Understanding Money: Its Properties, Types and Uses (2023)

What Is Money?

Money is a value system that facilitates the exchange of goods in an economy. Using money allows buyers and sellers to pay compared to less transaction costsbarter.

The first types of money wereWere. Their physical properties made them popular as a medium of exchange. In today's markets, money can also include government-issued oneslegal tenderorfiat money, cash substitute, escrow media or electroniccryptocurrencies.

how money works

money is aliquid fundsused to facilitate value transactions. It serves asmedium of exchangebetween individuals and entities. It's also astore of valueand aunit of accountwho can measure the value of other goods.

Before money was invented, most economies relied on itbarter, where individuals directly exchanged the goods they had for those they needed. This posed the problem of double demand: a transaction could only take place if both participants had something the other needed. Money eliminates this problem by acting as an intermediate good.

The first known forms of money were agricultural commodities such as grain or cattle. These goods were in high demand and traders knew they could use or trade these goods again in the future. Cocoa beans, cowrie shells and agricultural tools also served as early forms of money.

As economies became more complex, money became standardizedcurrencies. This reduced transaction costs by making value easier to measure and compare. Representations of money have also become increasingly abstract, from precious metals and minted coins to paper notes and, in modern times, electronic records.

What are the properties of money?

To be most useful, money should be fungible, durable, portable, recognizable, and stable. These properties reduce thetransaction feethe use of money by making it easy to exchange.

Money should be fungible

The word fungible refers to a quality that allows an item to be exchanged, substituted, or returned for another item assuming equivalent value. Monetary units should therefore be interchangeable.

For example, metal coins should have a standard weight and purity. Commodity money should be of relatively uniform quality. Attempting to use an unfungible good as money introduces transaction costs, where each unit of the good is valued individually before an exchange can take place.

Money should last

Money should be durable enough to retain its usefulness for many future exchanges. A perishable commodity or a commodity that rapidly deteriorates due to various exchanges is less useful for future transactions. Attempting to use an impermanent good as money contradicts the essential future-oriented use and value of money.

Money should be portable

Money should be easy to carry and share so that a meaningful amount can be carried or transported on the body. For example, attempting to use a good that is difficult or inconvenient to carry as money might require physical transport, which results in transaction costs.

Money should be recognizable

The authenticity and quantity of the goods should be easily recognizable for the users so that they can easily agree to the terms of an exchange. Using an unrecognizable commodity as money may result in transaction costs associated with authenticating the commodity and agreeing on the amount required for an exchange.

The money supply should be stable

The supply of the item used as money should be relatively constant over time to avoid fluctuations in value. Using an unstable good as money incurs transaction costs due to the risk that its value might rise or fall due to scarcity or abundance before the next transaction.

How is money used?

Money primarily serves as what good people use to exchange valuables. However, it also has secondary functions arising from its use as a medium of exchange.

money as a unit of account

By using money as a medium of exchange for buying and selling and as an indicator of value for all kinds of goods and services, money can be used as a unit of account.

This means money can track changes in the value of items over time and across transactions. People can use it to compare the values ​​of different combinations or amounts of different goods and services.

Money as a unit of account makes it possible to balance profits and losses, to balance a budget and to evaluate the total assets of a company.

Money as a store of value

The usefulness of money as a medium of exchange in transactions is inherently future-oriented. As such, it provides a means of storing a monetary value for future use without that value deteriorating.

So when people exchange items for money, that money retains a certain value that can be used in other transactions. This ability to act as a store of value makes it easier to save for the future and conduct long-distance transactions.

Money as the default of deferred payment

To the extent that money is accepted as a medium of exchange and serves as a useful store of value, it can be used over varying periods of time to transfer value in the form of credit and debt.

A person can borrow an amount of money from someone else for an agreed period of time and repay another agreed amount of money at a later date.

What are the different types of money

market money

Money can arise from the spontaneous ordering of markets. When traders trade various commodities, some commodities prove more convenient than others because they have the best combination of the five properties of money listed above.

Over time, these commodities may become more desirable as items of exchange than for practical use. At some point, people may come to desire a commodity only for future trade.

Precious metals such as gold and silver have often been used as market currencies in the past. They have been held in high esteem in many different cultures and societies. Today, people in cashless economies often turn to cigarettes, instant noodles, or other durable goods as market-driven money substitutes.

Currency issued by the government

When a certain type of money becomes widely accepted in an economy, government agencies can begin to regulate it as a currency. You can issue standardized coins or bills to further reduce transaction costs.

A government may also recognize some money as moneylegal tender, which means that courts and government agencies must accept this form of money as a form of last resort.

By spending money, the government can benefitdomination, the difference between a currency's face value and its cost of manufacture.

For example, if the cost of printing a $100 bill is only $10, the government makes a profit of $90 for each bill printed. However, governments that rely too heavily on seigniorage may do so inadvertentlyhumiliatetheir currency.

fiat currency

Many countries issue fiat currency, which is currency that is not a type of commodity. Instead, fiat money is backed by the economic strength of the issuing government. It derives its value from supply and demand and the stability of government.

Fiat money enables the issuing government to conduct economic policyincrease or decreasethe amount of money. In the US it isfederal reserveand thefinancial departmentMonitoring different types of money supply for the purpose of regulating and mitigating monetary problems.

Since fiat money is not a physical commodity, it is the responsibility of the issuing government to ensure that it satisfies the five properties of money described above.

DieIMF(IMF) andWorld Bankserve as global watchdogs for the exchange of international currencies.Governments may enact or establish capital controlsherringto stabilize their currency in the international market.

Substitute money and escrow media

To alleviate the stress of carrying large amounts of money, merchants and traders sometimes exchange monetary substitutes, such as written promissory notes, that can be cashed later. These statements can themselves take on some of the properties of money, especially when traders use them in place of actual currency.

For example, old banks issued bills of exchange to their depositors stating the amount deposited and the terms of redemption. Instead of withdrawing money from the bank to make payments, depositors would simply swap their bills, allowing the recipient to cash or swap them at will.

This use of money substitutes can increase the portability and durability of money, as well as reduce storage costs. However, money replacement products are associated with risks. Banks can print more bills than they have money to cash, a practice known asPartial reserve banking. When too many people try to withdraw money at the same time, the bank can sufferbank run.

Escrow media are types of cash substitutes that are circulated and are not fully backed by the base money held to back cash substitutes.Contemporary examples of fiduciary media include paper checks, tokens, and electronic credit.

cryptocurrencies as money

In recent years, digital currencies that do not exist in physical form, such asBitcoin, got introduced. Unlike electronic bank records or payment systems, these virtual currencies are not issued by any government or other central body. Cryptocurrencies have some properties of money and are sometimes used in online transactions.

Although cryptocurrencies are rarely used in day-to-day transactions, they have gained some utility as a speculative investment or store of value. Some jurisdictions have recognized cryptocurrencies as a means of payment, including theGovernment of El Salvador.

The final result

Money is an object of value that enables people and institutions to participate in transactions that result in an exchange of goods or services.

Money must be interchangeable, convenient to carry, recognized by all as legitimate, physically durable, and stable in value.

Money comes in a variety of forms, including precious metals, currency, and money substitutes. Although cryptocurrencies have some properties of money, they currently function without a central authority and are not backed by governments. While cryptocurrencies (like bitcoin) are considered property by the IRS for tax purposes, they are not considered legal tender by the US government.