What is Money?

According to renowned American Nobel Prize economist Milton Friedman, money is “a commodity accepted by general consent as a medium of economic exchange. It is the medium in which prices and values are expressed; as currency, it circulates anonymously from person to person and country to country, thus facilitating trade, and it is the principal measure of wealth”. In practice, money serves three basic functions: Store of Value, Unit of Account, and Medium of Exchange.

1. A Medium of Exchange

In order for people to exchange valuable goods and services, there must be some agreed-upon the process by which these goods and services are exchanged on a fair basis. Money serves as this agreed-upon method, or medium, of exchange and allows individuals and institutions to quantify value in a uniform way. Over the course of history, money has taken various forms, including the mere trade of crops for other commodities like meat. This example, known as bartering, will be explained further in this article. 

2. Store of Value

The second function of money is the ability to store value over time. This concept of storing value over time is essential because, over the course of history, mankind has handled all kinds of goods and services that decline in value over time. For example, a carpenter’s wooden products may not be worth the same to a customer if they have been sitting in storage for some time and have lost their novelty. Money, on the other hand, is assigned and keeps its value over time For example, if one were to forget about a $100 bill in his or her desk drawer, that $100 bill would still be worth $100 five years later. Ignoring external circumstances like the rise of prices due to inflation, that $100 bill still retains the value it was assigned when it was made. 

3. Unit of Account

The third function of money is to provide units of account or simply put, the ability to numerically measure the value of goods and services. While the unit of account may change for any given good or service over time, its changing nature applies to all goods and services, thus allowing for an equitable playing field among buyers and sellers.

Given these three key defining qualities, one is able to assess different forms of money throughout history and possibly predict the efficacy of future forms of money. The following sections delineate the major transformation of money over our known history and discuss their relative benefits and drawbacks. 

History of Money

1. Barter 

Before the current monetary system was created, people had to find a way to exchange goods and services. It is believed that the barter system is the oldest form of exchange in human history. Bartering is a method of exchange that people used to swap goods and services with one another. For example, let's say one person grew corn and his neighbor made clothes, and they wished to exchange with one another. These two people would need to agree on how many ears of corn are equivalent to one shirt, in value. If one or both of them agree on a price, the negotiation fails. If they both accept the terms of the trade, then both parties receive their desired items in exchange for their offering. 

While bartering was sufficient during a time when people needed to exchange goods with their local community, it does not function well according to the modern definition of money, as it does not store value. Corn, for example, is a commodity that expires in a short period of time. As such, the arbitrary bartering of goods is not an ideal method of value transfer. 

2. Physical Objects

Seashells

Later on, people opted for a uniform object that could represent tangible value, namely seashells. There was a more convenient choice than bartering alone given that they had a roughly uniform physical shape that was small, transportable, and fairly durable.  As such, it served as one of the first forms of money that could be considered a medium of exchange. In a hypothetical bartering exchange, there could be an issue in which person A wants an apple and is able to offer 2 oranges for it, but person B doesn’t want any oranges for the apples he can offer. The issue here lies in the fact that these two people do not share a common assessment of value. However, with seashells, people can evaluate 1 apple at the price of 2 seashells or 1 orange at the price of 1 seashell. Via this form of currency, the value of goods and services are standardized across a community, thus making a medium of exchange possible and facilitating trade immensely. 

Another interesting note is that in the past, seashells were used as spirit bundles, jewelry, and amulets in America. In Africa, they used cowries as charms for protection as talismans to resist enslavement. These are all additional reasons that people considered seashells valuable objects. However, since seashells have a virtually unlimited supply, they fail to preserve their value over time. 

Metals and Coins

At the end of the stone age, about 3000 years ago, there was a revolution of using precious metals instead of seashells as a form of currency. Various metals were considered to be far more valuable than seashells not only for their utility in making jewelry, swords, armor, and farming utensils but also because the cultivation of metal itself was a difficult process. As a result, they were limited in their supply and offered much more utility than seashells. Additionally, metal instruments, whether designed for the purpose of fashion or utilitarian needs, were incredibly durable, lasting for tens to hundreds of years.

