Understanding the different types of money: definitions and examples

There are four main types of money in the economy. Learn about each system and see examples.

What is money?

Money is simply a medium of exchange that can be used to purchase goods and services. It is also defined by its ability to act as a store of value.

Today, money and currencies are synonymous with each other, but coins and notes are just a physical representation of the concept of money. Throughout history, there has been a range of different mediums of exchange, including commodities. 

Discover the history of money

What are the characteristics of money?

The characteristics of money are what gives it value. There are three primary factors involved:

1. Legal standing – whether a country or society has recognised the asset as having monetary value
2. Accepted value – whether it is widely agreed upon that this asset has a standardised price that can be exchanged for other goods and services
3. Scarcity – that is supply is controlled and regulated, and its demand monitored

Different 4 types of money

Broadly, there are four accepted types of money used by economists today:

1. Fiat money – the notes and coins backed by a government
2. Commodity money – a good that has an agreed value
3. Fiduciary money – money that takes its value from a trust or promise of payment
4. Commercial bank money – credit and loans used in the banking system

What is fiat money?

Fiat money is a currency that is not backed by a commodity or physical good, but rather the strength of the issuing body. Its value comes from market supply and demand, which usually fluctuates in line with the perceived health of the economy.

Most governments use fiat money systems. This allows them to create economic policies that – alongside central banks – influence the money supply.

Fiat money underpins most modern monetary systems, which is why the terms ‘currencies’ and ‘money’ are used interchangeably. Most of the other systems derive their value from a comparison with fiat currency.

Why is it called fiat money?

Fiat money is named after the Latin word fiat, which translates to ‘determined by authority’. That’s because the value of the currencies is set by government bodies, not by their relation to another asset.

Fiat money has a floating value, which is determined by the strength of one currency against another in the open market. Fiat money is traded in what’s known as the foreign exchange market, or forex market.

Learn more about forex

Fiat money example

Fiat money is any global currency that is recognised as legal tender by its government. Examples include the Great British pound, United States dollar, euro, Australian dollar, Japanese yen and Chinese yuan.

When fiat money is traded against each other, they’re listed in pairs. So, the pound against the US dollar is GBP/USD, and the US dollar against the yen is USD/JPY.

Learn more about currency pairs

What is commodity money?

Commodity money is a physical asset that has an intrinsic value. This system is associated with bartering, where there is no standardised or agreed-upon medium of exchange.

Commodity money is widely used to refer to precious metals, such as gold, which historically backed most global currencies. But in some societies, grains and coffee have also been used.

Commodity money example

A common example of commodity money is the gold standard, which was a monetary system that pegged the value of a country’s currency to a specific amount of gold.

It was originally set out to stabilise the prices of global currencies because most paper money was backed by gold held in bank reserves.

The United Kingdom adopted the gold standard in 1812, while the US, Germany and France followed suit in the 1870s.

However, the gold standard reduced the ability of governments and financial institutions to respond to market events and economic changes, which is ultimately what caused the gold standard to be abandoned during World War I.

As of 2022, no country uses the gold standard and it has been replaced with fiat currencies.

What is fiduciary money?

Fiduciary money is a money substitute that is often a written statement of debt or intent of payment. It is essentially a promise of money at a later date, which is backed by nothing more than trust between the two parties in a transaction.

There are risks involved in a fiduciary money system of exchange, as the supply of money and the promises made may not align. So, if too many individuals using fiduciary money attempt to convert their statements at any one time, it can create a run on the fiat system that underpins the exchanges.

Example of fiduciary money

Examples of fiduciary money include paper cheques, banknotes, token coins or electronic credit.

If you were to receive a cheque for £1,000, the paper itself is worthless, it only has value once it has been deposited into an account and converted into fiat money.

What is commercial bank money?

Commercial bank money represents the loans generated by financial institutions. When a customer deposits funds in a bank account, it is loaned out to other customers, which earns the original depositor interest.

There is always a reserve requirement, which is the portion of client funds that a bank cannot lend out to other customers.

Commercial bank money is a vital part of any financial system, as it creates liquidity for the buying and selling of other forms of asset. For example, banks lend out to consumers in the form of mortgages, business loans and personal loans.

Commercial bank money example

Let’s say customer A puts £10,000 into her current account with a high street bank. The bank has a 10% reserve ratio, which means £1,000 must be left in the account at all times. The other £9,000 is lent out to customer B, who needed a loan to buy a car.

Customer B will need to repay the loan and will be charged interest for the time it takes to repay the funds. This interest (or a portion of it) is given to customer A, increasing the total number of funds in their account.