Money is a technology used for the communication of economic value between multiple parties. Its three main functions or uses can be summed up as:
- Unit of account: Measures the economic value of goods, products and services. This is also how we can attribute prices to things.
- Medium of Exchange: Money is a payment method that facilitates economic transactions between users. To avoid the limitations of barter, we need an intermediary token when buying any good, product or service.
- For example, instead of exchanging IT services for food, IT engineers can exchange their services for money, allowing them to buy the food.
- Store of value: Money will keep its economic value (power) through time and space. If you work today and earn X amount of coins (USD,JPY, etc.), you can hold on to the money before spending them. This is because it will hold its value until tomorrow, next week, or even next year.
Characteristics of Money and Bitcoin
- Durable: Any item used as money must be durable. If money is not able to retain its value, it will not be usable for future exchanges. For that reason, any item used as money must have a stable value. Even early societies recognised this and used long-lasting paper and metal money, rather than perishable goods like bananas or apples.
- Compared to paper money, Bitcoin is more durable since it is a digital asset and does not suffer any type of erosion.
- Divisible: Money must be capable of being divided into smaller parts. Divisible forms of money help make transactions of all sizes and amounts possible.
- One Bitcoin can be divided into up to eight decimal places, with constituent units called satoshi. So although there will exist “only” 21 million Bitcoins, each Bitcoin can be divided into 100 million satoshi. For each unit of Bitcoin, you can have up to 100 million different values for unitary transactions, in satoshi. Comparatively, with dollars and euros you can only have up to 100 different values, in cents.
- Fungible: Units of money should be similar enough that they are interchangeable with one another.
If different units are too dissimilar, their value for use in transactions could become unreliable or inconsistent. If you were to use a non-fungible good as money, the transaction costs would go up because it would be demanding to evaluate the value of all involved units.
As a borderless, apolitical and censorship resistant money, Bitcoin has achieved significant fungibility, and usually trades at roughly the same price across the globe.
- Portable: Money must be easily moved around from one location to the next. Large or bulky items, such as boulders or heavy gold bars, cannot easily be transported from place to place.
Bitcoin is a nonphysical asset, and can be sent and received from anywhere with an internet connection. It also operates entirely outside the banking system, so it is easy and fast to send and receive payments across borders.
- Verifiable: The authenticity and quantity of a good must be clear and verifiable to users. If not it is not, users will find it hard to agree upon the terms of an exchange. Using a non-recognisable good as money will lead to transaction costs of agreement on the authenticity and quantity of the goods – affecting all involved parties.
Every Bitcoin transaction is verified by the Bitcoin network nodes (miners). The network combines cryptography, mining algorithms and consensus mechanisms to ensure that digital money is not easily duplicated. This way, double-spending problems are prevented.
- Scarce: In order to maintain its value, money must have a limited supply. Money should be scarce enough to have value, but not so scarce that it becomes unavailable.
As an example, pebbles meet some of the other criteria but would not work well as money because they are too widely available. Too much money in circulation increases prices and inflation. Governments control the scarcity of money by limiting the quantity of money in circulation.
Bitcoin is the first digital asset that cannot be replicated. Unlike fiat money that is continuously being inflated, Bitcoin has a maximum supply of 21 million, guaranteeing that it is a scarce asset.
- Acceptable: Money should be commonly accepted. If a person does not know that the money they receive in exchange for their goods or services will be taken without any objection by others as well, they will not accept it as pay.
Bitcoin is already accepted by many merchants as a payment method to buy things like coffee, food, electronics, cars, houses, and so on. El Salvador was the first country that adopted Bitcoin as legal tender, and other countries will follow the same road.