Their only drawback compared to seashells was their size and weight. Larger trades became difficult when exchanges required high volumes of heavy metal equipment. To combat this logistical issue, metal coins were invented to be used as a more mobile form of money. Coins, regulated and backed by governments, were uniform and accepted by everyone over the course of many centuries. In this way, metal coins solved the issue of a unit of account, which was limited previously due to the sheer size and weight of previously used metal tools.

3. Paper money

Metal-backed paper

The first recorded use of paper money was 1000 years ago in China, and these bills were backed by precious metals like gold and silver. As mentioned above, paper money itself did not hold any intrinsic value relative to metal coins, but it was assigned a value equivalent to the metal by which it was backed. In fact, paper money was much less durable than metal coins; but, it was easier to produce and hold in large quantities, thus making it more efficient for larger populations. However, as is mentioned below, governments did not originally limit the supply of paper money, thus leading to the instability of its value. 

Fiat Paper

In China, the Mongol Yuan Dynasty (1215-1294) created its own form of paper currency that was only backed by the government and was used as the main form of currency at that time.   Fiat's value was no longer backed by any commodities; instead, it was determined by the government; as such, this form of fiat held no intrinsic value of its own. 

As mentioned earlier, metal-backed paper money was created at a time when the government minted coins backed by valuable physical commodities such as gold and silver, allowing them to be exchanged for these precious metals. Fiat money, however, was not convertible to these types of commodities since they were not directly linked to them. Hence, some nations that adopted this form of currency suffered from hyperinflation due to the overuse of an unlimited money supply. One of the worst cases of hyperinflation was the Mongol Dynasty in China. They increased the supply of currency to support high volumes of trading or to fund a larger economy overall; however, they increased the money supply far too quickly, which led to runaway inflation. The problem of hyperinflation stayed unresolved when the Mongol Dynasty collapsed. After the incident, China’s subsequent Ming Dynasty (1368-1644) attempted to implement the same form of fiat but quickly ceased its use after seeing the same risks and issues arise that were evident within the Mongol Dynasty. Instead, the Ming Dynasty elected to utilize metal-backed money, once again. 

As global trade expanded, the idea of fiat money slowly caught on. Traders and lenders, however, worried that the ability to merely print paper money to represent an exchange of value would too easily be abused, causing hyperinflation. Thus, they determined to link their fiat money to the value of gold, which created a standard for exchange between different currencies. This idea was later called the Gold Standard.

4. Gold Standard

The overuse of fiat supply caused many countries’ economies to break down, making their native currencies nearly valueless. The United Kingdom then came up with the Gold Standard in 1821 as a solution to this problem. The Gold Standard was a monetary system where every unit of fiat was linked to gold and could be converted into a fixed amount of gold. As such, governments were inclined to print money less frequently to preserve the value of gold, resulting in a boost of confidence in global trade. Over the course of time, many countries including Germany, France, and the United States popularized the Gold Standard. It was only during the Great Depression that the Gold Standard stopped being tied to fiat currency.

During the Great Depression, people chose to safeguard gold while the value of fiat decreased rather than depositing that gold in the bank. This resulted in an international shortage of gold, which in turn resulted in economic turmoil. Centrally governed financial entities like the American Federal Reserve could not take any action to further sustain the Gold Standard. If the Fed were to print more money, the value of the dollar would depreciate, and if they lowered interest rates, investors of gold would simply opt to sell their gold overseas for a greater return, leading to an even greater dearth of gold. As a result, gold became a precious asset that only specific entities could hold. This was the end of the Gold Standard era. 

Special Note: After World War I, compared to other big countries throughout the world, the U.S. had one of the only economies to emerging profitable from the period of conflict. The sheer economic power of the US after WWI led its currency to be the most reliable form of money in the world, thus becoming the new standard. 

5. Credit Cards

Credit cards were a massive step in the evolution of money. Western Union, one of the original financial services companies in the United States, created the first credit card in 1914, dubbed "Metal Money." For the first time ever, a typical customer could conveniently defer payment on something that they purchased. The creation of other credit card systems such as the Diners Club Card, American Express, and VISA led to the actual growth of credit cards by the 1950s. In 1966, Bank of America issued the first credit card that served general purposes. 

Since then credit cards have remained a mainstay in the global economic order since they provide high security, portability, and the ability to pay for goods and services almost instantly. With credit cards, people can borrow money up to a prespecified amount from commercial banks or hard money lenders to buy goods and services, as long as they pay off that debt. In the past, every time a person wanted to withdraw or borrow any amount of money, they had to physically visit their local bank to get authorized for a loan. However, credit cards only require the person to verify their credentials when the credit card is first issued. Credit cards also include a chip that encrypts user information, which enhances security. 

