Money makes the world go round, and it’s therefore very important to know the ins and outs of it. Here’s all you need to know.
There are seven types of money:
- Fiat Money
- Representative Money
- Commodity Money
- Paper Money
- Commercial Bank Money
- Digital (Electronic) Money
Let’s explain each type of money in greater detail.
1. Fiat Money
Fiat (from Latin: “let it be done”) money is what we use most of the time. For instance, if you went to the grocery store today, you used fiat money.
However, fiat money doesn’t have any intrinsic value. Meaning it’s worthless unless we as a society agree that it’s worth something.
Governments proclaim that their fiat money is to be used as legal tender for all transaction purposes and issue it via their central banks.
Although fiat money isn’t backed by any commodity like gold or silver, it is the basis for the whole monetary system.
US dollars, Euros, Pound sterling, Japanese Yen, and the Chinese renminbi are the most used currencies in world payments today.
The following are what makes money fiat money:
- It doesn’t have intrinsic value
- It isn’t backed by commodities
- It is officially declared as a legal tender
- It’s solely used because of a government decree
- It’s issued by a state via a central bank (in almost all cases)
2. Representative Money
Representative money, or receipt money, represents something of value and can be printed or digital. On its own, it doesn’t have any intrinsic value (just like fiat); however, it has to be backed by something that does, such as gold or silver.
Representative money is, therefore, mainly used as a claim on a commodity. Good examples are gold and silver certificates.
Gold certificates were issued from 1865 to 1934 by the US Treasury as a form of representative money. They were useful when the country still used the gold standard and were a handy way of paying for goods. Silver certificates were issued between 1878 and 1964.
To recap, representative money can be exchanged for a fixed quantity of a commodity and is directly tied to it. At the same time, it isn’t made out of that commodity. This brings us to the next type of money or currency.
3. Commodity Money
Commodity money has real value even if it isn’t used as a currency. The most well-known examples of commodity money include silver and gold, tea, copper, salt, alcohol, cigarettes, barley, cocoa beans, silk, candy, etc.
Even peculiar items such as decorated belts, shells, large stones, and iron nails were used as commodities.
Commodity is a type of money that was very common throughout history and is even used today when there’s no access to other forms of money. War-torn territories rely heavily on cigarettes and gasoline as currency, for example.
Commodity money dates back at least 100,000 years, according to some research.
However, it is gold and silver coins that are most known as commodity money. Unlike coins of today which would be almost worthless if melted, gold and silver coins used as commodity money would retain their value even if melted.
4. Paper Money
Paper money or banknotes, bills, or simply notes are usually issued by central banks or treasuries. We all know them and use them.
Banknotes have a long and exciting history. True paper money made its debut during the Song dynasty in 11th century China and later spread to the Yuan dynasty and the Mongol Empire.
Marco Polo and other European explorers brought the concept back to Europe in the 13th century.
In the beginning, paper money was based on precious metals like silver and gold and was seen as an IOU or a promise to pay the person in precious metals at some time in the future, sort of like a check.
Once banknotes had no backing and precious metals were removed from the monetary system, paper money was pure fiat money as we know it today.
Although in most countries the central bank issues banknotes, in some instances, private banks can also issue them. This is the case in Northern Ireland and Scotland, Hong Kong, and Macau.
As a curiosity, banknotes can have printing errors; however, they rarely make it off the factory floor as they are recognized by quality assurance and destroyed.
Coins have standardized weight and are made of copper and other non-precious metals. The highest value coin is generally worth less than the lowest value note. However, there can be special edition coins (bullions) that are intended for collectors and investors.
We already learned that coins of the past were used as commodity money. The coins we use today are used almost exclusively as fiat money. If a country decides particular coins are no longer to be used as legal tender, they would be worthless overnight.
Coins usually have an image of a monarch, famous person, or national emblem on their “heads” or obverse side and other types of information on the “tails” or reverse side.
In today’s modern economies, very little money happens to be in physical currency. In the US, for example, only around 10% consists of coins and paper money.
6. Commercial Bank Money
Commercial bank money, demand deposits, or checkbook money are any funds held in demand accounts in commercial banks. It’s the money you keep in the bank that you can withdraw whenever you want.
When you check your mobile banking app, for instance, to check your balance, what you see on the screen is commercial bank money.
it’s interesting that today, in most countries, commercial bank money accounts for the majority of the money supply.
During the Great Depression, this type of money would shrink to a great extent as people did “bank runs” to withdraw whatever funds they had in their bank accounts and furthermore contributed to the severity of the crisis.
On the other side, during the financial crisis in 2008, commercial bank deposits increased dramatically ($310B>$460B).
7. Digital (Electronic) Money
Digital money is also known as digital currency, e-money, electronic currency, electronic money, etc. It represents any money currency or even money-like asset that is stored, managed, or exchanged on the internet or on computers.
We recognize three types of digital money:
- Virtual Money
Virtual money or virtual currency is an unregulated type of money issued and controlled by its developers and used in tight-knit virtual communities.
Central bank digital currency (CBDC) is a concept heavily inspired by bitcoin and other blockchain-based cryptocurrencies issued by central banks, as opposed to privately-owned companies.
Cryptocurrencies are a type of digital currency that is decentralized and doesn’t have a need for intermediaries (banks) when being transferred.
There are more than 20,000 cryptocurrencies at the moment, with additional ones coming out every day. The most popular and most well-known cryptos are Bitcoin and Ethereum, and they have the highest valuation of any other cryptocurrency.
Although most people think Bitcoin is the origin of cryptocurrency, the concept was developed 26 years earlier by American cryptographer David Chaum when he developed ecash.
There have been several exciting developments in the crypto space in recent years. For instance, China, which was the single biggest market for crypto, banned all cryptocurrency transactions in 2021.
The same year, El Salvador was the first country in the world that recognized Bitcoin as a legal tender.
On the other side, the cryptocurrency space is plagued by what seem to be endless scams, such as rug pulls where the developer team behind crypto pumps the token before disappearing with the funds, thus leaving investors with a valueless asset.
All cryptocurrencies are awfully volatile and go through a boom and bust cycle every couple of years.
Complicated digital wallet systems and transactions, as well as wasting incredible amounts of energy, makes them unsuitable for a currency that people would use on a daily basis.
There are many types of money. Some are used much more often than others, and some are supposedly the future of money.
Although we’re spending more money than ever, we definitely have less physical contact with it as most people use debit and credit cards instead of paper money, coins, gold certificates, barley, and similar.