What Is Money?

Money is one of the greatest instruments of freedom ever invented by man.
Friedrich Hayek

Welcome to the Bitcoin Diploma. In this module, we'll explore the fundamental question of why money is essential in our lives. We'll look into the nature of money and its various forms, aiming to gain a deeper understanding of its significance.

Money is something we use every day, but do we actually understand why we need it and what it is?

• Why do people trade their time for money?
• Why do some people have more of it than others?
• Why is money different in other countries?
• Why can’t we just create more of it when we need it?

Let's start by answering the five following questions. Consider practical uses like acquiring necessities such as food and desired items. Try to be specific in your examples, balancing creativity with realism.

Why do we need money?

What is money?

Who controls money?

What gives money its “value”?

What questions do you have about money? 

Discussion: Why Do We Need Money?

Split into groups and:

• Share and discuss answers on the first four questions. Write down favorite answers.
• Share answers on the last question, and vote on one favorite question. Write down the result.
• Revisit answers and questions at the end of the course.

Now that you have a clearer understanding of why money is necessary, the upcoming modules will explore what money is, how it evolved through time, who influences it, and the newest form of it. Keep referring to your lists from this first day in class to draw connections between your insights and the evolution of money creation, definition, and usage over time.

Discussion: What is Money?

• Please do not eat the piece of candy placed on your desk yet.
• Who would be willing to trade their candy for a US$1 bill?
• Now, keep your hands up if you would still be willing to trade your candy for a $1 monopoly bill instead of your piece of candy.
• Why or why not?
• What makes one bill so desirable and another one as good as trash?
• What gives money its “value”?
• Where does money come from and who decides how much of it to print?
• Why not print more money and distribute it among everyone equally?

Money is a guarantee that we may have what we want in the future. Though we need nothing at the moment, it ensures the possibility of satisfying a new desire when it arises.
Aristotle

Have you ever stopped to think about what money really is? Or ever wondered what makes money…well, money? Most of us know how to use it, but not many of us understand where it comes from or how it works. Money is essentially a way to exchange goods and services. It represents the value of these items in a form that can be easily traded. Money can take many different forms, such as paper notes, coins, and electronic payments. Governments or other authorities typically issue and control money, but money is so much more than just a physical or digital medium of exchange; it’s like a universal language that allows us to trade with people all around the world, even if we don’t speak the same language or have the same culture. You can be on the other side of the world and still “speak” money by placing a product on the counter and exchanging it for the local currency or using a credit card.

Money is like a social contract that allows us to make exchanges without having to rely on bartering or finding someone who specifically wants what we have to offer. If a group of people started accepting chocolate as payment for most goods and services, chocolate would become money (although, since it would melt in some parts of the world, we might consider it bad money).

In other words, money itself doesn't have the power to satisfy human wants; it's just a tool that allows us to trade more efficiently.

Money represents the value BY which goods are exchanged. Money IS NOT the value FOR which goods are exchanged.

A transaction is an exchange or transfer of goods and services. It is a way of exchanging value between two or more parties.

There are many different types of transactions, ranging from simple exchanges (such as buying a sandwich at a deli) to more complex financial transactions (such as buying a house or investing in st

Transactions can be conducted in person, over the phone, online, or through other means, and they can involve a wide range of parties, including individuals, businesses, and financial institutions.

Money facilitates trade because everyone accepts it as final payment. It also allows us to measure value and compare different goods and services.

Money performs but a momentary function in an exchange; and when the transaction is finally closed, it will always be found that one kind of commodity has been exchanged for another.
Jean-Baptiste Say

When it comes to buying and selling goods and services, money is the key player. Money serves several important functions in the world, like:

Store of Value

Money should maintain its value over time, making it useful as a method to save and invest the value of human labor. This lets people use money to plan for the future. So, the next time you’re saving up for something special, remember that money is more than just a way to pay for things — it’s a tool to help you plan and invest in your future.

Medium of Exchange

With money, you don’t have to find someone who wants exactly what you have to trade. Instead, you can use money to buy and sell anything you want. This makes trading and commerce much more convenient.

Unit of Account

Money provides a universal standard for measuring value that allows people to express and compare the price of different goods and services. This allows for a more efficient and transparent market, where people can make informed decisions about what to buy and sell.

If you wanted to buy a new car, you could compare prices from different dealerships and make an informed decision about which one to buy based on the price in dollars. Without a unit of account, you’d have to try to compare the value of one car to another using something else, like the number of cows it was worth or the length of time it took to make the car.