People now can use credit cards for online purchases, and it is one of the most popular ways to pay for goods and services due to its level of convenience. 

6. Electronic money

 

“Electronic money refers to money that exists in banking computer systems that may be used to facilitate electronic transactions. Although its value is backed by fiat currency and may, therefore, be exchanged into a physical, tangible form, electronic money is primarily used for electronic transactions due to the sheer convenience of this methodology.” (Electronic Money, 2020). In short, electronic money (or e-money) is a digital representation of physical cash that a person or entity owns. E-money can also be stored in cards, devices, or servers, making it easily accessible from anywhere. A great example of this is banking apps, which provide users with an additional method of payment. 

The existence of e-money also served to expand e-commerce in recent decades. Given that e-money is digital, people do not have to conduct purchases in person. As economic activities grew increasingly global, e-money served to facilitate those purchases around the world. 

7. Cryptocurrencies

 

Cryptocurrencies comprise a digital asset and payment ecosystem that does not depend on banks or is under the control of any government to verify transactions. The system enables anyone anywhere to send or receive payments. Unlike previous forms of electronic or digital money, whether that be through banking applications or third-party payment facilitators, cryptocurrencies are fully owned and controlled by their owners. This means that as a medium of exchange, it is 100% available to use, unlike money kept in commercial banks, which can sometimes be frozen or restricted by government actors. While there are some instances by which access to cryptocurrencies can be restricted, these occurrences are a direct result of centralized entities, such as a centralized exchange, forcing their institutional power over the user. Fully decentralized cryptocurrencies, like Bitcoin, are far more resistant to this level of arbitrary commandeering.

Cryptocurrencies are also encrypted, meaning they provide better privacy and safety for peer-to-peer transactions. This further emphasizes the level of control and agency cryptocurrency owners have over their own money. And finally, cryptocurrency allows users to transfer money globally from peer to peer almost instantly without the need for any middlemen such as banks, or payment processors. 

Take Bitcoin - a cryptocurrency that was created in 2009 - as an example.  Unlike fiat, crypto does not get affected by interest rates or increases in money printing. In fact, there are exactly 21 million Bitcoins in supply, which makes it an amazing store of value that is resistant to inflation. Due to its ease of use and decentralized network, Bitcoin is already accepted as a legal tender in some countries. 

However, Bitcoin still has some major problems that most countries are unable to ignore, thus making it a less-than-ideal choice for everyday currency. Some countries are cautious of its volatility and decentralized nature. Some are afraid that cryptocurrencies will affect their current monetary systems, and also afraid of their use to support illegal activities like drug trafficking, money laundering, or even terrorism.

Conclusion

According to Deutsche Bank's "Imagine 2030" report, as demand for confidentiality and a more decentralized form of payment increases, cryptocurrency could be a legal form of exchange internationally. Cryptocurrencies cannot be centrally controlled by the government, provide a safe and anonymous means of digital value transfer, and utilize innovations in blockchain technology, which have many use cases in various industries.  Many experts believe that Bitcoin - the most popular cryptocurrency,  will reach a price of $100,000 and also believe that it will become the main exchange currency around the world. 

However, since it is decentralized, many people are taking advantage of it to support illegal activity. In addition, some critics are against Bitcoin for its volatility and value. For instance, Jamie Dimon, CEO of JPMorgan, said that “crypto is nothing but a ‘decentralized Ponzi scheme’” and it has no “real value”. This is not entirely true, although Bitcoin did generate high returns in the past, especially in the bullish market; there was a high probability that the market could crash at any given time. This is still a relatively new and unregulated asset class and there is a lot of uncertainty about what will happen next. Hence, Bitcoin or any other cryptos are strictly speculative assets since they are not backed by any stable currency. This means that their prices are volatile and could feasibly drop to zero at any given time, especially if a cryptocurrency’s native blockchain fails to function or loses the trust of its users. Therefore, there is not any certainty that it will be more valuable than it is right now in 100 years. In this way cryptocurrencies behave similarly to equities, so many people tend to see them as investments rather than currency.

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