The Price of Progress - A Closer Look at Our Financial System

An Introduction to Money

Introduction to Bitcoin & Stablecoin

An Introduction to Money

What is money?
What makes great money?
Characteristics of Money

Money is a fascinating and essential part of our daily lives. We use it daily to buy groceries, pay bills, and make countless transactions. But what is money, really? At its core, money is simply a medium of exchange, a tool that allows us to trade goods and services with one another. It's an abstract concept we all take for granted, yet it's fundamental to our economic system.

But not all money is created equal. Some forms of money are better than others, depending on their ability to serve as a store of value, a medium of exchange, and a unit of account. Gold, for example, has been highly valued for thousands of years because of its durability and scarcity. On the other hand, paper money is only as valuable as the trust we place in the institutions that issue it.

In this module, we'll explore money's different functions and characteristics and what makes good money. Whether you're an average Joe, a business owner, an investor, or simply curious about the world of finance, our goal is to assist you in gaining a deeper understanding of this abstract yet essential concept that touches all our lives. So let's dive in…

What is money?

In its simplest form, money can be understood as the medium by which two parties agree to settle an exchange of a product, good or service.

Money allows us to swap our resources or services for a store of value, regardless of whether we have an immediate use for this stored value. This has allowed our civilisation to expand and grow much more efficiently than it otherwise would have if we had continued to rely on practices such as barter.

For the average person, money holds its value as there are only two methods to obtain money:

We must expend time and energy in return for money (i.e. work, labour, services).
We must trade goods or resources in return for money.

It is important to note that in the second point above, in order to obtain these goods and resources to trade, someone at some stage had to spend the time and energy to create them. We can thus deduce that we must expend time and energy to obtain money. Therefore:

Money = Time + Energy

By viewing money as a store of time and energy, metaphorically speaking, we can better understand that money is essentially a battery– a store of energy that can be used at a later date. With this analogy in mind, the evolution of money, in theory, is this constant search for the most efficient battery to store time and energy.

What makes great money?

As you read the introduction, you may have noticed three important terms: store of value, medium of exchange, and unit of account. Don't worry if you're unfamiliar with this lingo. These three functions are essential for money to provide value to its holder and are commonly referred to as the functions of money.

Let's take a look at each one:

Store of Value: Money serves as a means of storing value for future use, enabling the holder to preserve their purchasing power over time. By doing so, it provides the holder with the ability to save and plan for the future. Gold serves as a prime example of such a store of value, as it has for centuries been able to purchase a decent suit with just one ounce.
Medium of Exchange: For money to serve as a viable medium of exchange for goods and services, it must be easily exchanged. While any asset can technically be used as money, larger and immovable assets like houses are not practical for use as a medium of exchange.
Unit of Account: Finally, money should function as a standard unit of measurement for the prices of goods and services. This means that items are priced and valued in terms of this money, allowing for easy comparison of the relative worth of different products and services.

When these three essential functions of money are met in their entirety, such money has the ability to meet the rigorous demands of trade. Without these functions, money is far less reliable and trustworthy, leading to insecurity and uncertainty in trade, which can have damaging effects on both a personal and national level.

With this in mind, when the money we use offers us a reliable means of storing value, an effective method of facilitating transactions, and a common measure of value, it enables us to save and build wealth, trade confidently and transact with ease. These functions together not only assist us in our capacity to trade and save but also lay the foundation for a stable and efficient economic system, fostering greater economic growth and prosperity for individuals and societies.

You're probably thinking, "Ok, I understand that for money to offer value, it must meet the functions of money laid out above, but how does it do that?"

Great question...

The concept of great money may seem complicated, but at its core, it is defined by certain essential characteristics that enable it to function as a reliable and effective store of value, medium of exchange, and unit of account. These elements are collectively known as the characteristics of money. By understanding the connections between the characteristics of money and its functions, we can develop a deeper understanding as to why certain money is preferable to others.

