Thoughts and ideas on people and technology.
January 20, 2025
“What is money?” sounds like a bit of a silly question. You’d probably hold up some cash or maybe flash your debit card. But I challenge you with this: imagine a 5-year-old asking you this question. How would you answer? If you showed them a $20 bill, they might respond with, “I know that’s a money, but what is it?” If you manage to explain that the bill is worth $20, they’re next question is going to be, “how many is your card?” How would you answer that? At some point you’d probably end up trying to distract them with something else while you worked to ignore the dread feeling that you should have those answers, but don’t. Never fear, for we will attempt to explain it in such a way that you’ll have an answer for 5, 15, 50, or 95-year-olds by the time we’re done this 4-part series!
Let’s start with an overview of the history of money. I highly recommend further reading on each of these; we’re going to skim most of them today. In the beginning, there was simple barter. If we each had something the other wanted, we could trade. But if the scale of what we want to trade is lopsided, say, chickens for a cow, or cows for a house, how do you make the trade work? Or what if you wanted to save up for a larger purchase? The answer is a placeholder; something that represents value in trade. An early example of this is the rai stones in Micronesia, which are essentially carved rocks. These worked well for store of value and medium of exchange, but not so much for unit of account. Precious metal coins arose later, with the most common being gold, silver, copper, and bronze. These worked well for all three of the major elements.
Store of value, medium of exchange, and unit of account are the three major elements of any system of money. Store of value means it holds its value well over time. If you put a gold coin in a box in your house and retrieve it 10 years later, it’s still a gold coin and should be in the same physical condition as it was when stored. Medium of exchange means it’s widely accepted for trade. This one is a bit trickier, but if you’re the Roman Empire you can simply make everyone accept denarius. Unit of account means units should hold the same value everywhere they’re used. This is similarly tricky, but if you’re the Dutch East India Company you can simply make VOC-stamped coins global denominations.
Renaissance-era Italy is where modern banking was born. A key concept invented during this time was the double-entry ledger, or double-entry bookkeeping system. In short, every transaction is recorded, and every transaction has two entries: one with an amount leaving an account, and one with the same amount going into a different account. At the end of every block of time all accounts will have an aggregate balance of 0, with individual accounts either having a credit or debit. This system is still in use today, as well as the broad use of credit notes in place of coins or direct trade. Credit notes could be written against an account and given in trade, and later the receiver could take the note to the bank, who would then record the transaction as complete. If this sounds familiar, that’s because modern cheques are the same thing.
Modern money systems take these concepts a step further. Banks now maintain a whole network of double-entry ledgers and in most countries banks are no longer required to hold reserves matching their credit notes issued. Credit notes are also the total physical currency, also known as a fiat currency, or currency by authority or decree. This essentially means fiat money has no intrinsic value other than the promise of the issuing authority to treat it as valid and the willingness of others to accept it in trade. For an example of “willingness to accept in trade”, many retail stores in Canada will accept American dollars even though they’re not required to.
If you’re now thinking, “thanks for the history lesson, but what does this mean to me and the payment terminal in my store?”, the answer will come 2 weeks from now when we cover the Canadian dollar. In the meantime if you want to learn a bit more about the systems our modern money is based on, read up on the Roman Empire and their currency, as well as that of the Dutch East India Company. If you really want to dive deep, Renaissance Italy’s banking systems are also fascinating and a little closer to us on the timeline.
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