3 min read

The value of money

Why does money have value? I've been thinking about this for a while.

One explanation says money value is valuable because of who will accept it. This seems sort of lame and circular, so for a long time I didn't like it. It also seems like the only way it could possibly work.

It seems worth elaborating on this basic idea though. Why would the issuer accept their money as payment? And why would anyone else?

First there's the case of modern national currencies. In this case it's pretty clear why anyone else would accept the money. You need that currency to pay your taxes, to pay fines, et cetera. If you don't, you go to jail. So the minimum value to you is that of not going to jail for failure to pay, however much you value that. Everyone cares about this to some extent or other, so that establishes a minimum value for the currency. That gives everyone besides the issuer some reason to accept the currency.

But why would the issuer accept their own currency? Because if they don't, then neither will anyone else. If they can't actually use the national money to pay taxes or fines – it's no good. The minimum value is gone.

Another case is things like PrimeCoin. Here there is no issuer in the usual sense. You have miners who create the coin by solving a mathematical problem (finding certain kinds of chains of prime numbers), and you have everyone else. In this case, why accept the coin? Here I'm not really sure. I think one possible answer is that you like the incentive that block rewards/transaction fees create. So the minimum value would be however much you value the enumeration of prime chains.

I'm finding it hard to compare these two cases. In the national case, you a tax payer minimum-value the currency because it allows you to pay your taxes and therefore not go to jail. The issuer – the government – accepts it (values it) because otherwise they can't pay tax payers with it. But in the PrimeCoin case, it seems reversed. Miners value the currency to the extent that other users in the network will accept it. The other users will accept it because they have their own minimum value for the work a PrimeCoin represents. Importantly, this value is not completely determined by the formal rational system of exchange. (I think the word is "exogenous.") In other words, it's PrimeCoin's users that provide the incentive.

In one sense PrimeCoin feels like the reverse of the government situation. My initial frame was that the government is providing the incentive by credibly promising to send you to jail if you don't pay. On the other hand, if nobody cared about going to jail, probably there is no minimum value? So in that sense, you could also view the national currency situation as being like the PrimeCoin situation. That view feels a bit slimey though.

I'd like to explore some more examples, and I might in another post. Like: Bank notes, gold coins, BitCoin, Ethereum. These two seem like a good start, though.

So this goes some way to understanding the minimum value of currency. A currency has some minimum value because of people or institutions who accept it, and they will accept it for reasons that ground out in something other than currency itself. That is: Not wanting to go to jail, or wanting more prime chains to be discovered, or whatever.

But where does value come from beyond the minimum? Because I think we value money more than the strict minimum of "I don't want to go to prison." Otherwise, we would try to make just enough to avoid that and obtain food, shelter, clothing, etc. some other way. My current guess: "Second parties" add value to the currency by accepting it for minimum-value reasons. The currency is worth more to the extent that you can use it to pay for things you want, and the "minimum value" makes this possible. This might be worth exploring more as its own post.