Money is something that fulfils the following three roles:
- Medium of exchange: Money needs to be something that is commonly and widely accepted as a way of paying for a wide range of goods.
- Unit of account: It should be possible to add and subtract quantities of money, and use the amount of money as a way of keeping track of things. The more divisible money is, the better.
- Store of value: It should be possible to store money for the future. The less likely money is to rot, spoil, or decay with time, the better.
Note that what is treated as money within a local community or economy need not be treated as money in a different economy, or even in the same economy at a different time period.
Types of money
Commodity money: physical goods of intrinsic value as money
Further information: Commodity money
Economies at various times in history have used certain physical goods of intrinsic value (i.e., valuable in their own right) as money. Typical goods used as money are:
- Precious metals, such as gold, silver, copper: Till the beginning of the twentieth century, many of the world's major currencies were pegged to a gold standard, i.e., every unit of currency corresponded to a claim on a fixed amount of gold.
- Salt: The word salary, as well as phrases such as worth my salt, derive from the use of salt as money.
- Cowrie shells.
- Tobacco: In the United States, tobacco was used as currency in the eighteenth century. During World War II, cigarettes were a currency used in war prisons and concentration camps in Germany.
Further information: Paper money
Paper money is money that holds no intrinsic value. Rather, its value comes from the fact that it can be used to claim something of value in the future. The success of paper money depends on the credibility of the person or organization on whom the claim can be made in principle. The typical form of paper money is fiat money, which is paper money issued by a government and accepted as legal tender (discussed below).
Further information: Fiat money
Fiat money is a unit of currency that is accepted as money by a governmental decree. The government may lend legitimacy to the currency, for instance, by accepting it as legal tender, allowing its use for the payment of taxes, and forbidding people from printing units of the currency. Typically, the only organization allowed to print fiat money is a central reserve bank and it needs to follow certain guidelines.