Currency is traditionally defined as a medium of exchange. We believe the term "medium" creates confusion in the age of digital payments. We suggest a focus on currency as a "unit" of exchange.
The term "medium" implies some form of action, a means or method of payment. Prior to digital payments, when all transactions were executed solely with physical currencies, this definition worked well because the physical currencies where actually moved in the exchange itself. In the age of digital payments and digital currencies, with payments and currencies playing two distinct roles, we need a more precise definition.
The term "medium of exchange" is no longer useful because most transactions are now accomplished digitally with IOUs, rather than the underlying currency itself. For example, the "medium of exchange" in most retail, dollar-denominated transactions is the digital transfer of a dollar-denominated bank IOU using a credit or debit card.
A better definition for currency is a "unit of exchange." It is this unit of value in which a transaction will ultimately be settled. This unit of value is always named (denominated) in a transaction, regardless of the payment method. For example, a debit card transaction could be denominated in dollars or bitcoin.
Thinking of currency as a "unit of exchange" helps to avoid several sources of confusion that are prevalent in discussions of digital currencies.
- Confusion about IOUs: Because the "medium of exchange" in most transactions is a bank IOU, it is sometimes stated that currencies are IOUs. This is not accurate. An IOU may be used as a currency, but most currencies, including the dollar and bitcoin, are not IOUs. There is no entity that will provide the holder with any value upon demand. They are both simply representations of value accepted in the market for payment.
- Confusion about payments: Because "medium of exchange" refers to some sort of action, using this definition can result in payment methods and currencies becoming synonymous. This causes confusion with bitcoin and other decentralized currency platforms because they are both payment method and currency. It is important to understand that bitcoin, the currency, can be used with any payment method, including credit and debit cards.
- Confusion about the role of government: When currency is associated with payment methods, governments appear to take on a more important role in currency creation than they actual do. Governments help create trusted payment infrastructures through the banking system. Before the invention of bitcoin, the role of government in creating efficient payments systems was arguably indispensable. Currency, on the other hand, does not rely on governments for its creation or efficiency. Currency, as a unit of exchange, is created by merchants and others who choose to accept the currency in payment.
So what does this matter for bitcoin and the other currencies that are competing to become a global currency? The ultimate goal for these currencies should be widespread adoption of the currency as a unit of exchange, not as a medium of exchange. For example, bitcoin needs to promote bitcoin-denominated transactions, not necessarily transactions that occur on the Bitcoin blockchain.
About The Currency Report: The Currency Report promotes the adoption of a decentralized global currency. We provide advisory services to new currency designers and investors, including our fund, the Global Currency Fund. Read the Guide to New Currency Valuation and Design, sign up for our blogs or, for accredited investors, inquire about our fund. For more information contact Shane Hadden at firstname.lastname@example.org.