Understanding Money Part I
Most of us interact with one or the other type of money on a daily basis. Whether we want to pay our bills or buy some grocery we have to use money as payment. With such ubiquity it might seem that money is as widey understood as it is used. However, that is not the case. Many of us use money without trying to understand it deeply. A good understanding of money helps us use it more efficiently and make better financial decisions. Money is a very complicated subject to understand fast but if you study it carefully it can prove to be a really interesting one. In this series of articles I will try to do my best to explain various aspects of it in a simple manner. Many of you probably know more about these subjects than I can ever hope to understand but I hope that my writings won't prove too tedious to be perused. I trust that I can learn more from many of you than you can learn from me but I am determined to write these informatory articles to make sure that I have tried as hard as I can to share my knowledge with those who might be interested. Without further ado let's dive into the concept of money.
What Is Money?
You might be familiar with the various banknotes and coins that are widely used in most countries around the world. These kinds of money are referred to as fiat money. While fiat money is currently the most common type of money in circulation, it is, by no means, the only type of money. Fiat money's worldwide adoption is a fairly new phenomenon, but I digress. The subject of this post is not about fiat currency. I might write another article about that another time but this article is about money in general. The most commonly accepted definition of money has three elements. For something to be considered money it has to have these three functions. First of all let's look at the three functions and then I will discuss them one by one. Here are the three fundamental functions of money:
1 UNIT OF ACCOUNT
2 STORE OF VALUE
3 MEDIUM OF EXCHANGE
Now let's see what each of the three functions of money really mean. Let's look at (unit of account) first.
UNIT OF ACCOUNT
In an economy all participants have to understand the relative worth of their commodities to other participants' commodities. A pound of sugar and a smartphone are both valuable but without a unit of account it is impossible to calculate how much each of them has value. With money as a unit of account we can easily compare the value of different commodities. For example let's say that a pound of sugar costs 1 dollar and a smartphone costs 2 hundred dollars. Now we can make better decisions about which one we really need to buy considering how much money we have. As you can see this is a really important function because without it economies wouldn't be able to function properly. Being able to understand the relative prices of all the available goods and services is the only way we can strategize financially.
STORE OF VALUE
Another function of money is storing value. This is incredibly important because without this function money would be arguably worthless. Commodity money, for example gold coins, store their value in themselves because the material, in this case gold, that they are made of is valuable. Fiat money is usually represented as cheap metal coins or banknotes that are intrinsically inexpensive but they derive their value extrinsically from government fiats. That is why even fiat money can be a good store of value if it is managed with good monetary policy. This function shouldn't be underestimated because without it money would almost be useless. Imagine working hard all week to earn some money that can't retain its value until the next week. Unfortunately many fiat currencies around the world suffer from bad management, which leads to inflation, which leads to the money losing its ability to store value properly. All fiat currencies are susceptible to inflation but Bitcoin is inflation resistant. That is why so many people have decided to invest in Bitcoin. Bitcoin's hard cap of 21 million bitcoin means it is one of the best stores of value that has ever existed.
MEDIUM OF EXCHANGE
The third function of money can be described as a medium of exchange. You could have a good store of value which is also a good unit of account but without it being a medium of exchange, as well, it cannot really be classified as money. For an item to be considered a medium of exchange it should be able to be used as payment for things that you want to buy or sell or services that you use or provide. One of the few fair criticisms that Bitcoin receives is that it is not widely accepted as payment by many businesses. Bitcoin is rapidly overcoming this obstacle. Everyday more and more businesses are accepting Bitcoin. El Salvador has made Bitcoin legal tender, which means that Bitcoin is no longer an obscure internet currency like many altcoins are.
Money play an important role in facilitating the advancement of civilizations. Understanding money might not be something that everyone is interested in but it is, nevertheless, an engaging subject with lots of fascinating aspects. Hopefully, I will be explaining other aspects of money in the coming days.