The history of human beings using currency is as old as history itself. Currency in the most specific sense as money has evolved over the millennia from natural objects to coins to paper to digital versions. We have long used currency as a medium of exchange, a method of payment, a store of value, a unit of account, a symbol of power and a standard of wealth and social status.
Originally and even before the beginning of written history, money had an explicit link to value. These included livestock and grain–things directly useful in themselves – but also merely attractive items such as cowrie shells or beads were exchanged for more useful commodities.
Later on as humans took increasingly specialised roles and as central governance and laws appeared, objects that occurred rarely in nature and its supply and circulation could be efficiently controlled – from shells, salt, cows to gold emerged as a currency for trade and exchange. The direct link between money and the inherent value would soon disappear.
Money needed to possess the qualities of portability, durability, transportability and generally accepted value. Cows were not easy to transport. They could die and lose the value.
Money soon turned into a means of political control and power. And stability, civil society as it became an alternative to the use of force – a nonviolent method and movement of exchange of goods and services within and between groups.
Here emerged a standard of value – an agreed-upon worth for a transaction in a medium of exchange: the value of goods and services needed be comparable and consistently determined. And a store of value – it needed to be in form that can saved, retrieved and exchanged at a later time, and be predictably useful and equivalent to its original value when retrieved. This also lead to precious metals being widely adopted by most societies as money. Well, you know the modern history of money where paper with numbers on it started to represent precious metals. And since the early 1970s, the world has stopped trying to keep to a gold standard.
Fast-forward, and currencies embraced the concept of lex monetae – a Latin phrase which means that a sovereign state legislates which currency it will use and controls its value.
Today there is a lot of buzz – both interest and intrigue around cryptocurrencies – bitcoin and altcoins. Nobody knows if any of them are here to stay. However, we know the qualities survived over the millennia are here to stay and any currency that will stay must adhere to these characteristics to be a good currency. And more importantly, not become a cow or salt in the history of money.
So what are the key characteristics of a good currency? What makes a good currency? What are the qualities and features that make money simply money?
These questions are not new to the humankind. Back in their day, Ancient Greek philosophers, including Aristotle -the father of modern science and economics – scratched their heads on these questions to explain what qualifies as a good currency.
- Stability. A currency should hold its unit of account or purchasing power in the foreseeable timeframe. A unit of account means a measurement of value. If the value of money keeps fluctuating it simply fails to be a measure of value, a medium of exchange or a standard of deferred payment.
Example: If I sell my car to you for a coin, I should still be able to use this coin to buy a similar car next month. If it happens that the car is worth 2 coins or if this coin can buy 2 cars tomorrow, I wouldn’t sell my car for 1 coin and you wouldn’t pay 1 coin for a car today. Just imagine if you agree to sell your home to me for a coin and we decide to go to register the transfer next Monday. what would happen if Elon Musk tweets the currency up or down on Sunday? A currency that changes drastically in the meantime can’t simply be a means of exchange, let alone something to ensure a store of value. So, a stable currency is in the best interest of everybody.
- Divisibility. It means a 100-dollar bill can be exchanged for other denominations, say five 20-dollar bills and is still worth the same (it can be changed back to a 100-dollar bill without any loss in value or can buy what a single 100-bill can buy). For example, gold survived cows as a means of exchange as a cow wasn’t easily and readily divisible into small increments (a cow could be cut into small pieces but the pieces become useless).
- Portability. This defines how easily, conveniently or safely you can carry or store your money. For example, if you want to give some money to your friend, giving an 100-dollar bill has advantages over a cow or gold. To some extent, this comes down to transferability in the modern sense. For example, how fast, securely, economically (at minimum loss/cost) and conveniently you can transfer from one part of the world to another where what your friend receives is of the same or similar value. It means the fees of transaction must be closer to zero for it be worth nearly the same (minimum loss of value during the transfer).
- Acceptability. It is broad term. Even though salt or cows have intrinsic value, not everybody would accept them as money. However, nobody would reject a 100-dollar bill as they can use the paper money to buy salt or a cow if they want to. Acceptability to certain extent overlaps with portability due to the fee of exchange or transfer. Exchanging salt or a cow would cost a higher fee and discourage their acceptability because there is less competition or demand to get it from you. Therefore, a good currency should have an exchange or transfer/transaction cost closer to zero to achieve broad acceptability. Acceptability also refers to how easy it is to use it as a good currency should be friction-free and understandable by everybody. Acceptability further indicates legislated value or adoption by the government. For example, to legally qualify as money, a means of payment must be granted a status by a country’s laws as its official monetary unit.
- Durability. Although it originally referred to the physical properties such as the preservation of shape, form, and substance over an extended period of time, this is more associated with its long-term value retainability and absolute stability in the modern economics. Therefore, durability is an important feature of the money for medium of exchange and store of value. A currency can only work as a medium of exchange if it stores value from one transaction to another over a long period of time. The example in the Stability section above is relevant here too.
- Scarcity. Also called paucity, scarcity denotes a gap between limited resources and theoretically limitless wants. So, essentially the notion of scarcity is that there is never enough of money to satisfy all conceivable human wants, even at advanced states of human technology. Scarcity involves making a sacrifice—giving something up, or making a trade-off or working hard to acquire it —in order to obtain more of the scarce resource that is wanted. This necessitates competition for scarce resources, and defines and retains value for exchange.
For example, although air is more important to us than gold, it is less scarce simply because the production cost of air is zero. Gold, on the other hand, has a high production cost. It has to be found and processed, both of which require a lot of resources. As a result, if I offer you some air, it has value of exchange for you. If I offer you some gold, well, your eyes get popping out of your head.
- Fungibility. Fungibility defines the property of a currency whose individual units are essentially interchangeable, and each of its parts is indistinguishable from another part. For example, there is no difference between one dollar and another dollar. If I borrowed one dollar from you, what I return to you tomorrow does not need to be the very 1-dollar coin.
- Elasticity. This denotes adaptability of the currency to the changing economic environment to maintain a good or fair medium of exchange. For example, an interest rate change regulates money supply or volume to control its scarcity against the changing demand in a fast or slow growing economy.
Another example is the population growth which means the money supply needs to adjust up to prevent it from being more scarce (hard to acquire or expensive). This comes down to inflation and deflation management in the modern economics.
- Storability. This originally referred to physical (compact) storability but nowadays it is more widely used to denote storability in terms of ever-evolving cyber challenges and sometimes liquidity. For example, a cow is hard to store both physically and from thieves. Gold can be lost or stolen and it might be hard for you to prove it at court while the money as your bank account balance is less likely to be lost or stolen without a trace.
- Liquidity. Liquidity stands for the ability of a currency to be quickly exchanged for another currency or asset. In general terms, a liquidity ensures transactions can take place readily, with low transaction costs and little impact on price or value (exchange rate). This essentially means that there are many sellers and buyers in the market. For example, the US dollar and the euro are highly liquid currencies and can be used almost anywhere to exchange to another local currency.
Illiquidity is the opposite of liquidity and occurs when a currency cannot easily and quickly be sold or exchanged without a substantial loss in value. This may cause volatility.
Cryptocurrencies are a new breed of proclaimed currencies that are gaining popularity for their volatility as digital assets rather than actual currencies. Although none of the currently available cryptocurrencies satisfy the basic characteristics of a good currency to stay, it does not mean we will not have a good digital currency in the future.
In the next post, we will look at why 99% of the current cryptocurrencies will quietly end up in the the ash heap of history.