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GLOSSARY, H-M, PERSONAL FINANCE

Money – Types of Stored Value

Written by Kevin Smith

Many years ago before money really existed, when an individual wanted to “purchase”
something, the exchange would occur through bartering.  Every item “purchased” would be
traded for a different item.  For example, if I needed eggs, I would find a producer of eggs (an
individual who raised chickens) and would try to trade something I had, such as milk or cheese
from my cow, for those eggs.  This bartering system worked well for a while, but eventually
society wanted an easier way to “trade” for those items that individuals needed.  Certain items
were selected by society to use in exchange transactions, such as shells or grains or precious
metals, but eventually money was created as a way to simplify these exchanges.

Money has value and works as a medium of exchange because we believe it has value.  And
because it has value, we want to keep it safe. So rather than collecting money in our homes under
a mattress or burying it in a coffee can in the back yard, our financial institutions and businesses
have worked to create ways for us to “store” our money safely while still allowing us access to
those funds.

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

“Medium of Exchange” means money acts as a go-between between everyone in the economy to
help trade. If you are a farmer that grows corn, you might have a hard time trading your corn
directly with a carpenter to help build your house, a manufacturer who builds tractors, a tailor
who makes clothes, and producers of everything else you need. But 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

“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. Money exists to show what the
“Exchange Rate” is between two different goods. Our same farmer from before might be trying
to decide if they want to grow corn or soybeans this year – which one will be more valuable?

Because both corn and soybeans are traded with money, he would just 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 of 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, so whoever receives the check can find
them)
 Your bank account number
 The number of this specific check

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.

In the simplest terms, when you give someone a check, they take it to their bank, who then uses
the bank routing number to contact your bank, and your account number to specify your exact
account. Your bank then confirms your signature, and withdraws the amount of the check from
your account (if you have enough money, that is) and transfers it to the other person’s account at
the other bank. The check is then “cancelled”, so it cannot be used again, and the cancelled check
is returned to you showing that it has been processed. Some banks will allow you to “overdraw”
your account to pay a check, but they will charge you an extra fee to do so.

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.

Try It!
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 is much harder to steal and modify a
check than it is to just take cash out of an envelope.

Second, checks are traceable. When a check is cashed, you get a picture of the final cancelled
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. This is because it is impossible
when receiving the check to know that the person giving it actually has the funds in their bank to
make the payment. Another problem of check fraud was people writing 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.

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.

In place of the signature of a check, you instead need to input 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 operate by using 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 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 frequently also makes it easy to over-spend, since it you do not 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 value (either using cash at a kiosk for
the card issuer, or sometimes online by transferring value from your bank account). Once it is
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 as a “use it anywhere” gift card. Generally speaking, prepaid cards work as a
more flexible form as cash.

Disadvantages of prepaid cards

Like cash, prepaid cards can be easily lost or stolen. Since they are not tied to you in any way
(and are normally given as gifts), whoever is currently holding the prepaid card controls all the
value it has. 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 which 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 a 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 as 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 limit, 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 are 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 are 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 is not
always easy to tell if they are a form of money in and of themselves, or if they 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 bitcoins and then visit a shop that lists their prices
in bitcoins and accepts bitcoins as payment, your bitcoins are acting as money. However, if that
shop lists all their prices in dollars, but they also accept bitcoins as payment, then your bitcoins
are just 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.

Pop Quiz

[qsm quiz=58]

Challenge Questions

1. 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?
 2. What additional security measures do you see happening in the future in order to keep
scammers from fraudulently stealing people’s money?
3. Describe your experience with using the different financial tools you learned about in this
lesson.

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