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Money – Types of Stored Value
Many years ago, before the concept of money existed, if an individual needed something they couldn’t provide for themselves, they would exchange something they owned with someone who had it. This was called bartering. Every item would be traded for a different item. For example, if I needed eggs, I would find a chicken farmer, and trade their eggs for something I had, such as milk or cheese.
This bartering system worked well for a while, but eventually society needed an easier way to keep track of how items were traded, especially over long distances. Certain commodities were selected because they were scarce and would last longer than fresh produce; such as seashells, grains, or precious metals. Eventually, paper money was created as a way to simplify exchange even further.
Money has value and works as a medium of exchange because we believe it has value. And since money has value, we need methods of keeping it safe. So, rather than keeping rolls of money under the mattress or buried in the backyard, our financial institutions provide a means of storing our savings safely, while allowing us access to those funds whenever we need to buy something.
Functions of Money
Money has three main functions, it works as a medium of exchange, a unit of account, and a store of value.
Medium of Exchange
A medium of exchange means money acts as a go-between for everyone in the economy to help trade goods and services. If you were a farmer that grew corn, you might have a hard time trading your corn directly with a carpenter who you hired to fix your kitchen cabinets. Or the manufacturer of the tractor you use in the fields. The tailor who sewed your new winter coat would equally prefer another alternative to a wagon full of corn in exchange for their services. If the markets allow you (and everyone else) to sell your products for money, it means everyone has a common medium of exchange.
Unit of Account
A unit of account is the next major function of money. Everything that can be bought or sold is only as valuable as what someone else is willing to pay for it. Money exists to show what the exchange rate is between two different goods. If a farmer is deciding whether to grow corn or soybeans this year, he will ask himself, which one will be more valuable?
Because both corn and soybeans are traded with money, he would be able to check the current prices for each one and focus on growing more of whatever is most valuable.
Store of Value
Our farmer just finished his harvest for the year, and has a silo full of corn that he can trade. However, he has expenses all year round; buying food and clothes, paying his mortgage, and all his other living expenses. If he were to trade just a little bit of corn for every purchase, the corn would rot away before the year was finished, losing all of its value.
Instead, selling his corn for money acts as a store of value. Money does not expire, and he can save it up over long periods of time.
Types of Stored Value
Checks
Checks might be the oldest form of stored value. Checks are a special document that banks use to transfer money from your account to the person or business whose name you write on the check.
Every check includes:
- Your bank routing number: an ID number for your bank.
- Your bank account number: your personal ID number.
- Your check number: every check has an ID number.
When you write a check, you also fill in the name of the person or company you are paying, the amount (both in numbers and written out with words), and the date. You can also include a memo with a reminder of what the payment is for.
When you bring a check to the bank, the teller will input the details such as the amount and paying bank routing number into the bank’s computer system, contact the issuing bank to confirm the signature, withdraw the funds from the other account, and transfer it into yours. The canceled check is then returned to you, along with the details of the transfer. For some banks, there is an option to overdraw the account, but this service will incur an additional fee.
This allows you to send any amount of money from your account to anyone else who has a bank account. Some check-cashing services also offer to convert checks directly into cash (for a fee) for people who do not have a bank account.
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Advantages of Using Checks
Checks are less popular in recent years, but they have some distinct advantages.
First, they are the safest way to send a payment by mail. It’s much harder to steal and modify a check than it is to take cash out of an envelope.
Second, checks are traceable. When a check is cashed, you get a picture of the final canceled check to show it was processed, so you can see if it was modified in any way (and serves as a perfect financial record to show the payment was received).
Disadvantages of checks
Writing checks requires a checkbook, which very few people want to carry around most of the time. Since checks are only validated using a signature, check fraud (people passing fake checks as genuine, or editing the amounts on a genuine check to be a greater amount) has historically been a major cause for concern.
Checks also take time to clear, or have the money transferred from your bank to another. This means that if you have any outstanding checks, you need to constantly reconcile your bank account to subtract any outstanding checks to know your true balance.
For businesses, taking checks can be risky, and very few still do when working with direct customers (although it is still very common for business-to-business transactions). This is because it’s impossible when receiving the check to know that the person who wrote it actually has the funds in their bank to make the payment. This is another type of common check fraud, where a person would write checks that they knew were unable to be cashed, often in other towns, leaving the businesses very few ways to recover their losses. Local businesses would often refuse to take any checks from non-local banks for this reason.
To avoid these types of fraud, virtually all checking accounts now feature debit cards too (as featured below), which is like writing an instant check.
Checks Without a Checking Account
If you do not have a checking account, your life will become very difficult. Your job will certainly pay you with a check, which means you’ll need to find some other way to convert your check into cash. Various options exist, but other than depositing into your own bank account you can expect to pay either a flat fee or a percentage of the check’s amount with any check cashing service.
Worse, you will need to find an alternative way to pay your bills, usually with a money order. Money orders are basically checks that another business will write for you. You pay them cash, and they give you the check. Of course, they will also charge a fee for this service.
