Money needs to fulfill three functions: A medium of exchange, a
store of value, and a unit of account. But what does this really mean?
Medium of exchange: means it is a payment mechanism—you can
use it to pay someone for something or to extinguish a debt or financial obligation.
To be a good medium of exchange, it doesn’t need to be
universally
accepted, but it should be should be widely accepted in the
particular context for which it is being used.
Store of value: means that in the near term, your
money will be worth the same as it is today. To be a good store of value, you
need to be reasonably confident that your money will buy you more or less the
same amount of goods and services tomorrow, next month, or next year. When this
breaks down, the money’s value is quickly eroded, a process often referred to
as hyperinflation. Individuals quickly develop alternative ways to denominate
value and undertake transactions, for example, bartering or using a ‘hard’ or
more successful and stable currency.
Unit of account: means it is something that you can use to compare the value of
two items or to count up the total value of your assets. If you record the
value of all of your possessions, you need some unit to price them in, to get a
total.
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