Notes on Money

Definitions, Clarifications, Economic perspectives

Why Do We Use Money in the First Place?

I would highly recommend reading all the work of Saifedean Ammous, particularly The Bitcoin Standard, The Fiat Standard, and Principles of Economics, where these concepts are explained in depth. If you are interested in even deeper study, please consider joining Saifedean's online academy, where you can also take courses on these concepts, discuss them in depth with other students, connect with them, and join the live weekly seminar discussions.

In this guide, I'll only briefly touch on very general ideas that will help you grasp the basics, but it will be worth your time to delve into this deeper if you choose to do so.

Before delving deeper into using Bitcoin as your primary money, it is important to understand the fundamental purpose of money. According to the Austrian School of Economics, money is defined as a widely accepted medium of exchange. However, for practical purposes, we can refine this definition slightly: money is any economic good that you use not because you intend to consume it or produce something else with it, but because you expect to exchange it for something else at a later time.

Considering this definition, we can observe that people have utilized a variety of goods as money throughout history. But the key question is: why do we need a medium of exchange in the first place? Why not simply engage in direct barter of goods and services?

The Problem of Direct Exchange

People engage in trade of goods and services because they value them differently. For example, person A has oranges, and person B has apples. Person A wants apples, and person B wants oranges. They trade, and both are better off because they now have something they value more than what they gave up.

However, this kind of direct exchange quickly runs into a problem called the double coincidence of wants. What if person A wants apples, but person B doesn't want oranges? Without a medium of exchange, the trade cannot occur.

A medium of exchange solves this problem. For example, if person A trades their oranges for bananas with person C, and then trades the bananas for apples with person B, the bananas acted as a medium of exchange. Person A didn't want the bananas for their own sake, but used them to obtain what they really desired - the apples.

What Makes a Good Medium of Exchange?

While any good can potentially serve as a medium of exchange, some are more effective at this role than others. The effectiveness of a medium of exchange is determined by its salability - how easily it can be exchanged for what you actually want. Salability can be measured across four key dimensions:

1. Salability over time: How well the value of the medium holds up over time. Fiat money, for example, loses purchasing power due to inflation, which is why people often use other assets like real estate, stocks, or precious metals to store value. Bitcoin, with its fixed supply of 21 million units, has superior salability over time as it cannot be inflated.

2. Salability across space: How easily the medium can be transferred across distances. Fiat money can be moved electronically, but this process can be slow, expensive, and subject to censorship or reversal. Other forms of money, like gold, are even more cumbersome to move across space. Bitcoin, on the other hand, can be sent anywhere in the world quickly, securely, and without permission, making it highly salable across space.

3. Salability across scales: How well the medium works for both small and large transactions. Bitcoin excels here because it can be divided into tiny fractions (satoshis) for small payments or used for large transactions without losing efficiency. Real estate, when used as money, cannot be easily divided up for small payments; it can only be liquidated all at once.

4. Salability across goods: How widely the medium is accepted in exchange for other goods and services. Fiat money is currently the most widely accepted form of payment, but Bitcoin is rapidly gaining traction as more businesses and individuals adopt it.

Considering these dimensions of salability, we can see that Bitcoin possesses several advantages over traditional forms of money, making it a highly effective medium of exchange.