What is money?

Special thanks to Panagiotis Michalopolous for insights and discussions.

We all are familiar with the most common use case of money: it is a store of value and medium of exchange. At least that is what we learned in Economics 101. However today, we will dig deeper by investigating the following questions: What does money mean in the contemporary world? How has it evolved with time? What are the properties of money?

I will answer the above three questions starting from the last one. “Money can be anything that has an underlying consensus coming from belief and acceptance by a large number of people.” The reason for this consensus can vary, but in each case, a consensus in some form exists giving value to money. Moreover, the size and quality (something dependent on human beliefs) of the underlying population decide the confidence that one might have in a certain form of money.

Let us now dive deeper into some of the properties that have gained the consensus of the human population for money. Such properties, later on, became “monetary” value.

1. Scarcity: Natural resources such as shells, pearls, jewels, etc are created in nature (at least until 500 years ago). Unlike other rocks and sand pebbles, these resources are more scarce. The scarcity of these materials is pretty evident to any human. Therefore, humans gathered an unsaid consensus on the scarcity of these materials.
2. Usefulness, resourcefulness, and technology: Entities such as land, sheep, and water are known to humans to provide usefulness in day-to-day lives. Such common knowledge and beliefs gathered a human consensus about the uses of these resources. Resources like iron and copper cannot be used directly however there are intermediary institutions that process them and create a useful product for large masses. Therefore, in this case, the consensus for resourcefulness is delegated to certain central institutions by a large number of people (what we call customers).
3. Representation of a community: This is one of the most important and powerful concepts to understand money these days. Gold was used as a medium of exchange until paper money was introduced. Paper money or artificial money has usually been backed by a commodity that is scarce or resourceful. But nowadays, the most important value in paper money comes from the signature of the government. If we dig deeper and ask what exactly is a government, turns out that a government is an institution that represents its population. Essentially, social consensus gives rise to institutions (governments), governments put their signature on a piece of paper which eventually gives value to coins and bills.

Now, we have the tools to calculate the monetary value of an object: scarcity, usefulness, acceptance by the population, and size of the population (independently increasing the monetary value).

Difference between wealth and money:

Personally, I believe that wealth is a conventional notion of money. Wealth is derived from well-being i.e. wealth is the old notion of money. If we look at the factors affecting the value of an object, we can observe that the first and second factors (scarcity and resourcefulness) are intuitive and natural to the human mind whereas the third factor is artificial/social/man-made. Therefore, anything that is scarce or useful can be considered wealth including land, gold, and cars whereas anything getting value from the representation of a community is generally not considered wealth. On the other hand, since wealth is a subset of money (it shares the first two factors), wealth also means money.

Can money be created out of thin air?

Nowadays, many people are confused about the new forms of money such as stocks, cryptocurrencies, NFTs, etc and they wonder whether money can be generated out of thin air. The answer is an absolute yes. Let's try to investigate whether we can generate any one of the above three properties out of thin air.

1. Scarcity: By definition, something being scarce implies that no one can generate more of it. However, the introduction of cryptocurrencies with the Nakamoto consensus gave a novel way to create scarcity of digital assets using cryptography and game theory.
2. Resourcefulness and technology: We have been working tirelessly since the onset of the industrial revolution to build technology and resources: not just for some individuals but for the whole society; not just for a couple of years but for the next 100 years. But where can we find the monetary value of the resources that we built? Well, part of the monetary value went into the physical infrastructure like metal, factories, and end products and the rest of the monetary value (which represents a majority of the total value) started accumulating in the technology. One way in which we created monetary value out of these technologies was by creating stocks for the businesses that use them.
3. Representation of the community: It is relatively easier to understand how this property can be generated out of thin air. We just need something that concretely represents a community. For example, take stocks. Each stock represents its underlying business which not just consists of the technology and resources that it owns but also the consumers that it affects. Another interesting example is bitcoin which represents the consensus of miners who verify the correctness of its transfer and the coin holders who believe in this coin. One can see that bitcoin doesn’t have value only due to its scarcity. Even if Bitcoin had an inflation rate of 50% p.a., it would still have some monetary value (no matter how meager). This is because bitcoin represents more than just its community. Being the first cryptocurrency, it also represents (to some extent) the technology behind it. And lastly, it also represents its resourcefulness in being a medium of exchange. But do we know something that has very little of the first two properties (scarcity and resourcefulness) and is dependent solely on the third property (representation of its community)? The answer to this is a meme coin. Yes, meme coins like Dogecoin do have real monetary value and people like Elon Musk can leverage the power of Twitter to create real monetary value out of thin air by strengthening the consensus of a large community by making them believe that the coin has a loyal community. Yes, there is positive feedback here (sometimes called a Ponzi scheme) but what isn’t a Ponzi scheme in the capitalistic economy? (To be discussed later).

I hope that you enjoyed my perspective on monetary values. Let us see what other properties of money are discovered after the introduction of cryptocurrencies.