Functions of Money
Imagine you catch fish and want a pair of shoes, but the shoemaker doesn't want fish today, she wants bread. You'd have to find someone who wants your fish AND has bread the shoemaker wants -- a chain of lucky matches called the 'double coincidence of wants.' Money exists to erase that problem entirely.
What You'll Learn
- Identify the three core functions of money: medium of exchange, store of value, unit of account - Explain why barter breaks down at scale using the double coincidence of wants - Compare historical forms of money (cowrie shells, silver coins, paper notes) against these three functions - Evaluate whether an asset like Bitcoin or gold fully satisfies all three functions
Function 1: Medium of Exchange
Money's most basic job is letting you trade your labor or goods for anything else without needing a matching partner. Ancient Chinese markets used cowrie shells as early as 1200 BCE; Lydia (in modern Turkey) minted the first standardized metal coins around 600 BCE under King Alyattes. Both solved the same problem: a widely accepted item everyone would take in trade.
Function 2: Store of Value
Money should hold its purchasing power over time so you can save today and spend later. This is why fish makes bad money -- it rots in days. Gold has been prized for this function for millennia because it doesn't corrode. But store of value can fail: during Germany's 1923 hyperinflation, prices doubled roughly every two days, and people spent wages immediately because cash lost value by the hour.
Hyperinflation destroys money's store-of-value function even while it may still work as a medium of exchange for a few hours. Venezuela's bolivar lost so much value between 2016 and 2019 that some vendors weighed cash on scales instead of counting it.
Function 3: Unit of Account
Money lets us compare the value of very different things using one common scale. Instead of saying 'a cow is worth 40 loaves of bread or 3 goats or half a canoe,' we can say a cow costs $800, a goat costs $200, and so on -- one shared yardstick for every price tag, contract, and accounting ledger.
Testing Modern Examples
Does gold pass all three tests today? It's a decent store of value and unit of account historically, but it's a poor medium of exchange now -- nobody hands over gold flakes at a coffee shop. Does Bitcoin pass? It works as a medium of exchange in some places and could serve as a unit of account, but its price swings (it fell over 60% in 2022 alone) make it a shaky store of value compared to a stable currency.
A society uses seashells that are widely accepted for trade, but the shells crumble to dust within a month. Which function of money does this system fail?
What problem does money primarily solve compared to barter?
Match each money function to its real-world example.
Terms
Definitions
Drag terms onto their definitions, or click a term then click a definition to match.
Design Your Own Currency
Invent a currency for a small island community (name it, describe what it's made of). Write 3-4 sentences explaining how your currency satisfies each of the three functions: medium of exchange, store of value, and unit of account. Then identify one weakness your currency might have and how the islanders could fix it.
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