Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value and sometimes, a standard of deferred payment. Any item or verifiable record that fulfils these functions can be considered as money.
Earlier last year, I understood money as the paper I held in my wallet or bank account. That's somehow wrong.
There are different types of things that can be seen as money. But before I can explore and explain how I see them today, there are a couple concepts necessary to bear in mind beforehand, so I can explain my current view of money.
Let's start with the island falacy.
The Island Situation
Imagine a piece of land, floating in the middle of the ocean. Now, put yourself in it. Only you live in this territory, no one else.
You dug the sand and found a chest. There, you can see a pile of US Dollars. It sums about 1 billion worth of units.
Although thrilled, you are not rich. You have nothing to spend that money with. It is simply a bag of paper. You put that aside and start working on a shelter for the night in this lonely island.
Building shelter is difficult for anyone who doesn't understand how houses are assembled, so you struggle with that for some time. If I were to offer you a hammer, or any other tool, you would gladly exchange that chest of money for that, because the former has more utility for you than the latter in this situation.
That's the analogy that many use to show how valueless Fiat Money is (Fiat is the technical name for the paper money government issues, by the way). But I have found it a bit misleading.
You don't live in a vacuum, so it is not honest to assume that if Fiat doesn't have value when you are alone, it has no value at all. So would be Gold, or Bitcoin, or any other type of money ever adopted. Its intrinsic value comes primary from being a medium of exchange.
New Actors in The Island
A ship just sank near of your island. Ten individuals have survived, and you welcomed them in your land. All of you know there is no way out now, so better keep used to the island life.
Fortunately, some of the new islanders is good with farming, other is great at hunting, other is a natural builder. You work together as a small community to make the life in the island bearable.
You can see where I am going with this: once you have a small community, you start developing a small society, with productive players who are able to create new good and services.
You play a role as well, it could be by helping organizing the island activities, or even producing something. For the sake of argument, let's distance now from the individuals and look at the group as an interconnected system.
Everyone is stuck in this island, they just want to live in peace, and they don't want to get exploited. Some are more productive than others, or can work smarter than the rest. It is safe to assume, then, the throughput of each individual differs, although there is an average to which the small community can be measured.
It is easy to manage a small community, but as years go by everyone notices it gets harder and harder to keep track of each ones responsibilities. At the beginning, you organized the island chores so everyone contributes, but at some point there is so much everyone can do, and a lot of time left to spare.
As the population grows, the islanders decide to come up with a medium of exchange, unity of account and store of value. A way that everyone can use to measure their throughput, or their production of good and services to the society.
Just like that, money is born.
Money Is Trust
Money is trust. Let that sink for a moment.
It is the trust you can redeem something in the future, for something good you've done in the past. It can be represented by anything.
Money is the materialization of trust among humans. We found a way to quantify, to put a number on it. Then, we pegged that number to some sort of object (paper, rock, food) that everyone can agree has value.
Gold has been deemed to be the ultimate type of money, but it is simply a rock. It is not even scarce, as miners can produce more gold per year, given the right incentives. The only difference between Gold and Government currency is where we get it from.
Therefore, to assume Fiat Currency has no intrinsic value is a falacy, because as long as a group of individuals believe it is useful, its network effect amid the individuals who use it is its intrinsic value.