What is money

Money is something we encounter everywhere in daily life, whether it be banknotes and coins, book money held in bank accounts or digital money on cards and smartphones.

It is not important what money is made of, or what form it takes. What does matter is that it is generally accepted as a means of payment. Money must perform three functions:  it must serve as a medium of exchange, as a unit of account and as a store of value.

Money is primarily used as a means of exchange and payment. Exchanging goods for goods is cumbersome. Without money, there would be long barter chains before everyone gets what they need, for example eggs for paper, paper for bread, bread for a bottle of water.

In a barter economy, even as few as 10 goods add up to 45 possible exchange ratios. If the value of each of the goods can be expressed in monetary units, the prices of the 10 goods are all that is required to compare them with each other. Money makes trading easier, as goods can be exchanged directly for money.

With money as a unit of account, the value of various goods and services can be compared quite simply, especially if the money is easily divisible, for example in euro and euro cents.

But first and foremost money also has to function as a store of value. It needs to retain its value over time, so it can be put aside and used to make a purchase at a later date. To serve as a store of value, money needs to be durable and stable in value. The owners of money must trust they will be able to buy just as much with their money at a later date as they can today. Therefore, the purchasing power of money needs to be preserved.

In the past, people tried to maintain the purchasing power of money through the choice of material, for example gold or silver. Nowadays, coins and banknotes have hardly any material value. Book money and digital money are in fact merely electronic data records. For this reason, people must be confident that their money will retain its value.

Central banks protect the value of money. In the euro area, the Bundesbank and the other Eurosystem central banks work together for price stability. With their monetary policy decisions they safeguard the value and thus uphold confidence in the euro. This is why only the Bundesbank with its regional offices and branches is allowed to circulate euro banknotes and euro coins in Germany. It ensures that counterfeit money is removed from circulation, so people can be sure that they are holding real money in their hands. In order to give people the confidence that the money in their bank accounts is safe, too, the Bundesbank also ensures that payment systems operate smoothly and is part of the team of European supervisors that keep an eye on bank’s businesses.

Alongside the official money, the countries’ currencies, there are also private arrangements which can serve as a mean of exchange, unit of account and store of value. These include vouchers, regional means of payment or so-called crypto assets such as bitcoins. Caution is recommended here, however, as these means of payment are not backed by any government institution, even if they are sometimes wrongly labelled as “currency”. The national central banks monitor these private arrangements carefully but do not manage or, more importantly, vouch for them in any way. In addition, when it comes to exchanging them for other goods, possibilities are few and far between. In this respect, these private arrangements do not fulfil the functions of money, or do so insufficiently. Crypto assets, in particular, are unsuitable as a store of value as they are subject to strong price fluctuations.