What is Money? A Beginner’s Guide to the Backbone of the Economy

Money—it’s something we use every day, but how often do we stop to think about what it really is?

At its core, money is a tool that makes our lives easier. Without it, trade and exchange would be complicated and inefficient.

But money is more than just coins, bills, or numbers on a screen. Let’s break it down into simple terms, explore its fascinating history, understand its attributes, and look at the different forms it takes.

A Brief History of Money

1. Bartering: The First Exchange System

Before money existed, people bartered. If you had wheat and needed meat, you’d find someone with extra meat who wanted wheat. The problem? What if the meat owner didn’t want wheat? Bartering relied on a “coincidence of wants,” which made trade tricky.

2. Commodity Money: Objects as Currency

To solve this, societies began using objects like salt, shells and rum as money. These items, known as commodity money, had value in themselves. For example:

- Salt was highly valued in ancient Rome and even used to pay soldiers (hence the word “salary”).

- Cowrie shells were a common currency in Asia and Africa.

3. Metal Money: Coins

Around 600 BCE, the first coins were minted in the ancient kingdom of Lydia (modern-day Turkey). Coins made of precious metals like gold and silver had intrinsic value and were easier to carry.

4. Paper Money: A Lighter Option

China introduced paper money around the Tang Dynasty (7th century). By the 13th century, Marco Polo marveled at the use of paper currency during his travels to China. Europeans adopted it much later.

5. Modern Money: Digital and Beyond

Today, we’ve moved from cash to credit cards to cryptocurrencies like Bitcoin. Money has evolved into something mostly digital, where numbers on a screen represent your purchasing power.

What Makes Money, Money?

Throughout history a variety of different tokens of exchange have been used as money, and what links these different forms of money is not their physical qualities but the function they perform. Each in their era were trusted as a reliable way to receive payment, make payment and as a way to store value over time. In other words, for something to function as money, it must have specific attributes. Think of money as having the below superpower:

1. Medium of Exchange 

   Money allows people to trade goods and services without bartering. It’s universally accepted in an economy and widely accepted as a means of payment.

2. Unit of Account 

   Money provides a standard measurement of value. Without it, comparing the value of goods and services would be complicated, even chaotic.

3. Store of Value 

   Money is considered to be a way to store value as it generally retains its value over time which means you can save it and use it later. How much value the money holds in modern economies is dependent on inflation rates as high inflation rates will devalue the currency.

4. Portability 

   Good money is easy to carry. A gold bar might be valuable, but a stack of bills is more practical to carry around.

5. Durability 

   Money should withstand wear and tear. That’s why paper money is designed to be tough, and coins are made of metal.

6. Divisibility 

   Money must be easy to divide into smaller units. Imagine trying to pay for a coffee with a whole gold nugget!

7. Uniformity 

   Every unit of money should be identical. A $10 bill is always worth $10, regardless of whether it’s crumpled or crisp.

8. Scarcity 

   Money must be limited in supply. If there’s too much, it loses value (think of hyperinflation). In circumstances where the Federal reserve of a country prints money in order to stimulate the economy, this results in the value of each dollar reducing.

Types of Money

Money comes in many forms. The item used as money does not need to have any value in its own right, even though some forms of money do, such as gold coins and copper ingots. Rather, money derives its value from the trust that people put in it. History shows that this trust can be lost if the money is mismanaged, for example, printing and issuing too much money as the value of the money will decrease.

Historically there have been two main forms of money – Physical money like coins and banknotes and Digital money like deposits held in a bank. Digital forms of money compromise the greatest share of money in a modern economy and is expected to retain this crown. Let’s take a quick look at the main forms of money:

1. Commodity Money

This is money that has value in itself, including gold, silver or cocoa beans (yes, the beans that make chocolate!). It’s tangible and often tied to physical assets.

2. Fiat Money

Most modern currencies, like the US Dollar or the Euro, are fiat money. They have no intrinsic value in themselves but are backed by government decree. In other words, they’re valuable because we trust them.

3. Representative Money

This type of money represents something of value. For example, early US dollars were backed by gold or silver. You could exchange the paper note for a specific amount of the precious metal.

4. Digital Money

Digital money is money you don’t physically hold, think PayPal accounts, Wise accounts and even your bank account. This is money stored electronically.

5. Cryptocurrency

There are two fields of thought on whether cryptocurrency, like Bitcoin, is actually a form of money. Whilst it is a medium of exchange, many argue that it isn’t a store of value due to the volatility.

Others would argue that cryptocurrencies like Bitcoin or Ethereum, as decentralized digital currencies based on blockchain technology, are a newer form of money. They don’t rely on governments or banks, their supply is often limited by design and adoption as a valuable token of exchange is increasing every year.

So why do we need money?

Money has value because we trust it, but this trust can be broken, so why do we keep on using money? The answer is that it is useful in facilitating trade. Trade allows people to focus on producing items in which they have knowledge or an advantage, and then using money to acquire other items they require.

Effectively we can trade with people we don’t know or trust in order to sell and acquire items. Money is evolving and the physical form of money (coins and bank notes) are being used less and less as economies turn to more digital money.

 Why Understanding Money Matters for Investing

Money has changed form many times over the years, but as long as people want to trade with each other, money will continue to exist in some form due to the function it performs in the economy.

Money is a tool that helps you achieve your goals, and knowing how it works empowers you to manage it wisely. Whether you’re learning to budget, invest, or plan for retirement, a solid foundation in the basics of money sets the stage for financial success.

So, next time you open your wallet, transfer funds, or tap your card, know that the money is more than just numbers; it’s the lifeblood of the economy and a key to building your wealth.