This is post #2 in my series on money and Bitcoin. You can jump to other posts here:
Introduction
Money solves the problem of the double coincidence of wants. Stated positively, both sides of a transaction must desire what the other has or the transaction can’t happen.
Money solves this problem in at least four ways:1
- Separates the act of buying from selling
- Enables economic specialization
- Increases market liquidity
- Enables indirect exchange
Let’s look closer at each of these four elements.
Separates Buying from Selling
Money serves as a medium of exchange2, decoupling the acts of selling and buying.
Individuals can sell their goods or services for a generally accepted medium of exchange (money) and then use that money to purchase goods or services from others at a later time. This separation of buying and selling enables greater economic flexibility and efficiency.
A graphic designer can provide services to a client and receive money, which she can use to purchase groceries or pay rent. This wouldn’t work if the designer depended on the grocer or landlord needing or wanting her services directly.
Enables Economic Specialization
Separating buying from selling using money enables economic specialization. Without money, individuals and communities must be self-sufficient. They must produce a wide range of goods and services, meeting all of their needs through bartering. This limits specialization, which is when someone becomes highly skilled or efficient in a particular trade or industry. Specialization, or a division of labor, is key to increased productivity, innovation, and economic growth.
With money as a medium of exchange, individuals and businesses can specialize in producing specific goods or services. They can rely on money to acquire the things they need from those who have similarly specialized.
A community with money can have specialized farmers, blacksmiths, tailors, and educators. Without money, everyone has to grow their own food, make their own tools and clothes, and educate their own children.
Increases Market Liquidity
Liquidity is how easily assets can be bought and sold without significantly affecting their prices. If an individual or business accepts a limited range of goods as payment, the list of potential buyers and sellers is limited. Market liquidity is severely restricted.
A widely accepted medium of exchange (money) facilitates more transactions and economic activity. Buyers can acquire items using money. Sellers will readily accept money, knowing they can use it to purchase from various providers. The list of potential buyers and sellers grows exponentially. This increased liquidity allows for markets that are many times larger and more efficient.
Enables Indirect Exchange
Indirect exchange is when goods are exchanged through a third party, rather than directly between two parties. In a barter system, direct exchange is required. If someone wants to buy something, they must find someone who both possesses that thing and is willing to accept what they have to offer in return.
Using money, individuals sell their goods or services and then use that money to purchase things from others. This enables more complex and efficient transaction chains.
A software developer can sell his services for money, and then purchase food from a grocery store, clothes from a retailer, car insurance from his provider, etc. He doesn’t need to directly trade his software development skills with each individual provider.
Summary
Without money, society as we know it would be impossible. We wouldn’t have the inventions or the quality of life we enjoy. The double coincidence of wants cripples economic growth and specialization. Money solves this problem in several ways.
Seven characteristics of money underpin these four solution areas. Just like tools have varying quality, different forms of money also have degrees of quality. My next post will look at the seven characteristics of money and compare various forms used by different societies in history.
1 https://www.perplexity.ai/search/What-are-some-1s_JkhU9TwGZSJzUTRqBZw#2
2 This is one of the three primary functions of money: medium of exchange. A store of value and a unit of account are the other two functions. A future post will look closer at these three functions.
This is post #2 in my series on money and Bitcoin. You can jump to other posts here: