What is Money? History, Functions, and Types Explained

Have you ever wondered why a shopkeeper accepts your 70-taka note when you buy rice? What is it about that note that makes anyone willing to accept it? And why is it written on the note, “The bearer of this note shall be paid on demand”? If you want to understand the current global economy, you first need to understand the modern monetary system. What is money, why does everyone accept and use it, how did it all begin, and what are its different forms? Let’s explore all of this today.

Money is a medium of exchange that people accept in return for goods or services and also use to settle debts. It is the most frequently exchanged entity in the world. Economies use money to facilitate transactions and accelerate economic growth.

Essentially, money carries a certain value, and people exchange it for goods or services of equivalent value. Compared to the barter system, money has made transactions much more effective and efficient.

Money is a type of liquid asset that facilitates transactions among multiple parties. It serves three main purposes:

• Medium of Exchange
• Store of Value
• Unit of Account

Let’s understand each of these:

Before the invention of money, people used the barter system to exchange goods. For example, if someone had one kilogram of wheat but needed corn, they would exchange wheat with someone who had corn. However, the barter system had many limitations, which led people to seek a more standardized form of money.

Initially, items like cowrie shells and gold were used as money. Later came metallic coins, and in the modern era, paper currency. Nowadays, no one uses barter anymore. If you want to buy corn, you simply pay its price using paper money. This transaction illustrates how money functions as a medium of exchange.

As shown in the earlier example, people now receive money in exchange for goods or services. But since goods and services have a certain value, money must also have value. Modern money is issued by a country's central bank, which assigns it a fixed value, often pegged to gold or the US dollar.

But what ensures the reliability of this money? What if it becomes useless? The guarantee comes from the government and central bank. You may have noticed the statement on Bangladeshi banknotes: “The bearer of this note shall be paid on demand.” This means if the note is damaged or invalid, the government and central bank must compensate the holder.

Because there is such a guarantee, money carries value and functions as a store of value.

If you go to a shop and ask for one kilogram of rice, the shopkeeper will tell you it costs 70 taka. That means one kg of rice is valued at 70 taka. But how is this price determined? Though it's a complex calculation, in a free market economy, prices are generally determined based on supply and demand.

Thus, by using money to express the value of various goods and services, it also functions as a unit of account.

The barter system had several limitations—complex record-keeping, difficulty in finding matching needs, and problems with large transactions. Perishable goods couldn't be stored easily. So, people looked for alternatives.

The first use of money-like items was around 1200 BCE, with cowrie shells being prominent. These were common in India and Pacific coastal regions. Evidence suggests that Europeans and Native Americans also used similar items. In Fiji, whale teeth were used as currency.

While better than barter, these forms of money still had limitations. People needed more durable options, so they began using metal coins. Though metal coins were used in Babylon around 2000 BCE, the first regulated coins appeared in 7th century BCE Lydia (modern-day Turkey), usually made of gold or silver alloys.

Metal coins became widespread and are still used today, especially for small transactions using copper coins, and gold/silver coins for larger ones. Until paper money was invented, metal coins were the only acceptable form of money.

As paper was invented in China, the earliest paper money also originated there between 997–1022 AD. These were made from mulberry tree bark and were initially used as promissory notes, not actual money. People could exchange them for gold or silver from money lenders. Over time, these notes began circulating as currency to avoid the risks of carrying precious metals.

Today’s system is similar but more regulated. Unlike earlier private banks, now only governments issue official currency.

Over time, people have shaped money into various forms based on needs. Currently, there are four primary types of money:

1. Commodity Money

This refers to money made from commodities. In simple terms, during the barter era, any item used as a medium of exchange was commodity money. The value of the money depended on the intrinsic value of the commodity used, such as gold, silver, copper, or even shells in ancient times.

2. Fiat Money

The word "fiat" means "sovereign decree." Fiat money has no intrinsic value and can't be converted into any precious material. Its value is assigned by the government, and its use is mandated within the country. This is how governments regulate the economy and prevent misuse of currency. Today, fiat money dominates the global financial system.

In Bangladesh, only the 1 and 2 taka notes are government-issued fiat money. Other notes are technically banknotes, not fiat currency.

3. Fiduciary Money (Bank Notes)

In Bangladesh, all notes from 5 to 1000 taka are fiduciary money. These are not government-issued but issued by the central bank. That's why Bangladeshi banknotes say: “The bearer of this note shall be paid on demand.” You could, in theory, go to the central bank and exchange the note for an equivalent government-issued note.

Like fiat money, banknotes have no intrinsic value. They are accepted based solely on trust in the government and central bank.

4. Demand Deposits

The money we deposit in bank savings or current accounts is also considered money. The bank is obligated to return your funds upon request. This is why you can withdraw money using checks or debit cards at any time.

In ancient times, economic transactions were small and simple, so strict regulation wasn't needed. But as trade expanded, people realized the need for a regulated monetary system. That's why more controllable forms of money like government and bank notes became popular.

Today, as the volume of economic transactions has skyrocketed, regulation is crucial. Without it, misuse of money could cause extreme inflation or even bankrupt a country—just like what repeatedly happened in medieval Europe.