Money in Crypto: Understanding Digital Value
Money is a widely used medium of exchange that facilitates trade and gives the ability to store material values.
What is Money?
Central banks, such as the U.S. Federal Reserve System, issue their own currency. This money can be either physical cash or electronic money. There has always been some type of medium that people in communities have used to exchange goods and services. This medium is called money, and it has three basic functions:
- Containing value: when you work for an hour, you expect to be paid in currency (money) that will still have value when you go to spend it on food or rent. If the value of the currency changes too much or too quickly, people stop trusting it and look for other ways to exchange goods and services (such as barter exchange).
- The medium of exchange: money makes trade efficient. Imagine trying to buy products without any common unit of exchange. You would have to look for someone who sells products and wants exactly what you have to offer.
- Unit of account: Money is the unit of measure for valuing goods and services.
Types of Money
There are several types of money:
- Cash money is a type of currency that is issued by the government or central bank. The government uses it to buy goods and services from the public and to pay for its activities. You can also use it to buy goods and services directly from other people if they agree to accept your cash in exchange for what they sell.
Cash can be in the form of coins, paper bills, and demand deposits, which are kept at financial institutions in different types of accounts. Demand deposits are also known as mobile money because they can easily be transferred with a phone call or wire transfer.
- Commodity money is any commodity that is widely accepted as a medium of exchange. You may have heard the term “barter,” used to refer to two people exchanging goods instead of using cash. Historically, gold and silver (think of coins) were used as commodity money, and later cigarettes and alcohol were also used.
- Fiat money is any currency issued by a government and considered legal tender. The key difference between fiat money and commodity money, such as gold or silver, is that fiat money is not backed by any physical object – it has value only because the government maintains its value, or because the two parties in the exchange agree on its value.
- Representative money is any form of currency that represents something else of value – in other words, there is an asset backing it up. For example, paper currency used to be exchanged for gold or silver – today it is simply paper with no intrinsic value other than that which we have agreed upon.
Today, many currencies are representative money because they are backed by assets held by the issuing country’s central bank.