Understanding physical currency

Part of a series on money.

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This is part of a short series on currency systems.

Currency is fundamentally an information technology that coordinates economic activity at scale across space and time.

The most important thing about a currency is that it can be exchanged for a variety of goods with a variety of people. This catalyzes commerce because you can buy goods from someone even if you don’t have the precise goods they need¹.

To do so, currency needs to have:

Measurability. If we can’t measure out more or less units of currency, we can’t use this to scale payments to buy more or less of a good, or offer different prices for different goods. Even barter systems can offer more of item A in return for more of item B, so an un-measurable currency would be useless compared to barter.

Belief in value. A large group of people needs to be willing to exchange actual goods or labor for it. Imagine an alternative history where everyone hated gold and saw no use for it. Gold would be de facto worthless because nobody would exchange for it.

The currency doesn’t need to be intrinsically valuable for this to work. If you think shells are worthless but despite that everyone wants to trade for them, you’ll assign them value because you know you can buy stuff from people later. Value can be contagious in this sense, and common knowledge that everyone values something can be important².

Resistance to forgery. If a currency can be produced by anyone in large quantities people lose their belief in value. If seawater was a currency, sellers could procure it on their own without needing to give away their goods, so they have no reason to exchange for it.

If few people know that you can forge a currency, the value remains. For example, if only one person knew you could print money at home, it would still work as a currency. Though the person with the money printer would probably force a high inflation rate.

Now let’s look at physical currency, something made out of atoms that satisfies these properties. With physical currency you want something that is:

• Durable so that it retains its value through time.

• Hard to produce (i.e. hard to forge).

• Easy to verify.

• Easy to measure.

• Has a low mass or volume per unit of value. This lowers the costs to store, secure, move, and quantify it.

Gold isn’t that useful on its own, but is excellent along these axes. It is extremely non-reactive and challenging to mine. No materials have its particular combination of color, density, softness, and stability; all of which are straightforward to check. You can also gauge purity and weigh it, making it easy to quantify. The value-per-volume is pretty good, though it is heavy. These properties make it a good Schelling point.

That gives us a template for other things that can act as physical currency. Minerals and other durable resources work well, especially if they’re useful for something. Manufactured goods work too, so long as you can easily check their authenticity. Computer chips would make an excellent currency; they’re hard to make, you can benchmark them, and they store a huge amount of value in a small amount of mass and volume.

Physical currency is a very limited form of cash. You can’t easily change the money supply, which makes it hard to provide loans, do monetary policy, or control exchange rates. It takes physical resources to produce, store, protect, measure, and move. It carries inherent risk of loss, destruction, theft, or forgery. There’s also the risk that people lose their belief in value if the currency is supplanted by a different resource or tastes change.

Next post, we’ll talk about fiat currency.

1. … in the exact quantity they need at the time they need them.

2. You can lose this common knowledge as well. See also: Keynesian Beauty Contest.