These three functions are what allow economies to become complex and dynamic. Without money, it would be much harder to buy and sell goods and services, and our economy would be much less developed.

People understand the value of something when it has a price expressed in money.

What function of money is this an example of?

• Evan decided to save a portion of his weekly paychecks to buy a puppy
• Adam buys two slices of pizza for $8.30
• Marc can’t decide whether to buy concert tickets for $75 or a ski pass for $95

Money works well only if it has certain key qualities. It needs to be useful for buying and selling (medium of exchange), saving for later (store of value), and measuring prices (unit of account). These qualities are what make money reliable and important.

• Durability refers to money's ability to resist physical deterioration and last over time. This ensures that money can circulate in the economy in an acceptable and recognizable state. Gold is a durable material that can withstand wear and tear, making it a good representation of money's durability characteristic.
• Divisibility refers to money's ability to be divided into smaller units so people can use it to make purchases of varying amounts. Paper bills can be easily divided into smaller denominations, making them a good representation of money's divisibility characteristic.
• Portability refers to the ease with which money can be transported and carried around. This allows people to use money to buy and sell goods and services without difficulty. Credit cards are portable, as they can easily be carried in a wallet or purse, making them a good representation of money's portability characteristic.
• Acceptability refers to the widespread acceptance of money as a form of payment so that people can use it to buy and sell goods and services with confidence. The US dollar is widely accepted as a form of payment, making it a good representation of money's acceptability characteristic.
• Scarcity refers to how difficult it is to make more units of the money, which helps maintain its value and prevents us from having to spend more money to buy the same amount of goods. Collectible stamps, rare and valuable ones, can be a good form of money because they are scarce and can appreciate in value over time. Stamp collectors often use their stamps as a way to invest their wealth and diversify their portfolio.
• Fungibility refers to the interchangeability of money so that one unit of money is equivalent to another unit of the same value. Money should be uniform. Copper coins are uniform in size and weight, making them a good representation of money's uniformity characteristic. One cent is always one cent.

Exercise

Different assets have different properties and perform the functions of money to varying degrees. Society determines which asset is used as money based on how well a particular good performs these functions.

To determine how well different items meet the specific characteristics of money, you can score each item below on a scale from 1 to 5.

(0 = Terrible; 3 = Okay; 5 = Excellent).

Adding up each item’s scores shows which is best suited to serve as money.

Use the following questions to help determine how well the different items in the table meet the characteristics of money.

• Durability: Can the money withstand wear and tear over time?
• Portability: Can the money be easily transported?
• Fungibility: Is the money interchangeable with other forms of money?
• Acceptability: Is the money widely accepted as a form of payment?
• Scarcity: Is the money scarce and difficult to make more of?
• Divisibility: Can the money be divided into smaller units?

* Please do not fill in the column for Bitcoin; we will return to it later in the course.

Money can be divided into two main categories: physical and digital.

Physical money

• Commodity money is a physical object that is widely valued and accepted as a medium of exchange.
  • Gold, silver and even gun powder once served as commodity money.
• Representative money represents a claim on a physical commodity.
  • Silver certificates could be exchanged for silver.
• Fiat money is the paper bills and coins issued by governments and accepted as a medium of exchange.
  • Federal Reserve notes are fiat money, decreed by the federal government to be an acceptable way to pay debts.

Digital currencies

Digital currencies can be used for online transactions and include electronic money, stablecoins, and cryptocurrencies.

Electronic currencies are digital versions of traditional currencies like dollars or euros. It is used for online payments through systems called payment rails, which move money from one place to another.

In the traditional financial system, these payment rails rely on intermediaries such as banks. These intermediaries charge fees and have the power to approve, delay, or reverse transactions.

Common examples of these systems include card networks, which process debit and credit card payments, and digital wallets, which store money and allow users to send and receive payments.

• Central Bank Digital Currencies (CBDCs): Digital versions of a country’s currency, issued and controlled by the central bank.
• Stablecoins: Digital currencies designed to keep a stable value, usually linked to an asset like the U.S. dollar.
• Cryptocurrencies: Digital currencies. Some are decentralized, meaning no single group controls them, while others are more centralized.

A key idea behind some digital currencies is removing intermediaries. This can make transactions more efficient and reduce the concentration of power. The goal is to create a system that works more like the internet, where control is shared rather than held by a single authority.

Imagine you are stranded in a desert and you only have one bottle of water left. You are thirsty and desperate for a drink, but you also know that you will need the water to survive until you can find more. This is a classic example of scarcity: you have a limited amount of a resource (water) and you must make choices about how to best use it.

