What Is Money? — Understanding Money

Film · What is money? · 1:36

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A short film in the language of this site's homepage: money's three jobs, as the Bank of England lists them; Carl Menger's account of how the most saleable good became money; the six qualities of a good money, five of them on Jevons's list of 1875; gold, fiat currency and bitcoin scored against them, with bitcoin's weak spots stated plainly (one bitcoin is always one bitcoin; measured in fiat, its price moves); and bitcoin's fixed supply, which anyone can check block by block.

Read the film, with its sources

Understanding Money · Module 1 of 4What is money? Most people use the word every day without a working definition. This film gives one: the jobs money does, where it came from, and the qualities that make a good money.
Money’s three jobsEconomists usually define money by what it does. The Bank of England’s introduction to money lists 3 roles: a store of value, which holds its value predictably over time; a unit of account, the thing goods and services are priced in; and a medium of exchange, which people hold because they plan to swap it for something else. The roles are closely linked: a money that will not hold its value is less useful to swap.McLeay, Radia and Thomas, “Money in the modern economy: an introduction”, Bank of England Quarterly Bulletin 2014 Q1, pp. 4–5
JUN 1892The economist Carl Menger asked how money began. Goods, he noticed, differ in how saleable they are: in his words, “the greater or less facility with which they can be disposed of at a market at any convenient time at current purchasing prices”. Cloth and silk, sold in quantity at will, fetch a considerable discount; astronomical instruments and Sanskrit writings hardly sell at all; the precious metals, he wrote, were far more saleable than anything else.Carl Menger, “On the Origin of Money”, Economic Journal 2(6), June 1892, pp. 244 and 249
JUN 1892Traders who could not find a direct swap took goods more saleable than their own, and traded them on. Over time, Menger wrote, practice and habit caused the most saleable goods to be accepted “not only by many, but finally by all”, in exchange for less saleable ones. In his account money emerged from trade, not from law.Carl Menger, “On the Origin of Money”, Economic Journal 2(6), June 1892, pp. 244 and 249
1875What makes a good saleable enough to be money? Six qualities: scarcity (new units cannot be made cheaply), durability, portability, divisibility, fungibility (each unit as good as any other) and verifiability (the receiver can check it without trusting the sender). Five are on the list of qualities William Stanley Jevons drew up in 1875, in his words portability, indestructibility, homogeneity, divisibility and cognizability. Scarcity is the modern way of putting what keeps a money’s value up.W. Stanley Jevons, Money and the Mechanism of Exchange (1875), chapter V, p. 31
Gold and fiat currencyScored against the six (this site’s reading of them, not a measurement): gold is scarce, durable and fungible, but heavy to move, awkward in small amounts, and its purity has to be tested. Fiat currency is easy to carry and divide, but it has no fixed limit: the Bank of England aims for prices to rise 2% a year, so a pound is meant to buy a little less each year. A note can be checked by eye; a bank balance is only as good as the bank’s books.Bank of England, Monetary policy: inflation target
BitcoinScored the same way, bitcoin is strong on scarcity, durability, portability, divisibility and verifiability: anyone running the software can check a payment for themselves, without trusting the sender. Fungibility is mixed. The white paper speaks of the “necessity to announce all transactions publicly”, so every coin’s history can be traced.Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System (2008), section 10, Privacy
TodayAgainst the three jobs, it is further along on some than others. It is used in payment, but not yet widely. As a store of value it is strong: its supply is fixed, and one bitcoin is always one bitcoin. Measured in fiat, its price moves; but you don’t price bitcoin, you price things in bitcoin. Few prices are set in it yet, so for most people it is not yet a unit of account. Keeping it safely takes care: lose the keys and the coins are lost. Multisig, which needs more than one key to spend, spreads that risk, but brings its own: a more complex setup that heirs must be able to follow.
TodayWhat bitcoin does have is a fixed supply: never more than 21,000,000 coins, a limit written into the software every full node runs. Anyone can count the coins issued so far, block by block; the film shows the count at the latest block.
The Bitcoin TransitionMoney is the most saleable good.

Before you can think clearly about Bitcoin, you need a working definition of money. Most people use the word without one. This is a problem, because the word is doing several jobs at once.

Carl Menger, the founder of the Austrian School, defined money as the most saleable good in a society — the good that could most readily be exchanged for other goods, across the widest range of counterparties, with the smallest loss in value. Under this definition, money is not designated by a government. It emerges from the market, through repeated acts of voluntary exchange.

The Three Functions

Conventionally, money is said to serve three functions: medium of exchange, store of value, and unit of account. These are not separable. An asset that fails at any of them is not fully money.

Medium of exchange — the function that allows an economy to move beyond barter. You accept money in exchange for your labour or goods because you know you can use it later for something you want.
Store of value — the function that allows you to defer consumption. If money loses value rapidly, you cannot save in it, and you cannot plan.
Unit of account — the function that allows prices to be compared and contracts to be written. All other prices in an economy reference the monetary unit.

Any serious monetary good must perform all three. Over history, the goods that have been selected as money — gold, silver, large stones, certain shells — were the ones that performed all three better than the alternatives.

The Properties That Make a Good Money

Empirically, the goods that have functioned as money have shared six properties. These are not arbitrary. They are the features that make an asset useful for the three monetary functions.

Scarcity — if new units can be produced cheaply, the good cannot store value
Durability — if the good decays, it cannot be held across time
Portability — if it cannot be moved, it cannot be exchanged across distance
Divisibility — if it cannot be split into small units, it cannot price small goods
Fungibility — one unit must be interchangeable with any other
Verifiability — the receiver must be able to confirm authenticity without trusting the sender

Bitcoin satisfies all six. So does gold, though Bitcoin exceeds gold on portability and divisibility. Fiat currency satisfies portability and divisibility well, but fails on scarcity and increasingly on verifiability.

Why This Matters Before Bitcoin

When you understand what money is supposed to do, and what properties it needs to do it, the Bitcoin discussion stops being about price. It becomes a straightforward comparison of assets against a clear specification. Which monetary good satisfies the six properties best at scale? That is the question. The answer is the one the market is gradually converging on.

The History of Hard Money