Money Fundamentals

Definition of Money

Money has many definitions. The multitude of definitions is a source of confusion. Aristotle defined the following as the most basic absolutes of money:

• Durable - Simple enough.

• Portable - or Easily Transferable.

• Divisible - or Serves as a Unit of Measurement. (We clarify this below)

• Intrinsically Valuable - Let’s change that to Has or Represents Value.

The first two conditions describe a technical issue that can easily be resolved with today’s technology. The two last conditions touch, IMHO, the true essence of money. Money measures something and it has or represents value. An alternative definition we offer here is the following. Money is anything that you can:

• Give (to others and they will be willing to get it from you)

• Get (from others, regardless of their willingness)

• Hold (for future Give or Get)

This may seem simplistic, but we challenge you to provide something that most people would reject as de-facto money and that, at the same time, meets these criteria, and vice versa, something that most people would consider to be money and that does not meet these criteria. We tried and could not find such examples.

Valuation of Money

Determining the value of any currency (cryptocurrency or FIAT) can be done in three ways:

• Market Supply and Demand. Allowing the “free” market to set the exchange rate in, theoretically, perfect, frictionless and free exchanges.

• Growth-rate of Source(s) of Value. Measuring the positive or negative growth rate of the sources of value that are reflected in its exchange rate and adjusting its supply to fit that rate. Central banks (try to or are supposed to try to) do that in order to reduce the risk of toxic inflation/deflation.

• A bit of both. The exchange rate of most, if not all, FIAT currencies is set by both floating rates in free markets and by the actions of central banks that have control over some of the supply.

Intrinsic value and representation of value

We’ve all heard the claim that some types of money do not have intrinsic value. Some people have said that about cryptocurrencies, others have said that about the US dollar. What are the implications of this debate? This question becomes more pronounced when one looks at the crypto-token markets with their massive value fluctuations and crashes.

Here’s our position: there’s a confusion between money having or not having intrinsic value and money being a function of real value created by a group (company, ecosystem or country). Money doesn’t have to have intrinsic value. Money needs to reflect value. Indeed, we have been using money that has zero intrinsic value for a while now and it seems to be working fine (without implying that it doesn’t represent actual value).

Underlying Value can exist without tangible collaterals

What about the claim that if there are no specific, tangible assets backing a currency, perhaps it has no sources of value, and the only determinants of its value are the “free” markets and the feeble actions of central banks. The fact that the “free” market is probably the most dominant determinant of the value of money does not mean that money does not have sources of value (it’s an enthymeme). We claim that all currencies reflect actual work-driven, underlying value created in the world and appreciated as such by users. This “underlying value” is hidden underneath the local exchange-rate fluctuations (that can be the result of a variety of volatility-inducing events or manipulation or both).

Currency Stability

The interesting question is the relationship of the money being minted and the Underlying Value created by the entity minting it. On a long-enough time-scale, and after cleaning out the local fluctuations, we will see that if there is a lasting discrepancy between the traded value (exchange rate) and the actual Underlying Value, the traded value will eventually correct to fit the Underlying Value. In simple terms, if ecosystem X issues a currency and if ecosystem X’s economy underperforms (i.e., the sources of underlying value are not as productive as they should be), its currency exchange rate will, eventually, drop proportionally. Even without tangible, clearly visible backing assets, all currencies reflect Underlying Value and have “sources of value”. Moreover, if the rate in which an ecosystem issues currency is different (faster or slower) than the growth rate of the growth of the economy that it represents, it will lead to inflation/deflation and devaluation/revaluation of the currency. If the money is completely disconnected from the actual value being created, there is almost a certainty that such discrepancies will occur, and they can become toxic very fast. If we have something that is measurable, countable, fungible and directly connected to the Underlying Value, we have a good candidate for a new currency that is less likely to suffer toxic fluctuations.

Source of Underlying Value

Here are the assumptions we use when we describe the source of Underlying Value:

• The source of Underlying Value is the energy invested through purposeful action. This means two things:

  • The only way to create new underlying value is by adding energy (work) to the system.

  • That energy being invested is “directional”. If it promotes the purpose of the economy, it creates new value. If it impedes, it destroys existing value.

• Different actions (invested energy), applied by different agents, at different times and circumstances create/destroy value at different rates.

• It’s possible to measure the value created/destroyed.

• It’s possible to change the unit of measurement over time without destabilizing the economy.