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Recent currency innovations like Bitcoin and an economic recovery now dragging into its seventh year have led many people to question what money is—and more importantly, what it should be. Answering this question is fundamental to any attempt to transform society.

Economists will tell you that money has many different functions, most importantly as a store of value and a medium of exchange. Wealthy people tend to focus on the former function, while those who must work to eat may think the latter more important. But over time these functions have been conflated, with disastrous results for equality and the economy. Making money into a positive force for social change requires detaching it from its role in storing value.

A store of value retains its worth over time. Gold is the classic example, but many other things have been used like stocks and shares, houses, and savings accounts. A medium of exchange, on the other hand, is something that allows people to buy and sell without the need to resort to bartering. Exchanges need a token which has value, or acts as a proxy for value—like a bank-note. But these tokens don’t have to be valuable in and of themselves so long as sellers know that they can spend them onwards.

The number of these tokens in circulation is critical, because without them transactions become more difficult and the economy grinds to a halt. But if the tokens are valuable they tend to be hoarded—taken out of circulation by the rich as a way of storing wealth. Once the tokens are scarce, and competition for them is high, the rich can get even richer by lending or investing them to make a profit.

In this way, money as a store of value and money as a means of exchange become increasingly entangled with one another. And it’s this problem that helps to explain the ups and downs of the business cycle and the inability of governments to respond to a monetary crisis in any meaningful way. The economy abounds with factories, raw materials and skilled labour, but often there’s no money to lubricate it. So either policy makers must issue more money and go further into debt (the stimulus approach), or try to pay back the debt and choke off the economy in consequence.

Either way, the banks win. More debt means more interest-income for them, and a choked-up economy means that they can acquire troubled assets cheaply. So what’s the solution?

The way out of this paradox is to use different instruments for different functions, as has been the case during a great deal of monetary history (though this is often unacknowledged). Modern legal tender is a descendant of store-of-value money. On the other hand, ‘common tender’ describes the plethora of non-valuable monies that have often circulated on a local basis.

Silvio Gesell, a German economist who was gaining influence until National Socialism put his country on the path to fascism, once proclaimed that "Money is an instrument of exchange and nothing else." He proposed a design in which paper money would need to be constantly validated by affixing a monthly stamp. It was tried out by a small town in Austria called Woergl in the depths of the Great Depression, which set aside some of its tax receipts and spent these new notes into circulation in their place.

The more notes that people held as the end of each month approached, the more they would try to spend them before the stamp came due. And each time the note changed hands, work was done and economic value was created. As a result, Woergl reached full employment, fixed its infrastructure and even built a ski jump. A hundred other towns were considering the model when the national government made it illegal in order to concentrate on accelerating an economic recovery using legal tender, which it could control more easily.

Today, such common tender is still illegal in Austria, but in most countries it can be created without government permission. However, the dominance of legal tender in a globalised economy doesn’t leave much room for complementary currencies. With around half of income going to taxes in the UK, for example, the demand for legal tender is unlikely to fall, especially when most people also have to pay legal tender to the banks in the form of interest. Banks don’t only collect interest on mortgages and the national debt: monetary expert Margrit Kennedy estimates that 50 per cent of the cost of goods and services is directly attributable to ‘capital costs’—in other words, to interest. Alternative currencies can’t compete with those that enjoy legal privileges, so they can only work in less essential or ‘grey’ parts of the economy.

Nevertheless, there’s a good deal of excitement around these currencies, especially Bitcoin, but Bitcoins can’t be created as needed and thus are scarce. Consequently, most people who hold them are hoping that their price will go up, rather than spending them as a medium of exchange.  Satoshi Nakomoto, Bitcoin’s creator, had set out to create a digital form of gold, so it’s no surprise to see this trend in motion.

A more promising approach is to use a local ‘credit clearing system,’ in which members are trusted to spend what they earn and earn back what they spend, thus closing their accounts at zero. There is no interest or actual money involved, but supply always equals demand. ‘Business barter systems’ can also work well, in which member businesses sell surplus capacity or unsold stock in exchange for supplies from others in the network. Unfortunately these systems are often heavily taxed, which limits the benefits of participation, and members may find themselves trapped in small markets with few trading partners.

At the community level, ‘Local Exchange Trading Systems’ (or LETS) and Time Banks operate on similar principles. For the past seven years I’ve been working with grassroots groups who use these systems alongside their own complementary currency or ‘unit of account’ which they issue and control. In a Time Bank the unit of account is one hour, and everyone’s hour is worth the same.

Participants in these schemes commonly report a completely different feeling when they use their complementary currencies. Legal tender money is stressful to use. Earning it involves competing for employment and obeying your boss, and when you do have your Pounds or Dollars there are lots of security concerns to contend with, along with paperwork, passwords and bank fees to pay.

In contrast, local currency units are much easier to earn and spend than legal tender, and the relationships that are built up around earning and exchanging them are qualitatively different. This is definitely not ‘business as usual.’ The anthropologist David Graeber talks about ‘settling a debt’ as a way of severing a relationship. But when a community is bound together in a mesh of small, unsettled, and often undocumented debts, its members have to stay on friendly terms with their neighbors.

Unfortunately neither LETS nor Time Banks are thriving, at least in the UK. ‘Quantitative Easing’ has displaced much of the economic pain that might have led people to seek out such alternatives. The LETS movement hasn’t managed to renew itself since its heyday in the recession of the early 1990s, and the buzz surrounding the ‘sharing economy’ has largely passed it by.

But these alternatives do demonstrate one important conclusion: that money can either be a fungible store of value or a worthless medium of exchange. However, it can’t be both at the same time without leading to rising inequality and other problems in the economy.

Legal tender is scarce and circulates only slowly, so it’s useful as a store of value and for settling debts within and between different countries. Common tender has only nominal value, so the quantity is easier to control. It circulates more readily so is more appropriate as the 'blood supply' of the economy. This is especially important for those who live from work, rather than from rents.

More than these different functions, however, complementary currencies have a different human and social value. They require high levels of trust between the participants to operate successfully, and they bind communities together instead of forcing them apart. Money which is plentiful helps people to move from insecurity and wasteful competition to co-operating with each other for the common good.

Matthew Slater is co-author with Prof Jem Bendell of a free online course, the Money and Society MOOC. For information on how to participate visit this link.