In this situation, you might decide to ration it and take small sips over a longer period of time to make it last as long as possible. Alternatively, you might decide to drink as much as you can in one go, satisfying your thirst momentarily, but this burst of hydration may not be enough to give you the energy to find more water in the future. Regardless of which choice you make, you are faced with a difficult decision.

Scarcity applies to all resources, not just water. Whether it’s money, time or even love and attention, we are constantly faced with choices about how to allocate our limited resources.

Scarcity forces us to weigh the pros and cons of how we use our resources and make trade-offs.

There are two types of scarcity

• Artificial scarcity, also known as centralized scarcity, includes things like limited-edition designer bags, rare sports cards, and numbered art pieces. These can be easily replicated or counterfeited.
• Natural scarcity, also known as decentralized scarcity, includes things like oceanfront property and precious metals like gold. These are harder to replicate or counterfeit.

The main difference between the two is control.

Centralized scarcity is determined by a single entity, like a company or government, while decentralized scarcity is not controlled by anyone. An example of centralized scarcity is that of luxury, limited-edition fashion items, such as bags or sneakers: it would be virtually costless for the company to produce 1,000 more units, but the elevated price is controlled by this artificially determined scarcity. It is the company’s control over the number of units which determines their value. By contrast, the only way to find and exploit salt, shells or gold is by expending a considerable amount of effort and energy (or ‘work’). In the case of these naturally scarce resources, that expense only makes sense economically if the resulting good is highly valued.

No one person or group controls the price of a naturally occurring resource to influence its price, but it’s the other way around: it is the demand for that good in the market which determines whether energy should be expended to extract more of it.

Scarcity influences our choices. Understanding it can improve our decision-making: we are often faced with the choice between immediate gains and long-term benefits, and these trade-offs shape our path to achieving our goals.

Example of time preference

You have the option to receive $100 today or $110 in a year. If you have a high time preference, you might choose to receive the $100 today because you value having the $100 now more than the benefits of waiting a year for the extra $10. On the other hand, if you have a low time preference, you’ll prefer to wait for the larger reward because you are more focused on long-term planning and less concerned with immediate gratification.

Time preference refers to the idea that people generally prefer to have something NOW rather than later.

Going back to the earlier example of the bottle of water in the desert, drinking all the water right away, even if it means you won’t have any left for later, shows a high time preference: the thirst you feel in that moment is so pressing that you discount the thirst you might feel in the future in favor of satisfying your present thirst. This is perfectly natural: we tend to prefer present gratification over present privation for a future benefit, because the future is always uncertain.

Trying to ration water by taking small sips at a time, on the other hand, demonstrates a lower time preference and a rational allocation of a scarce resource. This means you are willing to delay satisfying your thirst in the present to improve your long-term chances of survival. This does not come naturally and requires significant effort, self-control and future orientation.

Opportunity cost refers to the value of the next best alternative that you give up when you make a decision. Every decision involves trade-offs, and so every decision carries an opportunity cost.

In the desert example, the opportunity cost of drinking all the water right away is the survival benefits you would have gained from rationing the water and using it over a longer period of time.

Let’s say you decide to ration the water and take small sips over a longer period of time. As a result, you have the energy and hydration you need to search for more water. While you are searching, you come across a cactus that contains a small amount of water. It’s not a lot, but it’s enough to quench your thirst for the moment. If you had decided to drink all of your water at once, you might not have had the energy to search for more water and come across the cactus.

In this case, the opportunity cost of drinking all of your water at once would have been the chance to find the cactus and get more hydration.

This example illustrates how opportunity cost involves not just the immediate trade-off between two options, but also the potential future opportunities that may be gained or lost as a result of our choices.

Our willingness to give up a larger reward in the future in exchange for a smaller reward now is influenced by our time preference, or how much we value immediate gratification versus long-term planning.

Activity: Time preference

1. Listen to the teacher’s explanation of the candy choice.
2. Decide whether you would like to receive a small candy or marshmallow now or wait until the end of the class to receive two candies or a larger, more desirable candy.
3. Commit to your decision and let the teacher know your choice. Receive your candy either immediately or at the end of the class, based on your decision.
4. Participate in the class discussion about the activity, reflecting on your decision-making process and the concept of time preference.

Conclusion and Discussion

• What factors influenced your decision to take the candy now or wait for a larger reward later?
• How do you feel about your decision now that the activity is over?
• Can you think of real-life examples where high time preference might be harmful and where low time preference might be beneficial?
• What are some potential consequences of choosing high time preference over low time preference?