Understanding Money: Its Properties, Types, and Uses

What Is Money?

Money facilitates the exchange of goods in an economy, reducing transaction costs compared to barter trading.

The first types of money were commodities with physical properties that made them desirable as a medium of exchange. Contemporary money includes government-issued legal tender, fiat money, money substitutes, fiduciary media, and electronic cryptocurrencies.

Key Takeaways

• Money is a system that facilitates the exchange of goods.
• Using money eliminates the problem of bartering.
• The first forms of money were agricultural commodities.
• Most money systems today are based on standardized currencies controlled by central banks.
• Digital cryptocurrencies also have properties of money.

How Money Works

Money is a liquid asset that facilitates transactions of value. It is used as a medium of exchange, a store of value, and a unit of account.

Before money, economies relied on bartering, which raised the problem of the double coincidence of wants. Money acts as an intermediary good, solving this problem.

The first known forms of money were agricultural commodities. As economies became more complex, money was standardized into currencies, making it easier to measure and compare value. Representations of money evolved from precious metals and stamped coins to paper notes and electronic records.

During World War II, cigarettes became a de facto currency for soldiers in prisoner-of-war camps.

What Are the Properties of Money?

Money should be fungible, durable, portable, recognizable, and have a stable supply to reduce transaction costs.

Money Should Be Fungible

Units of money should be interchangeable with one another.

Money Should Be Durable

Money should retain its usefulness for many future exchanges.

Money Should Be Portable

Money should be easy to carry and divide.

Money Should Be Recognizable

Users should easily recognize the authenticity and quantity of money.

Money’s Supply Should Be Stable

The supply of money should be relatively constant to prevent fluctuations in value.

How Is Money Used?

Money is primarily used for exchanges of items of value and has secondary functions as a unit of account and a store of value.

Money As a Unit of Account

Money can track changes in the value of items over time, allowing comparisons of different goods and services.

Money As a Store of Value

Money retains its value for future exchanges and facilitates saving and long-distance transactions.

Money As a Standard of Deferred Payment

Money can transfer value over different time periods in the form of credits and debts.

Different Types of Money

Market-Determined Money

Money can originate from the spontaneous order of markets, with goods becoming desirable for future trading.

Government-Issued Currency

Currency issued and regulated by governments reduces transaction costs and can serve as legal tender.

Issuing money allows governments to benefit from seigniorage, but relying too heavily on this can debase the currency.

Fiat Currency

Fiat currency derives its value from supply and demand and is backed by the economic strength and stability of the issuing government.

Money Substitutes and Fiduciary Media

Money substitutes, such as written statements of debt, can increase portability and durability but carry risks.

Fiduciary media are backed by base money and include paper checks, token coins, and electronic credit.

Cryptocurrencies As Money

Cryptocurrencies have properties of money and can be used as a medium of exchange and a store of value.

Though cryptocurrencies lack a central authority and government backing, they have utility as a speculative investment or online transaction medium.

What Are the 4 Types of Money?

Market-determined money, government-issued currency, fiat currency, and money substitutes are the four types of money.

What Is the Difference Between Hard and Soft Money?

Hard money is based on valuable commodities, while soft money, such as printed banknotes, carries the risk of inflation from excessive printing.

Is Cryptocurrency Money?

Cryptocurrency has many properties of money and is used for transactions but lacks widespread legal recognition as a foreign currency.

The Bottom Line

Money is an item of value that facilitates exchanges of goods or services. It should be exchangeable, convenient to carry, recognized, durable, and stable in value.

Money comes in various forms, including precious metals, currencies, and money substitutes. Cryptocurrencies have some properties of money but lack government backing and legal tender status in many jurisdictions.