Problems Defining Money

There seems to be confusion about the functions of currency, and the definition of what money is. I’d like to explain why the confusion exists — and it starts with the fact that “Money” and “Currency” aren’t defined simply or clearly.

For something to be considered money by economists, it must have certain uses, or characteristics. Economists have identified three. It should be a;

  1. Unit of Account, which is used to measure value.

2) Store of Value, which is used to hold in order to ensure it can be used in the future.

3) Medium of Exchange, which is used to allow transactions without direct barter.

That last one is the one even critics agree bitcoin displays most obviously. But bitcoin definitely displays all three of these characteristics, to a greater or lesser extent. On the other hand, almost everything else can display these characteristics to some extent as well. The things historically used as money have been whatever does these function best.

Gold has served as a store of value for millennia at least, since it is a fairly compact and valuable item, and has intrinsic worth for its beauty. It was also of limited supply ensuring that it remained valuable, and it worked well as a store of value . Even before coinage, it was a useful medium of exchange, since relatively large amounts can be carried easily, and it is also divisible. Once coinage was created, this was still sometimes true, and Spanish pieces of eight were broken into pieces to allow this. Coinage also led to gold as a much more useful unit of account, no longer requiring careful measurement and sometimes difficult verification of its nature.

Other historical “money” was less well suited for some of these different tasks; Cattle was a great medium of exchange in ancient cultures, was easy to validate, and was a reasonable store of value over the short term. It was also a unit of account, but served this purpose less well. (They sometimes varied in value between different animals, and over time, and were not easily divisible — it tended to get messy when you split them in half.)

Now, many things fall into the grey area created by our linguistic imprecision in grouping these functions. This means that they are money, but aren’t perfectly suited for the purpose. Examples include the UN’s Special drawing rights, which are a unit of account (1) and a store of value (2), but not a medium of exchange(3). Similarly, banknotes (or fiat currencies!) and gold certificates are a great unit of account (1), and a very convenient medium of exchange (3), but their reliability as a store of value (2) is contingent on the trustworthiness of the issuer, which can vary.

Cryptocurrencies are great as a medium of exchange, since the transaction system is designed explicitly for transacting, and they are divisible into fairly small amounts. Their usefulness as a unit of account and store of value, however, is less clear. As exchange rates fluctuate, the reliability of these uses can be tricky. As Bitcoin has stabilized, this has become a less critical issue, but digital currencies lack intrinsic worth, so any stability is limited by trust. As noted, fiat as a store of value also depends on trust, albeit different; it’s trust in a central bank instead of a algorithm and a social agreement.

In terms of just these three characteristics, we seem to have nothing that works quite as well as gold once did, leading some to wonder why we don’t go back to gold. But this is a bad idea, because those three characteristics aren’t a full list of what we need from a currency — notably, gold has a fixed supply, not just a limited one, which has real downsides. (Not just nominal ones. But that’s a different discussion.)

In any case, I think that it’s obvious that nothing fits the platonic ideal of a currency. And arguing about definitions is a silly thing to do. (That doesn’t mean you can use words however you want!) Given the lack of a platonic exemplar, the question of whether to call something money is really just asking what the best trade-off is between different choices — and that’s subjective and contentious. Which, I think, explains the confusion I started with.

Added: But this confusion misses the point; Instead of arguing definitions, we need to look at expanding definitions and obsoleting industries.