Types of Currency
What gives currency its value? Depending on the type of money, there are many different ways that value is assigned and handled. These are the types of currency.
Fiat currency is, at its core, money that is worth what the government and free market determine it is worth.
It gets its value through fiat. Every developed nation uses fiat currency, because the value can be controlled through monetary policies. Some examples of fiat currency include the American dollar, British pound, and Euro.
Asset Backed Currency
Sometimes, assets like gold and silver are used to guarantee the value of currency. Often, asset backed currencies are made out of a precious metal, but this isn’t always the case. Sometimes an asset backed currency can be exchanged for a given quantity of the asset, like the American dollar was exchangeable for gold prior to the 1930’s.
Commodity Backed Currency
Commodity backed currencies are largely a relic of history. Commodities like tobacco were used to guarantee the value of currency. Although they aren’t in use anymore, commodity backed currencies played a large role in the early days of capitalism. Their weakness is that there was often a shortage of a particular commodity due to yearly fluctuations, and that could wipe out or drastically increase the amount of wealth in any given financial system.
The final, and most modern, type of currency is digital currency.
Digital currencies get their value through scarcity imposed on them by the need to solve difficult equations. For example, Bitcoins need to be ‘mined’ by computers that solve mathematical problems. Digital currencies tend to be anonymous by design, and can only be spent by using computers to handle the transaction.