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What Is Money?

What Is Money?

Money is a tool that enables humans to perform 3 basic functions: store value, exchange value, and account for value. In order for money to perform its 3 basic functions, it needs to possess 6 key characteristics: scarcity, durability, acceptability, portability, divisibility, and fungibility.

It is natural for people to want to trade things. When two or more people want to trade, they need to have exactly what the other person wants at the same time, in the same place, and in the same amount. If neither party has what the other wants, they are unable to trade with each other. Money is the solution to this problem because it provides a way to store value through time (store of value), move value through space (medium of exchange), and account for value at any scale (unit of account).

The 3 Functions Of Money

Money has 3 basic functions. Anything that society uses as a store of value, a medium of exchange and a unit of account is, by matter of fact, money.

Unfortunately, too many people think that money is just paper issued by governments with faces of historical figures on it but that’s because they don’t understand that real money is actually made by markets, not by governments. In fact, government monopolies over the supply of money is actually a relatively new construct within the past few hundred years.

Let’s look more closely at each of these 3 functions of money.

Store Of Value

Money’s first and foremost function is as a store of value. Storing value is one of the most basic human needs to establish an industrialized society. If humans cannot store value, then we will never grow or adapt beyond what we can gather with our hands.

Whenever two or more people agree that something can be used as a store of value, they are then willing to use that something as a medium of exchange amongst themselves.

Bitcoin’s primary use case is as a store of value so all of us who believe in bitcoin is valuable are doing whatever we can to store more bitcoin for later.

Medium Of Exchange

Once you have accepted something as a trusted store of value, you can begin to find others who also trust that same thing as a store of value. When you find each other, you can begin to use that something as a medium of exchange.

Bitcoin is already used as a medium of exchange amongst those who trust that it has value. It is more difficult to use bitcoin as a medium of exchange than it is to store value since not every bitcoin hodler has something worth buying. I trust bitcoin as a store of value but I don’t have much to sell so it is difficult for others to use bitcoin as a medium of exchange with me.

As soon as enough people use something as a store of value and a medium of exchange, the market price will begin to stabilize and they can begin to use it as a unit of account.

Unit Of Account

A unit of account is how we measure goods and services against each other and against money itself. If you want to buy goods at the store, you use money to account for those goods. 1 Apple might cost $2 today but might go on sale to $1 next week so we account for the apple differently based on market conditions.

Bitcoin is not yet widely used as a unit of account by itself since it is currently incredibly volatile but it can still be used to account for things in relation to different fiat currencies around the world. If you want to buy an apple for 1 EUR, 1 USD, 1 AUD or 1 GBP, you can account for any of these purchases with bitcoin but the amount of bitcoin will be different against each fiat currency.

The 6 Characteristics of Good Money

Money performs the three basic functions listed above but in order to do that, it needs to possess six key characteristics. The stronger each of these characteristics in a given monetary unit, the better the money.

Scarcity – Money needs to be limited in supply otherwise there is no need to work for it.
Durability – Money needs to be durable so it can’t be easily damaged or destroyed.
Acceptability – Money needs to be widely accepted in order to be used for exchange both near and far.
Transportability – Money needs to be easy to transport to enable exchange.
Divisibility – Money needs to be easily divisible into smaller units for purchases big and small.
Fungibility or Uniformity – Each unit of money needs to be the same as all of the others.

Let’s look at how Bitcoin possesses each one of these characteristics.

Scarcity

Scarcity is probably one of the most important elements of good money. If something isn’t scarce then people won’t want to use it to store value. Scarcity is what gives something value. If someone tries to pay you with something you can easily get yourself, that something doesn’t have any value to you.

In different societies in the past, scarce objects such as eagle feathers, whales teeth, large rocks and even cowry shells have all been used as money primarily due to their scarcity.

If someone wanted to pay you with something that was abundant, like napkins, you would probably laugh at the idea that they wanted to pay with pieces of paper. If they made those pieces of paper difficult to counterfeit with all sorts of special features that made them rare, you might be more inclined to accept them for payment.

Bitcoin is the world’s first digitally scarce commodity and the first time in human history that bits of information have not been able to be duplicated or counterfeit. This has huge implications for the information age and the use of information as money.

