What is Money?

What is Money?
What is money, exactly?

Money is a constantly evolving technology that arises organically from the free market, establishing itself as the most saleable good and resolving the issue of the double coincidence of wants. Fundamentally, money serves as a medium of exchange, acting as a universally accepted basis for individuals conducting transactions. Its pivotal role lies in providing a standardized unit that facilitates efficient trade by overcoming the inherent limitations associated with a barter system. 

In a barter system, where goods and services are traded directly with each other, problems naturally arise when transacting with others. For example, imagine a scenario where one individual has apples and is seeking oranges in exchange. Another individual, however, possesses oranges but is not interested in apples. This example highlights the issue of the double coincidence of wants. 

The initial individual may find it challenging to locate someone who both desires apples and possesses the oranges that they desire. This mismatch in preferences and availability underscores the inefficiencies inherent in barter systems, highlighting the need for a universally accepted medium of exchange (i.e. money) to streamline transactions and facilitate smoother economic interactions.

Throughout history, the double coincidence of wants has led to the emergence of various commodities, each serving the role of money in society. Over different historical periods and in diverse regions of the world, a range of goods have served as mediums of exchange. This has included items such as beads, shells, salt, stones, precious metals, and more recently government-issued fiat and Bitcoin. What all of these have in common is that they, to varying degrees, fulfill the three primary functions of money.

The Functions of Money

Medium of Exchange

A medium of exchange is a function of money that facilitates transactions by serving as an intermediary in the exchange of goods and services. Meaning, it is widely accepted in transactions, allowing people to buy and sell using a common unit rather than engaging in barter.

Store of Value

The store of value function refers to the ability of money to retain its purchasing power over time. Money serves as a repository of wealth, allowing us to save value for future use, making this characteristic essential for maintaining the economic well-being of individuals and firms over the long-term.

Unit of Account

A unit of account is a function of money that provides a standardized measure for expressing the values of goods, services, and assets in an economy. Money serves as a common unit in which prices are expressed, allowing for efficient comparison and evaluation of different products and economic activities.

The Properties of Money 

Beyond the three core functions of money, there are six more key properties that have been defining characteristics of monies useability and longevity, and thus their overall adoption.

Durable

The durability of money signifies its ability to withstand wear and tear over time, ensuring that the physical or digital form of currency remains intact and usable for an extended period.

Divisible

Money's divisibility ensures it can be broken down into smaller units, facilitating transactions of varying sizes and contributing to its versatility.

Scarce

Money maintains value through its scarcity, meaning it is desirable for money to have a limited supply, or slow growing supply, that is not subject to constant inflation. Scarcity enhances monies desirability and ability to serve as a medium of exchange over the long term.

Fungible

Money is fungible when each unit is interchangeable with any other unit because they possess the same value, promoting uniformity and seamless transactions within the economy.

Portable

Money must be easily transportable, allowing for convenient transactions and widespread use in various economic activities.

Verifiable

The authenticity and value of money should be readily verifiable, enabling users to confirm its legitimacy and trustworthiness when making transactions and conducting economic activity.

Other Key Attributes of Money

Saleability

Money is often characterized as being the most saleable good in a market. Saleability refers to the ease at which something can be exchanged for the things you want with the least loss in its purchasing power. This quality underscores the need for money to be an efficient and fluid monetary medium to best facilitate transactions in an economic system.

Stock-to-flow

The stock-to-flow ratio, expressed as a quantitative measure, compares the existing supply of a commodity (the stock) to the annual production rate (the flow). Historically, gold has exhibited a substantial stock-to-flow ratio contributing significantly to its historical role as money. The stock-to-flow ratio provides insight into the soundness and scarcity of a monetary asset, influencing its long-term value. A higher stock-to-flow ratio is considered more desirable than a low one since this signifies the flow of new units is much smaller than the existing stock.

Is Bitcoin Money?

Yes, Bitcoin unequivocally qualifies as money, excelling across all three functions and boasting monetary properties that position it as a formidable form of currency. Money typically evolves through stages, often starting as a collectible or store of value. Once a critical mass of individuals begin preserving their wealth in it, the natural progression is for the good to transition into a medium of exchange. Only after achieving the dual status of store of value and medium of exchange can it become a widely recognized unit of account for measuring economic value.