Characteristics of Money

Store of Value

For money to maintain its purchasing power over time, it must be:

Durable: When we talk about money being durable, we are referring to its ability to withstand the wear and tear of time and use. A durable store of value means that the money will retain its value over time, regardless of any physical or environmental factors that may cause it to deteriorate. For example, if you store your money in gold, it will retain its value and shine even if the coins it represents were to become obsolete. Durable money is important because it allows us to save our wealth over time without fear of losing its value.

Scarce: When money offers scarcity, we mean a limited available supply. This is important for a store of value because if there is too much of a particular currency, it can decrease in value. A scarce currency is more likely to hold its value over time, making it a reliable store of wealth. Think of it like a limited edition item - if there are only a few of them, they are more valuable and sought-after than if there were a limitless supply. Similarly, a scarce currency is more likely to hold its value and maintain its purchasing power, making it a better option for storing wealth.

Immutable: For money to offer immutability, it should be impervious to reversal or alteration once a transaction has been made. This is a crucial characteristic of a reliable store of value because it ensures that the value of the money is not subject to arbitrary changes or manipulations. For example, if you purchase something with cash, you cannot later change your mind and reverse the transaction. Similarly, with cryptocurrencies like Bitcoin, once a transaction has been recorded on the blockchain, it cannot be altered or reversed. This immutability provides a sense of security and reliability for both buyers and sellers in financial transactions.

Medium of Exchange

For money to be an effective intermediary for buying and selling goods and services, it must be:

Portable: When we talk about money being "portable," we mean that it is easy to carry and transport from one place to another. This is an important characteristic of a medium of exchange because it enables us to use money to buy and sell goods and services in different locations. For example, if you wanted to buy a coffee from a café, you could use your portable money (such as cash or a credit card) to pay, no matter where you are. In contrast, if you had to carry around large, heavy objects as a means of exchange, it would be much more difficult to use them in transactions.

Divisible: This is a critical characteristic of a good medium of exchange, which refers to the ability of money to be divided into smaller units to facilitate transactions of varying sizes. For example, making small purchases would be challenging if we only had large denominations of money. Divisibility allows us to make exact payments, regardless of the transaction size, making money more useful and practical in everyday life. Essentially, the more divisible a currency is, the more convenient it is for individuals to use and transact with.

Accepted: When we discuss acceptability, we are referring to whether there is widespread acceptance of a particular form of money. This means that people are willing to accept and use this form of money as a means of exchange for goods and services. If a currency is widely accepted, it becomes easier for people to engage in trade, as there is a common currency to buy and sell goods and services. The more widely accepted a currency is, the more valuable it becomes, as more people are willing to use it. Conversely, if a currency is not widely accepted, it loses its value, as people will hesitate to accept it as a means of exchange.

Unit of Account

For money to be used as a common measure of the value of goods and services, it must be:

Fungible: When money is said to be fungible, every unit of currency is interchangeable with any other unit. In simpler terms, it means that money is uniform and identical, regardless of where it came from or who owns it. For example, if you owe someone $10 and you give them a $10 bill, it doesn't matter if the bill came from your wallet or someone else's wallet. As long as it's a genuine $10 bill, it's considered to be of equal value. The concept of fungibility is important because it allows money to function effectively as a common unit of measurement, making transactions simpler and more efficient.

Conclusion

Money is a crucial and fascinating part of our daily lives. It serves as an intermediary, allowing us to trade goods and services with one another. However, not all money is created equal. Some forms of money are superior as a store of value, like gold coinage, while others may be more effective as a medium of exchange, the US dollar. However, when these functions are met in their entirety, it enables us to transact confidently and with ease, which not only assists us as individuals but fosters greater economic growth and prosperity for our economy.

In the upcoming modules, we'll explore two popular forms of money: Bitcoin and stablecoins. By examining them through the content discussed in this section, we'll explore how they fulfil the various functions of currency and how they can greatly benefit society.

From bartering to the invention of coins and paper currency, money has undergone a series of transformations to adapt to the ever-changing needs of society. As we move on to the next chapter, let's alter course, directing our attention toward the evolution of money.