Types of Money: Commodity, Representative, Fiat and Bitcoin
There are four main types of money: commodity money, valuable in itself, like gold coins; representative money, a paper claim on a commodity; fiat money, valuable because a government declares it so; and bank money, the deposits banks create when they lend. Bitcoin fits none of them neatly.
People have used shells, metal, paper and ledger entries as money. Most of them fall into a few types, and the type decides who can create more of it and what it is really worth. The Bank of England puts the modern version plainly: “Money today is a type of IOU”, a promise that everyone trusts other people will accept.
The four types of money at a glance
- Commodity money: a good that is valuable in its own right, used as money. Gold and silver coins.
- Representative money: a paper claim on a commodity, exchangeable on demand. Banknotes under the gold standard.
- Fiat money: money by government decree, exchangeable for nothing else. The dollar, the pound and the euro today.
- Bank money: deposits that commercial banks create when they lend. Most of the money people hold.
Bitcoin is a fifth thing, covered at the end.
1. Commodity money
Commodity money is a good that would be valuable for other purposes, used as money. The Bank of England quotes Adam Smith: iron was money among the ancient Spartans and copper among the Romans, and many societies used gold. In some prisoner-of-war camps in the Second World War, cigarettes became money; even non-smokers accepted them, because they could swap them for something else later (Bank of England).
Its strength is that people trust it to keep its value, because the thing itself is wanted. Its weaknesses are practical. It is costly to use, since metal used as money cannot also be used for building or jewellery. It is heavy to move, hard to divide into small amounts and hard to check: a coin can be clipped or mixed with cheaper metal. And its supply depends on mining, so a new discovery can flood the market.
The history of money, from shells to satoshis →
2. Representative money
Representative money is a paper claim on a commodity held somewhere else. It began with receipts. In the Bank of England's account, goldsmith-bankers stored gold coins for customers and gave out receipts, and the receipts started to circulate as a kind of money. When the Bank of England was founded in 1694, its first banknotes were convertible into gold on demand, and apart from a few short breaks that is how its currency worked for most of the next 250 years: the gold standard.
Representative money is lighter and easier to use than metal, but it brings a new risk: the issuer. A bank can issue more receipts than it holds gold, and a government can suspend the right to redeem them. Both happened repeatedly. In the end the Bank of England stopped offering gold for its notes in 1931, during the Great Depression, and the United States stopped redeeming Federal Reserve notes in gold for its own citizens in 1934.
3. Fiat money
Fiat money is money because the state declares it to be. In the Bank of England's words, it is money “that is not convertible to any other asset”, and “since 1931, Bank of England money has been fiat money”. The dollar's last link to gold ended on 15 August 1971, when the United States stopped converting dollars held by foreign governments. Every major currency today is fiat money.
Fiat money is cheap to produce and its supply can be changed at will, which is its appeal to governments and its cost to savers. Central banks aim for about 2% inflation a year, and in practice it has been more: a dollar from August 1971 buys about 12 cents' worth today.
What is fiat money? How it works, and why it loses value →
4. Bank money
Most money today is not notes and coins at all. The Bank of England names three main types of money in a modern economy: currency (notes and coins), bank deposits, and the reserves commercial banks hold at the central bank. Of the money held by the public in the UK, 97% was bank deposits (December 2013), and commercial banks create those deposits themselves when they make loans.
A deposit is your bank's promise to pay you central bank money on demand. It works as money because people trust the bank, and deposit-guarantee schemes protect small balances. When that trust fails, people queue to take their money out: a bank run.
How fiat money is actually created →
Where does bitcoin fit?
Bitcoin does not fit neatly into any of the four. It is not representative money, because it is not a claim on anything held elsewhere. It is not fiat money, because no government issues it or declares its value. It is not bank money, because it is nobody's liability: holding bitcoin in your own wallet does not depend on anyone keeping a promise.
It is closest to commodity money: a bearer asset whose value comes from what it is, not from an issuer's promise. But unlike gold, its supply cannot be increased by a new discovery. It is created only on a fixed schedule, and the total can never exceed 21 million. It also fixes commodity money's practical problems: it can be checked by anyone running the software, divided into a hundred million units, and sent anywhere.
How many bitcoins are there? The live count →
Other kinds of money you may hear about
- Central bank digital currencies (CBDCs): a digital form of central bank money, available to the public. A CBDC is fiat money in a new format, issued and controlled by the central bank.
- Electronic money: balances held with payment companies and apps. They are claims on the company, which keeps central bank or bank money to back them.
- Barter: trading goods directly, without money at all. It only works when each side wants what the other has.
Questions people ask
What are the four types of money?
Commodity money (valuable in itself, like gold coins), representative money (a paper claim on a commodity), fiat money (money by government decree, like today's dollar and pound) and bank money (the deposits commercial banks create when they lend).
What is the difference between commodity money and fiat money?
Commodity money is valuable in itself, so its supply is limited by how much of the commodity exists. Fiat money has no value of its own; it is money because the state declares it so, and its supply is whatever the central bank and the banking system create.
Is the US dollar representative money?
No. It was partly representative until Federal Reserve notes stopped being redeemable in gold, in 1934 for Americans and 1971 for foreign governments. Since then it has been fiat money.
What type of money is bitcoin?
A new type: a bearer asset with no issuer and a supply capped at 21 million. It is closest to commodity money, but it cannot be mined in unlimited amounts and it is easy to check, divide and send.
Sources
Written by
The Bitcoin Transition
The Bitcoin Transition is a free, non-commercial educational project. We publish from first principles, in the voice of the protocol itself: direct, technically precise, and free from fiat-denominated framing.
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