Divisibility

Divisibility is an important part of good money. Most, if not all, government-issued currencies are all divisible into 100 smaller units. The US dollar is divisible into 100 cents with the word cent coming from the Latin word centum which means “hundred”. This is also where words like century and centigrade come from.

If money is not divisible it becomes difficult to use it for trade since you will need to trade in larger amounts of something. Imagine using a $100 bill to pay for a $25 t-shirt but you couldn’t receive change. You would need to buy 4 shirts or find a way to divide your $100 bill into something smaller. Money needs to be divisible in order for people to be able to use it as an effective medium of exchange and a unit of account.

Transportability

Transportability is also another important aspect of good money. If you cannot easily transport your money, then it will be difficult to use for trade since you will have difficulty moving the money itself.

Gold was once the most widely used form of money on the planet because it was easy to transport in small amounts but it became too costly to move large amounts of it. To make gold more transportable, humans invented paper bills/notes called representative money. These notes were just paper that were used to represent gold in a vault at a bank or other repository. We now mostly use electronic payments to transport money but there is a lot more friction to transport money on these payment networks since the fees can be high and payments are subject to being seized.

Bitcoin is the most transportable form of money since it can be sent anywhere in the world, without being stopped for a fraction of what other payment networks cost.

Sending bitcoin is also what’s called a push payment, not a pull payment like all of the legacy money transmitting networks.

Durability

Good money needs to be durable. If something is easy to destroy, then it makes for bad money. Paper money is one of the worst forms of money for this very reason. Paper is easily destroyed by water, fire or simply by being torn up.

Gold, on the other hand, is incredibly durable compared to paper money since it is a mineral that can’t burn up, dissolve in water and even if it is cut into smaller pieces, each piece still holds value.

Bitcoin is not a physical object. Each and every piece of bitcoin lives on a distributed ledger all around the world so it is possibly the most durable form of money in the information age. If your wallet is destroyed, you can recover your bitcoins using your seed phrase.

Durability is part of what makes money a store of value. If your money is easy to destroy, it will not be a good place to store value.

Fungibility

Good money needs to be fungible. This means that each unit of money needs to be the same (or almost the same) as the next. Each dollar looks almost exactly the same as all of the others. Each Euro looks almost exactly the same as the next and so on with each fiat currency around the world.

From a purely scientific standpoint, each bitcoin is exactly the same as the next so it meets the need for a fungible unit. There’s some pretty substantial debate as to how fungible bitcoins are in relation to their history on the blockchain. Some governments have said that certain bitcoins are not the same as others so, from a legal perspective, bitcoin lacks certain fungibility.

The bitcoin space is working hard to increase the level of privacy of bitcoin by making it more difficult to analyze the blockchain. There are a number of tools and projects like MimbleWimble and The Lightning Network that are working hard to increase the fungibility of Bitcoin.

Acceptability

Good money needs to be acceptable far and wide. Since most forms of money today are issued by governments, it makes sense that those monies are accepted in the country that the money is issued. In order for you to conduct trade in foreign countries, you will need the local currency that is widely accepted.

In Australia, you will need Australian dollars. In Japan, you will need the Japanese Yen. In the Euro Zone, you will need the Euro. What’s more interesting is that bitcoin is accepted by some individuals and businesses in all of these countries.

Bitcoin is not very acceptable by itself yet but one of the primary reason for this blog is for us to help more people around the world to better understand what bitcoin is and how it works so that they will hopefully accept bitcoin as payment for goods and services.

Is Bitcoin Money?

In its current state, Bitcoin is primarily used as a store of value and for some who are further down the rabbit hole, it is also accepted as a medium of exchange but bitcoin has not yet become stable enough to be used as a reliable unit of account all by itself yet.

Some believe that since bitcoin is money without borders, it doesn’t need to function as a unit of account because it can be accounted for in the local government currency where the trade takes place.

For example, if you buy bitcoin in the US and go on a trip to Argentina, you can still spend bitcoin but you will need to denominate your bitcoin in Argentine Pesos. In this sense, bitcoin is accounted for in the local currency and doesn’t need to be a unit of account all by itself.