There are two types of money: commodity money and representative money.
Commodity money is traditionally found in gold and silver coins. Gold and silver are suitable for coinage because they do not decay, rot, or rust; were malleable and divisible into smaller parts (such as gold “pieces of eight”); and were rare and not able to be counterfeited. Gold and silver have been used as money for 2,500 years.
The risk with commodity money is debasement. This involves reducing the quantity of gold or silver in a coin without changing its face value. The Roman Empire substantially devalued its currency by debasement. By 300 A.D., the once invincible Roman Denarius was no longer accepted as currency by the public.
The origin of the word “Eurerka!” (Greek: “I found it!”) is attributed to Archimedes, who, while bathing, discovered a method for determining the purity of gold objects by water displacement. This method would be used for centuries to ascertain the validity of commodity money.
Representative money is money that does not have intrinsic value itself, but can be exchanged for things that do have intrinsic value. There are two types of representative money: fiat money and fiduciary money.
Fiat money is money that has a stated value by decree of a government. It is legal currency and only has value because the issuing authority says so. Nearly all money in the world, including coins and banknotes, is fiat money. The U.S. dollar has been pure fiat money for less than 50 years.
The primary problem with fiat money is the risk of inflation, which is caused by issuing more money. Since it costs almost nothing to make fiat money, the temptation to use it to pay the public debt is overwhelming. Modern examples include German Marks post-WWI, and Venezuela’s Bolivar today.
In 1918, a German Reichsmark was worth one gold mark. Five years later, it would take 1 trillion Reichsmarks to exchange for one gold mark.
In 2005, the Venezuelan Bolivar was worth about 40 U.S. cents. In early 2018, one Venezeulan Bolivar was worth about 10 cents. By August 2018, it took almost 2.5 million Bolivars to buy one U.S. dollar.
Fiduciary money has value only because parties engaging in exchange agree on its value. You have been using fiduciary money for most of your life. It includes things like frequent flyer points, transit cards and tokens, even grocery coupons. Cryptocurrency is fiduciary money because the users agree on its value.
A great example of fiduciary money involves a once-popular Italian telephone token−the gettone.
The word gettone (pronounced “jet-TONE-ay”, plural: gettoni) literally means "token." The first Italian telephone token was created in 1927. It was a little disc made of an alloy of copper, nickel and zinc, or bronze. Production stopped in 1983 when it was replaced with magnetic phone cards. It is estimated that 600 million such tokens were produced.
Gettoni were commonly used as and interchangeable with a 50 Lira coin until 1980, when its value (and the cost of a phone call) suddenly doubled to 100 Lira. The doubling occurred again in 1984, to 200 Lira, again a result of a price increase associated with pay-phone calls. It remained at that value until 2001, when the Euro was introduced and the gettone suddenly lost its money-like nature in the Italian economy.
The parallels between the gettone and cryptocurrency are many. Both serve only limited roles as a literal form of currency, and as fiduciary money both are intrinsically worthless. It was not necessary to have a gettone to make a phone call; one could use a phone at the home or office to do that. Likewise, one is not required to use cryptocurrency to make purchases, but can choose to do so for convenience or other reasons. People carried both gettoni and Lira, in the same way people hold cryptocurrency and sovereign fiat money. Like cryptocurrency, the cost to counterfeit a gettone, relative to its value as a medium of exchange, was so high it was ridiculous to even consider it. And, like cryptocurrency, a user could do one of three things: spend it, exchange it for government currency, or hold it.