Fiat, commodity, representational, fiduciary, and commercial bank money are the five different types of money in use today.
A unit of account, a store of value, and a medium of exchange are the other three roles they all do.
What is currency? Money is simply something that is widely used as a medium of exchange for goods and services in economics (Merriam-Webster).
So, while technically anything might be regarded as money, paper banknotes, coins, and credits are the forms that are currently most widely accepted (backed by banks).
Functions of Money
The three purposes (or services) that money fulfills define it:
1.) Store of Value
Additionally, money needs to be a store of value, which means it must hold its value over time.
It must be functional as a trustworthy means of exchange and be able to be saved, stored, and retrieved.
I couldn’t “Stack My Apples” and keep getting richer if I exchanged a lot of chairs for apples.
They would eventually be worth LESS when they become brittle and WORTHLESS when they become spoilt.
One could counter that money doesn’t genuinely “store value” either because of inflation-related fluctuations in purchasing power.
2.) Unit of Account
Money works as a shared benchmark for determining the worth of goods and services by serving as a unit of account.
It is reliable and makes it simple to compare the value of a $1 Coke to a $50 chair.
However, it would be more difficult for me to comprehend their values if I had to pay for the drink with pencils and the chair with apples.
It’s simpler to quote and haggle pricing when using money as a common unit of measurement.
3.) A Medium of Exchange
The ability to exchange goods and services is money’s primary and most significant application.
It serves as a means of exchange that enables those who use it to readily obtain what they need because it is a widely accepted form of payment.
People would have to rely on the barter system if there was no money. Individuals trade products and services under this system.
A double coincidence of wants, which occurs when both parties have what the other wants, is a good system.
For instance, if I wanted to trade someone a fancy car for a pre-owned speedboat, we would both be satisfied with the results.
The issue arises, however, when the person cannot swap an item or service that the other party values.
What would happen, for instance, if I wanted to purchase your car for ten cows and a few chickens? They wouldn’t likely be considered payment, in my opinion.
5 Types Of Money
There have been many different types of money throughout history, including seashells, condiments, banknotes, and debit cards. Fiat money is the type of currency in use right now.
1.) Commercial Bank Money
A claim against a bank for the purchase of goods and services is made with commercial money, commonly referred to as demand deposits (through the means of withdrawing in person, check, ATMs, or online banking).
The bank has produced this currency out of debt. Through a procedure known as fractional-reserve banking, they produce more money.
Only a portion of the “money the bank holds” is actually housed within this.
The bank gets more money from the interest and fees it charges clients by lending the remaining percent to others in the form of loans.
In other words, the bank uses the money you deposit as a loan to generate debt in other people and earn additional money from the interest paid on that debt.
3.) Fiduciary Money
Fiduciary money, which gets its name from the Latin word fiducia, which means “to trust,” operates on the promise and faith that it will be converted by the issuer into fiat or commodity money (bank).
Because it is not legal cash mandated by the government, people are not obligated to accept it as payment.
4.) Representative Money
Like fiat money, representative money has no intrinsic value. It is supported by a commodity, as opposed to fiat money.
It could be exchanged for precious metals (like gold) kept in a bank vault since it was backed by commodities. A certificate was more convenient to transport than a chest of riches.
5.) Commodity Money
Contrary to fiat money, commodity money has intrinsic worth, which derives from the product it is made of.
Money that is lost or destroyed cannot be replaced. It is also most likely the oldest type of currency.
These goods serve as a means of commerce and are valued because they are hard to come by.
Using this kind of money is similar to using the barter system, where like-for-like items and services are traded.
Using commodity money serves as a unit of account that enables you to compare the worth of goods and services, in contrast to the barter system.
6.) Fiat Money
Fiat money, also known as fiat currency, is money whose value is determined by the governing body and not by the money’s intrinsic value.
It must be accepted as payment everywhere once the government proclaims it to be legal money.
A partially destroyed bill can be replaced by the Federal Reserve Bank because it has no intrinsic worth. Commodity money, on the other hand, cannot be.
Properties of Money
The following seven characteristics of money are shared by fiat, commodity, representational, fiduciary, and commercial bank money:
Durability: It must be durable enough to endure the abrasion from holding hands.
Divisibility: capable of division. Ex: Four equal quarters can be made from a $1 bill.
Portability: It need to be portable and simple to carry anywhere.
Cognizability: Its worth must be clear to see. A $1 bill is designated with a “1,” whereas a ten-dollar bill is designated with a “10.” You can quickly assess and contrast their value.
Fungibility: If it may be used to exchange for other forms of currency, it is fungible. For instance, despite any stains or tears, every dollar bill is valued the same as every other dollar bill. In a trade, a bruised apple would not be equivalent to an unbruised apple.
Stability of value: Over an extended period, the value ought to be steady.
Limited Supply: Money must be rather difficult to get by and scarce. The government controls the money supply to ensure that its value is preserved. Ex: Due to its scarcity, water is used as currency in post-apocalyptic TV series.
Fiat money is the primary type of money utilized in economies today; it has no intrinsic value other than what the government decides it should be worth. The fact that all forms of money serve as a medium of exchange, a store of value, and a unit of account is what counts.