Money has taken on many different forms throughout history. While the basic functions of money—as a medium of exchange, a unit of account, and a store of value—have remained constant, the physical and conceptual forms of money have evolved significantly.
Here are the main types of money, as categorized by economists:
1. Commodity Money
This is the simplest and earliest form of money. Commodity money is a good that has intrinsic value, meaning it has value in and of itself, separate from its use as money.
How it works: The value of the money is derived from the commodity it is made of. The item used as money could also be used for other purposes. For example, a gold coin has value as a medium of exchange, but the gold itself can also be used for jewelry or other industrial applications.
Examples: Historically, this included things like gold, silver, copper, salt, shells, cattle, and even cigarettes in some specific situations. The gold standard is a famous example of a monetary system based on commodity money, where a country's currency was directly linked to a fixed amount of gold.
2. Fiat Money
This is the most common type of money used in the world today. Fiat money has no intrinsic value; its value is derived from a government’s decree that it is legal tender.
How it works: The word “fiat” comes from the Latin for “it shall be.” The value of fiat money is based on the public’s trust in the government that issues it and the stability of the economy it represents. The government controls the supply of money through its central bank, which is a key tool for managing the economy.
Examples: The U.S. dollar, the euro, the Japanese yen, and the British pound are all examples of fiat money. The physical paper or metal of a banknote or coin is virtually worthless, but the government's declaration and the public's acceptance of it as a medium of exchange gives it value.
3. Fiduciary Money
Fiduciary money is a type of money that takes its value from a trust or a promise of payment. Its value is not guaranteed by the government, but by the confidence that the issuer will honor the promise.
How it works: The key is the trust between the two parties in a transaction. The money itself is essentially a representation of a debt or a claim on an asset.
Examples: A check is a classic example of fiduciary money. The piece of paper itself has no value, but the person accepting it trusts that the bank will honor the check and transfer the corresponding amount of fiat money. Banknotes are also sometimes considered a form of fiduciary money, as they were originally a promise by a bank to pay a certain amount of gold or silver to the bearer.
4. Commercial Bank Money
This type of money is the most prevalent form of money in modern economies. It exists primarily as a digital record within the banking system.
How it works: Commercial bank money is essentially the debt generated by commercial banks in the form of loans and credit. When a bank gives a loan, it creates a new deposit in the borrower’s account, which increases the money supply. This money is used for payments and transactions through various electronic means, such as debit cards, wire transfers, and online banking.
Examples: The balance you see in your checking or savings account is a form of commercial bank money. It's not a physical pile of cash sitting in a vault, but rather a digital entry representing the bank's liability to you, which you can then use to make payments.
The Relationship Between the Types
In a modern economy, these types of money are intertwined.
Commercial bank money (digital balances) is a claim on fiat money (cash), and fiat money itself is the base currency.
Fiduciary money (like checks) is a tool used to transfer commercial bank money.
The entire system relies on a combination of government authority (for fiat money) and the trust and confidence of individuals and institutions (for fiduciary and commercial bank money).