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What Is Money? - Understanding What Qualifies As Money

 

By Nerly Shammah Apr 22, 2023

 

Money is anything accepted by two or more people as a medium of exchange. This means that money can be anything asides from the popularly known fiat currencies which are considered "legal tender" across nations of the world. 

 

 

Money exists in many forms, as of today, we have both physical and digital money, some not legally recognized and others legally recognized as legal tender like the US Dollars for physical money, and Bitcoin as digital money recognized as legal tender in El Salvador.

 

What qualifies as money is simply anything that is accepted by two or a group of people as a "medium or means of exchange". Money is also often referred to as a "unit of account" as though it acts as a tool for placing value on goods and services, the world's most powerful unit of account as of April 2023 is the United States Dollars. 

 

 

Understanding Money And Its Roles In An Economic System 

 

Prior to the development of money-based structures for business and economic activities, the world traded goods and services via a barter system more commonly referred to as "Trade By Barter". This system of trade was at that time the only means for humans to obtain their needs and wants by sacrificing what they own in exchange. For instance, if a person had a bag of rice and was in need of a goat for meat, he'd need to find someone that has a goat and is willing to trade his goat for rice. 

 

Of course, this system of trade proved highly inefficient as it wasn't always easy to find a trading mate and the value of the goods and services exchange was never appropriately measured. Money, being a unit of account, was introduced into the system to solve the flaws of these unfair and inefficient trade structures. According to Investopedia, commodity money was introduced in the 17th and early 18th centuries to combat this. A system in which beaver pelts and dried corn were reportedly used as a unit of account for trades of both goods and services.

 

The role of money in an economic system is to create an efficient means of conveying value from one account to the other. Money is studied in finance and applied in economics as a generally acknowledged store of value and unit of account. The concept of money has a lot to do with creating a balance in business and economic structures. Given its sole purpose of being a value determinant, money serves a pillar role in global trades of goods and services.

 

Types Of Money

 

There are many types of money and over the years, money has taken on diverse forms and has created a new meaning for itself based on the sector of application. 

 

That said, there are primarily 5 types of money including fiat money, commodity money, fiduciary money, commercial bank money and decentralized money.

 

Fiat money is the most popular form of money leveraged worldwide as "national currencies, accepted by all as legal tender". Examples of fiat money are the US dollar, the Chinese Yuan, Nigerian Naira and all other paper currencies. Fiat money is backed by government policies, more specifically "central bank policies" which control the creation and issuance of fiat currencies based on diverse economic studies and pre-set theories. 

 

Commodity money on the other hand is a type of currency or money that derives its value from commodities such as precious metals. These commodities have intrinsic value, rather than relying solely on government fiat or legal tender laws.

 

In the past, gold most specifically was used as commodity money and also served as a reserve asset for the money in circulation because it has inherent value and is thus widely accepted as a means of exchange. Fun to note that other commodities like livestock, shells and salt have likewise been leveraged as a medium of exchange or money categorized under commodity money in different parts of the world throughout history.

 

The advantages commodity money has over fiat money include but is not limited to being less vulnerable to inflation caused by excessive expansion of the money supply. Notwithstanding, commodity money is also known to be quite inefficient given that it is scarce and costs a lot to store and transport. 

 

Fiduciary money shares strong similarities with fiat currencies and decentralized money at the same time. Fiduciary money is a type of money built around trust in the system that issues it. This makes it widely similar to fiat currencies as though, unlike commodity money, fiduciary money isn't limited but easily expanded by the regulating body, likewise, with decentralized money, fiduciary money could be argued to be a strong representation of what most cryptocurrencies are - money issued by a system(often decentralized) and is leveraged by others based on the trust in the system. 

 

However, most decentralized networks are built to be "permissionless and trustless", thus, it makes it increasingly difficult to tell or factor in if all cryptocurrencies are indeed an example of fiduciary money.

 

Decentralized money is basically money issued and protected by cryptographic algorithms powered by blockchain technology. Most decentralized money systems are trustless and permissionless, governed via diverse consensus protocols like proof of work(PoW), the consensus mechanism of the Bitcoin blockchain, proof of stake(PoS), popularly used by the Ethereum blockchain, and delegated proof of stake(DPoS), used on decentralized networks like the Hive Blockchain.

 

All of these are but not the only forms of money as though whatever is accepted by two or more people in exchange for a good or service is money, the definition and form of money thus change at a rapid pace as innovations meet technology advancements.

 

How Much Money Is In The World?

 

There's an unlimited amount of money in the world. That is like trying to know the value of every single thing in the world and that is not determinable. 

 

Every building, every farm, every car, every piece of clothing, every soil, and every person is effectively a walking, standing, flying or rolling piece of value, given that money is a unit of account, the only way to determine the total money in the world is to give an account of everything that exists in the world.

 

However, economists leverage diverse economic concepts or theories to determine the money value in specific sectors of business, finance and economic operations. The theories categorize money into three forms:

 

M1 Money Supply:

M1 is the basic definition or form of the money supply. M1 money supply includes the most liquid(easily available for spending or investing) forms of money. This means all currencies in circulation - banknotes and coins inclusive, checking account deposits held at banks, credit unions, and more are categorized under the M1 money supply. M1 typically represents or is a snapshot of the (potential total) amount of money that can be readily used to make purchases, payments or investments.

 

M2 Money Supply:

M2 is the combination of the M1 money supply plus what is referred to as "near money", which refers to highly liquid financial assets or assets that can be easily converted into cash. Near money includes savings account deposits, money market account balances, and other time deposits. M2 is reportedly used as an indicator of the overall health of an economy, this is because it provides a measure or overview of the total amount of money available for spending and investment.

 

M3 Money Supply:

M3 is a broader category of the money supply which includes all M2 money in addition to other forms of less-liquid money forms such as large-time deposits, institutional money, market funds, and repurchase agreements. M3 is leveraged less frequently compared to M1 and M2, however, M3 money supply can be useful in assessing or determining the overall money supply and liquidity in the financial markets and economic system. 

 

How Is Money Created?

 

Money is primarily created via loans issued by banks to creditworthy individuals or institutions for an agreed interest payment upon the settlement of all loans.

 

The medium of money creation ensures that all currencies are backed by efficient production or labour which in turn benefits the economy via increased product sales and cash flow, thereby reducing the chances of inflation in an economic system. 

 

Does The Central Bank Print Money? 

 

The central bank does print money, however, physical money is but the smallest form of the money supply. This means that the central bank creates more virtual money than physical money, so the idea of printing physical cash is but a slightly flawed theory on how money goes into circulation. 

 

Does Money Printing Cause Inflation?

 

It is a popular opinion that money printing causes inflation based on the laws of supply and demand. However, inflation most times is a reaction of the economy(people) to the idea that more money has been printed rather than actually being a direct cause.

 

Knowing all these, it should be rather obvious that money is a lot more than physical cash and thus, is applicable in many fields including the expanding virtual economy of cryptocurrencies and decentralized finance investments products.