Commodity money is money whose value comes from a commodity of which it is made. Commodity money consists of objects that have value and can be used as money. Since payment by commodity generally provides a useful good, commodity money is similar to barter, but is distinguishable from it in having a single recognized unit of exchange.
Examples of commodities that have been used as mediums of exchange include gold, silver, copper, peppercorns, large stones (such as Rai stones), decorated belts, shells, alcohol, cigarettes, cannabis, candy, barley, etc. These items were sometimes used in a metric of perceived value in conjunction to one another, in various commodity valuation or price system economies.
Commodities often come into being in situations where other forms of money are not available or not trusted. Various commodities that were used in pre-Revolutionary
include wampum, maize, iron nails, beaver pelts, and tobacco.
- Commodity Money serves an additional purpose. For example, gold can be turned into jewelry, while cigarettes can be smoked. This gives the holder added options; he can either use or spend the money.
- It may be possible to acquire money that wasn't previously in circulation. For example, if gold is used as commodity money and somebody discovers more of this metal, he or she may be able to get more value from its role as money than from its role as a base for jewelry.
- Risk of Volatility- While commodity money typically has less volatility during turbulent economic developments; commodity money can still lose value. For example, both gold and oil are valuable commodities. However, the prices of both gold and oil undergo increases and decreases over time. Thus, the risk of volatility still exists with commodity money.
- Lack of Divisibility- Commodity money is typically not as divisible as traditional paper money. For example, you can divide dollars into quarters, nickels, dimes and pennies. However, you may have a difficult time dividing a bar of gold into small denominations needed to make everyday purchases.
- Bandwagon Ups and Downs- Commodities also suffer from the bandwagon effect. The bandwagon effect is that the price of commodities may rise and fall with the whims of the general population.
- Value- Another problem with commodity money is assessing the value of items purchased with the commodity money. Measuring the exact amounts of value of commodity money is not easy, and therefore, it is difficult to manage your wealth using commodity money.