What Is a Medium Of Exchange?

A medium of exchange is an intermediary instrument or system used to facilitate the sale, purchase or trade of goods between parties. For a system to function as a medium of exchange, it must represent a standard of value. Further, all parties must accept that standard. In modern economies, the medium of exchange is currency.

How a Medium Of Exchange Works

Using a medium of exchange allows for greater efficiency in an economy and stimulates an increase in overall trading activity. In a traditional barter system, trade between two parties can only happen if one party has a commodity that another party desires, and vice versa. But the realistic chances of this type of simultaneous cross occurrence are improbable. Thankfully, with a medium of exchange, such as gold, if one party had a cow and happened to be in the market for a lawn mower, the cow owner could sell his animal for gold coins, which he may, in turn, use to purchase the lawnmower.

Money as a Medium of Exchange

Money enables anyone who possesses it to participate as an equal market player. When consumers use money to purchase an item or service, they are effectively making a bid in response to an asking price. This interaction creates order and predictability in the marketplace. Producers know what to produce and how much to charge, while consumers can reliably plan their budgets around predictable and stable pricing models.

When money, as represented by a currency, is no longer viable as a medium of exchange, or if its monetary units can no longer be accurately valued. Consumers lose their ability to plan budgets, and there is no longer a way to gauge supply and demand accurately. In short, market volatility will cause the markets to become chaotic.

Prices are bid up or raised, in response to worries about scarcity and fears of the unknown. Meanwhile, supply diminishes because of hoarding behaviors, coupled with an inability of producers to quickly replenish inventory.

Alternative Currencies as a Medium of Exchange

Alternative currencies appeared throughout time, to spur commerce or buttress a national currency, during periods of economic duress. In the early 20th century, companies had to issue company scrip and other forms of emergency currency, to pay their workers because massive bank failures caused widespread cash shortages. Workers could redeem the scrip for food and services, or they could hold onto it for future redemption in U.S. dollars, once they became available.

Across the United States, local currencies have sprung up with the primary purpose of fostering economic growth and sustainability, within a given region. The best-known case of thriving local money occurred in 2006, in the Berkshires region of Massachusetts, with the first issuing of BerkShares. Subsequently, hundreds of businesses​​​​​​​ across all communities now accept them. The value of BerkShares is pegged to the value of the dollar but is issued at a discount.

Real Word Example

Due to recent inflationary activity in the country of Venezuela, prices have doubled for essential goods and services, causing shortages in necessities such as food and medicine. Consequently, the Bolivar, Venezuela’s national currency, has plummeted in value. According to cryptoslate.com, in response, many savvy investors have turned to cryptocurrency.