used stones, carvings, coins, or anything they perceived as valuable, used as money. The concept of money kept evolving, ultimately reaching the current and most widely used money type – Fiat Money. The evolution of money took place primarily because of its inherent characteristics and requirements of complex human civilization.
Purposes of Money
Money serves many purposes in the current globalized world. Here are the three primary purposes that money serves.
a. Provides Medium of Exchange and Payment:
The most essential function money provides is the provision of a medium of exchange and payments for goods and services. Money can be used to pay taxes and loan repayments. It is the primary function of money.
b. Measure the value of goods and services:
Money is used as a standard to determine the value of goods and services. It measures and assigns a value to a specific good or service, facilitating trading and other economic activities. Without a centralized valuation with money, trading would not have reached current heights.
c. Provide storage for value:
Money not only assigns a value to goods and services but also stores value for later usage. However, every currency loses value over time, and it is still a suitable medium for storing the value of goods and services for future usage.
Characteristics of Money
Every good cannot be used as money; instead, money should possess certain characteristics to fulfil its purpose. Some of the important characteristics are as follows:
a. Money should be limited (Scarce):
Money should always be limited in number; otherwise, money will lose its value and ultimately become worthless. People must strive to get it; only then can money serve its purpose. Too much availability of money in the market will decrease its value. That’s why countries do not print unlimited money.
b. Money should be easily transportable (Portability):
Large items were used as money during the early time of human civilization. Due to its size or weight, trade was limited because it was difficult to carry more money from one place to another. Portability is the primary cause of the evolution of money. Today, we see most portable forms of money.
c. Money should last long (Durability):
Money should be (made) of materials that last longer. Even in making today’s paper currencies, great care is taken about durability while deciding on the material of money. Durability is essential; one cannot make money from easily perishable items. For instance, fruits or vegetables are not fit for money.
d. Money should be acceptable to everyone (Acceptability):
Acceptability is an inherent characteristic of money. Everyone should accept money without any exception. Without general acceptability, money does not serve its purpose. Today, countries make their currency acceptable by punishing individuals who do not accept it inside the country.
e. Money should be in multiple denominations (Divisibility):
It is an essential characteristic of money, and money should be in different denominations. People buy items worth different prices, so money should offer them a wide range of options to make payments for goods and services. For instance, an Apple may cost one dollar and a few cents, whereas an iPhone may cost a thousand dollars, so good money should cater to all these requirements.
f. Money should sustain its value (Stability):
Good money offers a stable value. People trust only stable money; the general acceptability of unstable money slowly diminishes over time, hence losing its inherent purpose. USD is the most widely used and trusted currency globally, primarily because of its stability.
g. Money should be interchangeable (Fungibility):
Fungibility requires that people can easily recognize and convert money into any other denomination. Sound money is highly fungible, for example, people can easily recognize and replace a 10-dollar note with two 5-dollar notes, whereas a gold nugget, although valuable, is not easily fungible.
The Four Types of Money
Money comes in various forms to serve different purposes. Here are the most common types of money:
a. Commodity Money:
Commodity money refers to any physical asset or commodity that serves the purpose of money and possesses intrinsic value. Throughout history, people have used everyday items such as salt or coffee beans as a form of currency. Gold and Silver (God’s Money) are the best examples of commodity money.
b. Fiat Money:
Fiat means “determined by an authority,” so fiat money is money issued by an authority (governments in the case of paper currencies). Fiat money derives its value from demand and supply from the issuing authority and the economic health of the issuing country. All currencies used in the world are fiat currencies. According to FRED Economic Data, $ 2337.788 billion are in circulation worldwide.
c. Fiduciary Money:
Fiduciary means “involving trust.” Fiduciary money is not a physical form of money. Instead, it is just a written statement of payment in the form of bonds and cheques involving trust between trustee and beneficiary. Trust plays a crucial role in fiduciary money. One can easily convert fiduciary money into any other type of money, even though it has no intrinsic value.
d. Commercial Bank Money:
Commercial bank money refers to all the money that is held in commercial bank accounts. Commercial banks participate in lending and borrowing using their customers’ funds.
In the last two decades, cryptocurrencies have gained popularity, although they still do not enjoy widespread recognition as money, despite acquiring most of the characteristics of money. Most term them as virtual assets because they do not have any physical form.
Bottom Line
The concept of money has evolved to serve humankind, mainly by providing a means of exchange. It simplifies trade and helps evaluate the value of goods and services. Money serves three primary purposes: providing a medium of exchange and payment, measuring the value of goods and services, and providing storage for value. It should possess certain characteristics, such as being limited, portable, durable, acceptable to everyone, in multiple denominations, sustainable in value, and interchangeable. The article also explains the four types of money, namely, commodity money, fiat money, fiduciary money, and commercial bank money.
