Money is everywhere. Some love it, some hate it, but none can deny its importance. In this post, we will see the main functions and properties of modern money, which is also called Fiat Money ( dollars, euros, etc ) what it is used for and what do we get from using it.
Money has three main functions: means of exchange, unit of account and store of value. No currency is perfect for all these roles. There are compromises in some areas and money is evolving along with our society.
Now let’s explore these three main functions
Money today is a type of IOU ( I Owe You ), but one that is special because everyone in the economy trusts that it will be accepted by other people as a medium of exchange to facilitate transactions for goods and services.
Without money, all transactions would have to be conducted by barter. The difficulty with this system is that in order to have a particular good or service from a supplier, one has to possess a good or service of equal value, which the supplier also desires and this is called double coincidence of wants, which is very difficult to happen. But, because everyone trusts money, they are happy to accept it in exchange for goods and services and it has become a universally accepted medium of exchange
There are five properties that make a system a good medium of exchange. These are durability, which means money can be passed around without the danger of wear and damage, transportability, it’s whether money can be easily put in my pocket and transferred anywhere.
Next is divisibility, if they can be divided into smaller “pieces”, fungibility or interchangeability with goods, services, or other currencies and last non-counterfeit ability. It has to be extremely difficult if not impossible to make fake money.
The modern money that we use is durable and divisible. They are transportable unless they aren’t ( capital controls - we Greeks know a thing or two about them). They are fungible, that means you can exchange euros for both dollars and books. And maybe the biggest problem of money is counterfeit notes, which no one really knows how many are in circulation.
A store of value is a mechanism by which wealth can be saved and retrieved in the future with some predictability about its future value. If money could not be store value over time, it would not solve the double coincidence of wants problem and therefore would not be adopted as a medium of exchange.
Money is not the only store of value that we have. There are many other stores of value or assets as we call them like precious metals, jewelry, bonds, stocks, land, works of art, and even baseball cards and stamps. As all asset prices have greater or lesser degrees of unpredictability and volatility there is no perfect store of value.
One could say that money is not a great store of value, since it depreciates with inflation. However, money is more liquid than most other stores of value because as a medium of exchange, it is readily accepted everywhere. Furthermore, money is an easily transported store of value that is available in a number of convenient denominations.
The last main function of money is as a unit of account, a standard measurement of the value of goods, services, economic activities, assets and liabilities. It’s the thing that everything is priced after, so it provides a common measure of the value of what is being exchanged.
The stability of the value of the unit of account makes it more useful as a unit of account. In inflationary currencies like the ones that we use, over long periods of time, results are not comparable, leading to the need to use nominal (actual) vs. real (inflation-adjusted) values in order to make measurements comparable again.
These three functions are all closely linked to each other and yet there is no one form of currency or asset that is perfect for all these three roles. For example, there are many good stores of value that are not good means of exchange. Houses tend to remain valuable over quite long periods of time, but cannot be easily passed around as payment.
There are cases that an asset is less useful as the medium of exchange if it will not be worth as much tomorrow or in other words, if it is not a good store of value. In some countries where the traditional currency has become a poor store of value due to hyperinflation, foreign currencies are used as an alternative medium of exchange or even a store of value.
And now let’s see how Bitcoin is related to these three properties of money. I will use just Bitcoin because this is what everybody knows.
Bitcoin and Digital Currencies
The idea of a digital currency started at the end of the previous century without real success, until Bitcoin was created in 2009. This new kind of money based on blockchain technology promises to change the way we see and interact with money.
Bitcoin is private and decentralized which means it is not issued by any official state authority or centralized issuing party/counter-party but from a group of users. It is digital and fully electronic currency, so there are no physical coins or notes and there are no fake coins because anti-counterfeiting is conducted through cryptography.
It has a fixed Supply which is regulated by the protocol itself and only 21,000,000 bitcoins (BTCs) will ever exist. The monetary policy is transparent and available to everyone to examine and verify, as the protocol is based on open source code and consensus. Key characteristics (like money supply) can’t change unless a majority of participants in key parts of the system vote to change them. These are the basic features of Bitcoin.
Bitcoin as a Medium of Exchange
Bitcoin was created as a digital medium of exchange. It is highly durable and there is no way for it to degrade/break (it is just code) and the blockchain is backed up on thousands of computers globally. It is highly portable, since there are no intermediaries worldwide, the initial confirmation takes about 10 minutes and irreversibility in an hour or so.
It is also fungible: all bitcoins have the same value, regardless of who owns them or what their history is and can be exchanged for products/services. Each bitcoin can be divided into 100 million units ( satoshis ) and that makes it highly divisible and as we mentioned it is resistant to counterfeiting. Bitcoin funds are assigned to a specific address and cannot be duplicated, as it takes a huge amount of computing power to double spend Bitcoin.
Bitcoin as a Unit of Account
For the time being Bitcoin cannot be a unit of account because of significant fluctuations in its price. But the price could be more stable over time if the regulatory environment will become clear and markets between Bitcoin and fiat currency will become more liquid and perhaps more stable.
Bitcoin as a Store of Value
Bitcoin is starting to be considered as a good store of value since it has proven that over time it performs better than other assets. Traditional money institutions are buying Bitcoin and have it in their portfolios. Obviously, Bitcoin is a very young and rather immature asset class and it has to be dealt with caution but on the other hand, people that trust it may have an advantage over late adopters. Whether you should have or not it’s not up to me to tell, one should make his due diligence and consult with a professional financial advisor. What I write here is for educational purposes only.
And until we have all the digital or fiat or whatever money we want…
Be Healthy and Smile !!!
References and Additional Material
[1] Introduction to Digital Currencies MOOC 9 from University of Nicosia.
[2]https://poseidon01.ssrn.com/delivery.php?ID=602105112074019109098093072067082100009027025060007078094069113010096011074019099022118037004106027044014126064099095076069020038018032065037098084111086028087091064042045082105023067093077091023080064075098066090111089065009026123011006070015121082&EXT=pdf
[3] https://www.cliffsnotes.com/study-guides/economics/money-and-banking/functions-of-money
[4] https://www.tutor2u.net/economics/reference/characteristics-and-functions-of-money
[5] https://staffwww.fullcoll.edu/fchan/macro/4functions_of_money.htm
[6] https://www.youtube.com/playlist?list=PL68lGg7SjGZDxL4vZmFrlb8T_Iz79HXeL
This is a revised edition of a Steemit blog post of mine.
All graphical elements were created at my canva.com pro account.