This means if you do not have a checking account, you will need to pay extra twice; both to get your money and to spend it!
Debit Cards
Debit cards are very similar to checks, and are usually tied to your checking account. The biggest difference is that all payments are controlled electronically, so transactions are usually processed instantly.
Instead of your signature, you need a PIN number to verify your identity and authenticate the purchase. Debit cards may or may not be used for online transactions, depending on your card issuer.
Debit cards evolved from ATM cards. ATM cards were originally used only at ATM machines to withdraw cash and to check account balances. The cards use a magnetic stripe that contains your bank account information. When you swipe your card, the card reader reads your account information and electronically notifies your bank of money being subtracted or added to your account. In most of the world, and increasingly in the United States, debit cards also come with a chip, which includes more security features, thus increasing the difficulty of stealing your account information when you use your debit card.
Advantages of Debit Cards
Debit cards were developed to make financial transactions easier than using checks. The money comes directly from your linked account, usually a checking account, and you don’t need to carry around a checkbook and a pen. Because the electronic transaction occurs almost instantly, the seller knows immediately that the funds were transferred or that the transaction was rejected due to a lack of funds. This reduces the possibility that check fraud will occur, a positive outcome for retailers.
Since debit cards do not require a verification signature, a unique PIN number is used to verify that the individual using the card is the rightful owner of that card. Without the correct pin number, the transaction will not go through.
Disadvantages of Debit Cards
Debit cards can be counterfeited. Remember that the magnetic stripe stores your bank account information, so when you swipe your card, the data that describes your account can now be captured. On the other hand, the chip on your chip debit card scrambles your data, making it extremely hard to capture your account information.
Using a debit card makes it easy to over-spend since you don’t see the money actually changing hands. This can make it possible to overdraw your account, which typically comes with heavy fees from your bank.
Prepaid Cards
Prepaid cards are usually issued by a credit card company or bank and are often given as gifts. To use a prepaid card, you need to charge it by adding funds. Either you can add cash at a kiosk for the card issuer, or sometimes online by transferring funds from your bank account. Once it’s stored, you can use a prepaid card any place you would use a credit card. The card issuer may charge a fee to use these services.
Advantages of Prepaid Cards
Prepaid cards can be a great way for people without a credit card to make online transactions since you can make payments in the same way as you would with a credit card. They are also often used as gifts, since you can use the money anywhere. Generally speaking, prepaid cards work as a more flexible form of cash.
Disadvantages of Prepaid Cards
Like cash, prepaid cards can be easily lost or stolen. Since they’re not tied to you in any way, whoever is currently holding the prepaid card controls all the value it contains. This makes them very risky to use for large amounts of money.
The card issuer also usually charges a fee to use the card, and if you maintain a balance, they may charge storage fees as well.
Gift Cards
Gift Cards are another form of stored value. Many stores and online retailers will let you convert cash into a gift card that you can use in their store. Gift cards usually have no fees, so they retain their value longer than other prepaid cards.
As their name implies, a gift card is typically given as a gift. Due to their limiting nature, it is very rare to purchase and use a gift card for yourself.
Advantages of Gift Cards
Gift cards are great to give as gifts. Because they can only be used in one location, they are less prone to theft and loss than other stored value cards.
Disadvantages of Gift Cards
Although you can purchase gift cards at many different retail locations, the card itself can only be used at the place of business identified on the card. For some businesses, like Amazon.com (AMZN) this is not really a limitation since there are a lot of products available, but for restaurants and individual retailers, it might be.
Note about Credit Cards
Unlike these other items, credit cards are not a form of stored value and do not act as money. This is because credit cards are a loan (or a form of credit). When you make a purchase using a credit card, no value is being transferred from you to the place where you’re spending money. Instead, you are creating a debt that you must pay back later with interest.
In contrast, when you use any of the items of stored value, money is being directly transferred from you to the person you’re paying. There is no loan or credit card company acting as a middle man. There is a direct transfer from one person or company to another.
Bitcoins and Other Virtual Currencies
Bitcoins and virtual currencies have become very popular in the last few years, but it’s not always easy to tell if they are a form of money in and of themselves, or ifthey are just a stored value of money. Their actual definition shifts based on how you, the consumer, uses them.
For example, if you convert your dollars into Bitcoin and then visit a shop that lists their prices in Bitcoins and accepts Bitcoins as payment, your Bitcoin is acting like money. However, if that shop lists all their prices in dollars, but they also accept Bitcoin as payment, then your Bitcoin is acting as a stored value for dollars.
To make things more complicated, you can also buy Bitcoin because you think its value will go up over time. This means that you are treating it not as stored value or as money but as an investment, and you are using speculation to try to gain a profit.
Challenge Questions
- As technology continues to evolve in our society, it is possible that the way we store our money and pay for transactions will change? What do you think that process might look like 15 years from now?
- What additional security measures do you see happening in the future in order to keep scammers from fraudulently stealing people’s money?
- Describe your experience with using the different financial tools you learned about in this lesson.