What Is a Banknote?

Written by Bradon MatthewsUpdated: 28th Oct 2021
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Have you ever wished you could create a $5000 bill? Well, you can’t. But the federal government can if they decide to make a $5000 banknote.

While you’re already familiar with at least one kind of banknote, you probably don’t know what a banknote really is. Don’t worry. We’re here to help.

We’re here to answer all your burning banknote questions.

Brief History of Banknotes

Way back in the day, when banknotes were just coming into existence, they used to be backed by precious metals.

Before banknotes, people traded using coins or sometimes bars of metals like gold and silver. The issue with doing so is that it’s difficult and inconvenient to carry around a bunch of heavy material like that.

As a solution, banknotes were born. This allowed people to carry around paper rather than metal, making trading a much easier and less laborious endeavor.

Originally, banknotes could be issued by anyone. Because they were just IOUs for precious metals, all that mattered was that the person using the banknote to trade was good for the amount promised.

Over time, this changed. As currency stopped being backed by gold and became an increasingly abstract concept, the government made sure they were the only ones who could issue banknotes. This was necessary, as, without such restrictions, money would essentially become meaningless.

This is still the case today. In the US, only the Federal Reserve can order banknotes.

What Is a Banknote?

In today’s world, a banknote is simply a piece of paper that promises it is worth the value printed on it. Any commonly exchanged and federally issued paper you can use to pay for something is a banknote.

In America, our banknotes are dollar bills. Whether it’s a $1 or a $20, the bill in your wallet is a banknote.

How Do Banknotes Work?

Banknotes used to work as promissory notes for materials like gold and silver. While they aren’t backed by gold any longer, banknotes today work in a very similar fashion.

The difference with modern banknotes is that rather than precious materials, they promise they are in demand in accordance with the number printed on the paper.

As an example, consider a twenty-dollar bill. The bill isn’t backed by twenty dollars’ worth of gold. It’s backed by the collective idea that the bill is worth twenty dollars.

While that might sound roundabout, the supply and demand of our economic system ensures banknotes hold their value and are worth what they claim.

We all know twenty dollars is worth twenty dollars, and the government ensures us a twenty is worth twenty dollars.

Because of this, we can freely trade products and services without having to barter with physical goods.

Is a Banknote Real Money?

Money is defined as any kind of currency commonly used to trade. This means money is made up of coins and banknotes. Banknotes are themselves money.

By definition, banknotes are real money.

What’s the Difference Between a Banknote and Money?

Money is synonymous with currency. Anything you spend to get physical goods or services is considered money.

Banknotes are an example of money in that they are something you can give someone to purchase something.

That said, the two are different. Banknotes are paper-only. Money can take many forms. Coins are an example of non-banknote money.

Additionally, money can be entirely non-material, like the money sitting in your bank account. The bank doesn’t need to have every dime of your account sitting in its vault for you to spend it.

What Are the Advantages of Banknotes?

The obvious advantage of banknotes is that you don’t have to carry around a bunch of heavier materials to buy things. Paper is light and easy to carry, making it an ideal choice for currency.

Additionally, banknotes are very affordable to produce. Paper is easy to make and easy to acquire, meaning governments can easily distribute it throughout the population.

Finally, paper money is easy to store. It’s thin, light, and doesn’t rot or decay. This allows banks to keep large amounts of currency that can be easily accessed by bank members.

What Are the Disadvantages of Banknotes?

Banknotes face two primary problems.

The first is that they are easily destructible. This destructibility means people can lose money through soiling or ripping banknotes. If you’ve ever had the misfortune of accidentally tearing or burning a bill, you’ve experienced this firsthand.

The second issue is that banknotes are easier to counterfeit than coins. While governments have taken measures to make it more difficult, paper money will always be easier to fake than coins.

Anybody with access to paper and a printer can at least attempt to produce fake banknotes. It’s much harder to access material like nickel, and it’s even more difficult to shape it properly.

Are there Alternatives to Banknotes?

There are multiple alternatives to banknotes, a few of which we use here in the US already.

For starters, there is simple trading. Instead of banknotes, people could just use a barter system where they trade items deemed equally valuable.

Coins are a currency alternative to banknotes. Coins are used alongside banknotes in many countries. Since most coins aren’t made of precious metal any longer, they operate in the same way banknotes do.

Moving past basic currency, we have checks, debit cards, and credit cards. These forms of payment work by pulling money directly from your bank account, essentially promising that you have the amount of currency you’re paying and giving it to the entity you purchase.

All modern options share a collective faith in the value of the currency being exchanged. So long as that faith is there and the government ensures there is a system in place, almost anything could be used as an alternative to banknotes.

Is a Banknote a Form of a Promissory Note?

Yes, banknotes are a type of promissory note. A promissory note is an instrument that serves as a promise from one party to pay another a certain amount of money.

Banknotes are essentially doing just this. The only difference is that it is the promise itself that is being promised.

The government’s promise to the person holding the banknote is what makes the banknote valuable, not some material backing it.

Bottom Line: What Is a Banknote?

Banknotes allow us to trade with ease and simplicity. If you’re one of the many people who hate carrying around tons of loose change, you can thank banknotes for providing the first alternative.

Here in the US, our banknotes are the one, five, ten, twenty, fifty, and one-hundred-dollar bills you’ve probably seen a million times.

So, there you have it, everything you need to know about banknotes. There’s more to that cash in your pocket than you thought, isn’t there?

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Bradon Matthews
Bradon Matthews

Bradon Mathews is a personal finance writer & product analyst with a breadth of experience. He enjoys analyzing market information and trends to help you make sense of the complex and ever-changing world of finance. His passion is providing practical advice so you can feel more confident managing your money. Bradon attended Colorado State University where he studied Philosophy.