Bitcoin is a Store of Value

Bitcoin’s supply cap of 21 million coins ensures scarcity which is a fundamental driver of value in economics. Unlike fiat currencies, users of Bitcoin don't need to worry about currency debasement or inflation eroding their purchasing power over time. With a supply cap of 21 million coins, forever, Bitcoin establishes itself as one of the best stores of value available today.

Bitcoin is a Medium of Exchange

Bitcoin’s core design is to function as a peer-to-peer currency enabling global transactions at a speed and scale we have never before witnessed. While its acceptance as payment for goods and services is not universal, it is quickly becoming one of the most saleable currencies on a global scale, gaining recognition as a spendable asset in many urban centers.

Bitcoin is a Unit of Account

Bitcoin is gradually being employed to measure economic value in certain cases. As Bitcoin adoption continues to grow, more merchants accept it as payment, and an increasing number of individuals and firms store their value in it, its role as a unit of account will expand.Beyond these functions, Bitcoin exhibits essential monetary characteristics:

  • Portability: Bitcoin’s digital nature makes it highly portable. It is accessible on any smartphone and can be brought anywhere with you by memorizing a set of 12 words.
  • Divisibility: Bitcoin is divisible into 100 million subunits called 'satoshis,' accommodating transactions of any size.
  • Durability: Thanks to its digital nature, Bitcoin remains durable over time, impervious to decay.
  • Verifiability: The Bitcoin network utilizes advanced cryptography, ensuring the legitimacy of all transactions and providing users with confidence in the authenticity of their Bitcoin holdings, making Bitcoin easily and readily verifiable.
  • Fungibility: Each Bitcoin is identical and holds equal value, making it fungible and interchangeable with any other Bitcoin.
  • Scarcity: Bitcoin’s supply is capped at 21 million coins, adding a critical dimension to its monetary properties and contributing to its status as a unique and valuable form of money.

Bitcoin is Saleable

In addition to excelling across all functions and properties of desirable money, Bitcoin is rapidly emerging as one of the most saleable currencies on a global scale. Picture this scenario: You find yourself in a random urban center anywhere in the world—what would be the optimal currency to have? The answer, irrespective of your origin, is often US dollars or to a lesser extent gold. Unlike many local currencies such as the Egyptian pound or the Canadian dollar, which have limited utility beyond their respective borders, US dollars, while not flawless, enjoy relatively widespread acceptance internationally.

Drawing a parallel, Bitcoin's digital and borderless nature positions it in a similar advantageous position. Regardless of your location or origin, Bitcoin is increasingly gaining acceptance across diverse geographical regions. Much like the ubiquity of US dollars, Bitcoin's global adoption makes it relatively saleable on an international scale, elevating its status as a more universally recognized and usable form of money compared to many fiat currencies. While not yet as saleable as the world's most recognized forms of money, the innate versatility of Bitcoin transcends traditional limitations, solidifying its role as a truly global currency.

Bitcoin Has a High Stock-to-Flow Ratio

In the context of Bitcoin, its stock-to-flow ratio is remarkably high, signifying a scarcity that is unmatched in traditional finance. Bitcoin's high stock-to-flow ratio is primarily a result of its capped supply of 21 million coins. Unlike traditional fiat currencies subject to unpredictable inflationary pressures, Bitcoin's issuance is algorithmically controlled through a process known as mining and the predetermined halving events, which occur approximately every four years and reduce the rate at which new bitcoins are introduced into circulation. Currently, Bitcoin’s stock-to-flow ratio is roughly equal to that of gold, however, following the Bitcoin halving in April 2024, its stock-to-flow ratio will surpass that of gold, making it the monetary asset with the highest stock-to-flow — highlighting just how scarce Bitcoin is.

Summary

In unraveling the essence of money, it's evident that its forms have evolved over time, adapting to serve as a medium of exchange, store of value, and unit of account. The ability of money to serve these roles is underpinned by key monetary properties such as its durability, portability, divisibility, scarcity, verifiability, and fungibility. Money, as a technology, organically emerges to streamline economic activity by addressing the double coincidence of wants and serving as a medium from transactions. The journey from barter to Bitcoin exemplifies this adaptive evolution, showcasing money's resilience in meeting the collective needs of its users. While Bitcoin excels in its monetary roles today, it doesn't preclude the existence of other forms of money coexisting. The future of this vital economic asset remains unpredictable, emphasizing the ongoing evolution of money and its ability to meet the changing dynamics of human exchange.