Currency: What It Is, How It Works, and How It Relates to Money

What Is Currency?

Currency is a medium of exchange for goods and services. In short, it's money, in the form of paper and coins, usually issued by a government and generally accepted at its face value as a method of payment.

Currency is the primary medium of exchange in the modern world, having long ago replaced bartering as a means of trading goods and services.

In the 21st century, a new form of currency has entered the vocabulary and realm of exchange: the virtual currency, also known as cryptocurrency. Virtual currencies, such as Bitcoin and Ethereum, have no physical form or government backing in the United States. They are traded and stored electronically.

Understanding Currency

Currency in some form has been in use for at least 3,000 years. At one time only in the form of coins, currency proved to be crucial to facilitating trade across continents.

A key characteristic of modern currency is that it is worthless in itself. That is, bills are pieces of paper rather than coins made of gold, silver, or bronze.

The concept of using paper as a currency may have been developed in China as early as 1000 BC, but the acceptance of a piece of paper in return for something of real value took a long time to catch on. Modern currencies are issued on paper in various denominations, with fractional issues in the form of coins.

Money vs. Currency

The terms money and currency are often thought to mean the same thing. However, while related, they have different meanings.

Money is a broader term that refers to an intangible system of value that makes the exchange of goods and services possible, now and in the future. Currency is simply one, tangible form of money.

Money is used in a variety of ways, all related to its future use in some kind of transaction. For example, money is a store of value. This means that it has and maintains a certain value that supports ongoing exchanges. People know that the money they received today essentially will have the same value next week when they need to make a purchase or pay a bill.

Money is also referred to as a unit of account. That means it can be used to account for changes in the value of items over time. Businesses use money as a unit of account when they prepare a budget or give assets a value. Profits and losses are established and relied upon using money as a unit of account.

Money also has certain properties that allow for the smooth exchange of goods:

• It is fungible, or, exchangeable, so that it doesn't need to be re-valued for every transaction.
• It is durable so that it lasts for many exchanges over time.
• It is convenient to carry and divide.
• It is recognizable so that people can trust it and confidently complete their exchanges of goods and services.
• The supply of money should be stable so that its value is reliable.

Understanding what money is clarifies the meaning of currency. It's a form of money used every day by people all over the world. Checks are another form of money (known as money substitutes). Cigarettes have even been a form of money, as they were for soldiers during the Second World War.

Types of Currency

The United States Mint defines currency as money in the form of paper and coins that's used as a medium of exchange. Currencies are created and distributed by individual countries around the world.

U.S. currency in paper form is issued by the Bureau of Engraving and Printing as $1, $2, $5, $10, $20, $50, and $100 bills. The $500, $1,000, $5,000, and $10,000 bills are no longer issued but those still in circulation are redeemable at full face value. Currency issued in 1861 or earlier is no longer valid and would not be redeemable at full face value.

U.S. currency in the form of coins is issued by the Mint in denominations of 1¢, 5¢, 10¢, 25¢, 50¢, and $1.

There are over 200 national currencies currently in circulation. Including the U.S., 42 countries either use the U.S. dollar or peg their currencies directly to the dollar. According to the International Monetary Fund (IMF) the dollar makes up 58.8% of the foreign exchange reserves.

Most countries issue their own currencies. For example, Switzerland's official currency is the Swiss franc, and Japan's is the yen. An exception is the euro, which has been adopted by most countries that are members of the European Union.

Some countries accept the U.S. dollar as legal tender in addition to their own currencies, like the Bahamas, Zimbabwe, and Panama. For some time after the founding of the U.S. Mint in 1792, Americans continued to use Spanish coins because they were heavier and presumably felt more valuable.

There are also branded currencies, like airline and credit card points and Disney Dollars. These are issued by companies and are used only to pay for the products and services to which they are tied.

Currency Trading

The exchange rate is the current value of any currency relative to another currency. As a result, rates are quoted for currency pairs, such as the EUR/USD (euro to U.S. dollar). Exchange rates fluctuate constantly in response to economic and political events.

These fluctuations create the market for currency trading. The foreign exchange market where these trades are conducted is one of the world's largest markets, based on sheer volume. All trades are in large volumes, with a standard minimum lot of 100,000. Most currency traders are professionals investing for themselves or for institutional clients that include banks and large corporations.

The foreign exchange market has no physical address. Trading is entirely electronic and goes on 24 hours a day to accommodate traders in every time zone.

For the rest of us, currency exchange typically is done at an airport kiosk or a bank before we go on a trip or while traveling.

Consumer advocates say that travelers get the best value by exchanging cash at a bank or at an in-network ATM. Other options may have higher fees and unattractive exchange rates.