What is Money? It's a G.A.M.E.
To understand Bitcoin’s significance, applicability, and potential, it is worthwhile to first understand money.
What is money?
Ultimately, money is a representation of value.
Value is created through time and effort, which can then be stored or transferred as money. Historically, many different things have functioned as money, from shells to metal coins to paper notes.
When discussing the future of money, it is valuable to consider what functions money serves, which are often given as threefold:
Store of Value: People hold money because it can store the value of their time and effort.
Unit of Account: Prices are denominated in terms of money as a way to measure value.
Medium of Exchange: People transact with money as a way to exchange value.
People store value in dollars until they find an attractive price for a good or service for which they exchange their dollars.
When looking at this three-part definition it is useful to understand that not all three are equal. It is possible for something to be used as money even if it is not commonly used as a unit of account or if it is a poor store of value.
During periods of high-inflation as has been the case in Venezuela, some businesses have denominated prices in dollars, which are more stable at holding value than Venezuelan bolivars. Using dollars as the unit of account prevents the need to adjust prices on a weekly or daily basis. However, without a reliable supply of dollars circulating in the country, customers may need to use bolivars instead, with the dollar-to-bolivar exchange rate being calculated at the time of transaction. The $2 coffee could be paid for with 500,000 bolivars.
In such cases, the dollar is used as the unit of account whereby people make economic comparisons, but the Venezuelan bolivar is used as the medium by which value is exchanged. The bolivar is the money because there are no actual dollars used in this transaction, only the abstraction of a dollar.
It is also common in periods of high inflation for people’s spending habits to be strongly influenced by their money. In Lebanon, holding inflating Lebanese pounds for any period of time all but guarantees the loss of value, thereby encouraging people to spend their paycheck as soon as they receive it. A money’s ability to store value can vary widely while still functioning as a medium of exchange, albeit an inconvenient one.
In extreme cases of inflation, a money’s inability to store value can impair its use as a medium of exchange to the point of collapse. As money loses value at an accelerating rate, people will increasingly be incentivized to spend it as soon as they receive it. If such an incentive becomes too extreme, to the point where people want to spend it before they receive it, then people will abandon their local currency as a medium of exchange. Under such circumstances, people will seek alternative means of exchanging value, such as a barter system.
These examples demonstrate that a perception of sufficient store value properties is a prerequisite for a money to be generally accepted as a medium of exchange. Achieving general acceptance is evidence that a money is perceived to acceptably store value, just as the abandonment of a money demonstrates the perception that it insufficiently stores value. A money’s use as a unit of account is a byproduct of its use as a store of value and medium of exchange.
Therefore, money can be defined as anything that achieves General Acceptance as a Medium of Exchange (GAME).
Money does not have to be paper or metal, it does not have to be sanctioned by the local government, and it does not need a long history. Money simply needs general acceptance.
To understand the future of money, it is important to recognize that the current manifestations of money, such as dollars, euros and yen, are merely the latest in a long evolution of GAMEs. If a new asset were to emerge that was competitive in terms of its abilities to store value or be used as a medium of exchange, then free markets may begin to use it as money. If that new asset were to gain sufficient popularity, to the point where it gained general acceptance, then that new asset would be money.
Just as there were GAMEs prior to the money we commonly use today, so too could there be a future where a new money renders predecessors obsolete.
In the next piece we will examine how to compare the competitiveness of different monies’ ability to act as stores of value or mediums of exchange.