In Economics, money is defined as anything that is generally accepted as payment for goods or services or in the payment of debts.

Anyway, no matter the form that money takes, whether we are talking about paper money, gold, or checking account deposits, it has three primary functions, it is first and foremost a medium of exchange, a unit of account, and a store of value.

That money is a medium of exchange means that it is used by economic actors to pay for goods and services, a unit of account means that money, in an economy, is used to measure value, and store of value means that it is a repository of purchasing power that is available over time and is used to save purchasing power from the time income is received until the time it is spent on the market.

In order to better understand the functions of money and the forms it has taken over time, it is useful to look at the evolution of the method of conducting transactions, the payment system, over time.

The payment system has been evolving over time, and the form of money has evolved together with it, in fact, at first precious metals like gold and silver or other commodities like coffee, pearls, and seashells were used as principal means of payment and were therefore also the main form of money in most economies.

Then, governments started to adopt paper assets such as currency and checks as means of payment, which then also became the only legal way to settle transactions in main economies, in fact nowadays you cannot pay taxes with a big bag full of seashells.

Finally, is also important to keep in mind that as everything else changes over time, even the payment system is constantly changing, in fact, we are seeing, thanks to new technologies, the introduction of electronic payment and electronic money (or e-money), money that exists only in electronic form, and that is changing the way in which we behave in the markets.

Commodity Money

As said in the introduction, money, in its original form consisted in different goods that shared one common attribute, they were universally acceptable, which means that everyone (at least in a certain market) recognized an intrinsic value to that given good, and therefore they were willing to accept it as a payment in exchange for certain goods or services.

The most common goods that have been used in these simpler economies were precious metals like gold and silver, or commodities like coffee beans and tobacco, or even other goods like pearls and seashells.

The problems with a payment system based on commodity money are numerous, in fact, commodities are generally hard to transport and store, which, together with the low standardization of these markets that led to the use of different goods as means of payment at the same time, made it hard to “price” things and to settle transactions, making it harder for economies to become more complex and grow.

Paper currency

The payment system then developed from the commodity money, with the introduction of paper currency which consists of pieces of paper that function as a medium of exchange.

Initially, these pieces of paper have been issued in the first place carrying a guarantee that they were convertible into coins or into a fixed quantity of precious metal (usually gold or silver) by the bank.

However, in more recent times, this system has evolved even more with the introduction of fiat money, paper currency decreed as legal tender by governments (which means that it must be accepted as legal payment for debts ) but not convertible into coins or precious metals.

Fiat money has value only because the government of a certain country maintains it, or because parties that engage in exchange agree on its value.

In this kind of environment, a central bank can introduce new money into the economy by purchasing financial assets or by lending money to financial institutions, then the system of commercial banks redeploys this base money into the economy by credit creation.

Paper money has many advantages that solve some of the problems related to the use of commodity money, in fact, it is much lighter than precious metals, coins, or other goods that were previously used as means of payment. Moreover, they have also solved the problems related to pricing that arose with the use of different forms of commodity money.

However, there are also drawbacks with this system, major ones are that coins and paper currency are easily stolen and can be also expensive to transport in large amounts because of their bulk that even if it is lower than commodity money is still relevant. In order to solve these major problems, thanks to technological developments in the banking world, we have seen the introduction of checks.

Checks

A check is an instruction from you to a bank to transfer money from your account to someone else’s account when he deposits the check, therefore allowing the transaction to take place without the need to carry around large amounts.

As said in the previous section, checks have been introduced in order to solve the problems related to the transportation of large amounts of paper money and coins, in terms of transaction costs, risks, and time. It has been made possible thanks to recent technological developments.

The introduction of checks in the economy has improved the efficiency of payment systems, and in addition to the lower transaction and transportation costs, they have reduced the loss from thefts.

However, even though technology has sped up processes, it still takes time to get checks from one place to another, which means that if your need for cash is urgent, receiving payments by check can be frustrating. Moreover, costs related to the processing of checks are high, which means that paying with a check for small sums of money, can be highly inconvenient.

Electronic Payment and E-Money

Another development that has been made possible by the improved technology of recent times, and in particular by the development of inexpensive computers, smartphones, and the spread of the Internet, is the introduction of electronic payment and e-money.

Electronic payment allows to pay bills electronically, which makes the process of paying bills cheaper and more convenient, especially with the possibility to set recurring bills to be automatically paid by deducting them from your bank account.

E-Money, on the other hand, consists of money that exists only in electronic form. There are three main forms of electronic money, that are used in different areas and therefore are designed for different purposes, debit cards, stored-value cards, and e-cash.

  • debit cards are the first form of e-money being created with the purpose of enabling customers to purchase goods and services by transferring funds directly from their bank accounts to a merchant’s account;
  • stored-value cards work in two main ways, in their simplest form they work like a prepaid phone card, which means that they are purchased for a set amount of money that the consumer pays upfront, or on the other hand, they can take the form of a smart card that can be loaded with digital cash from the owner’s bank account whenever needed;
  • e-cash is a form of electronic money that is widely used on the internet to purchase goods and services. Consumers can get e-cash by transferring cash that they have on their bank account, to an account with an online payment provider (like Paypal, Stripe, etc.).

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