What Are Banknotes and How Are They Used?

A banknote is a promissory note used to pay a specific amount of money. It is payable to the bearer on demand and is considered legal tender. Along with coins, banknotes make up modern money.

Banknotes are also known as "bills" or "notes."

Key Takeaways

– A banknote is a form of currency used for payment.

– Only the Federal Reserve Bank can print banknotes in the U.S.

– Banknotes used to be backed by precious metals like gold and silver, but now they are a fiat currency backed by good faith.

How Banknotes Work

In the past, valuable objects such as gold and silver were used for bartering. Eventually, paper money and coins replaced these physical assets as representative currency. Initially, precious metals backed these new currencies to provide credibility.

Nowadays, only the government backs banknotes. The Federal Reserve is the only bank in the United States that can create and mint banknotes. Banknotes are widely used in financial transactions worldwide.

Previously, U.S. citizens could exchange paper money for gold or silver. However, in 1964, the U.S. government stopped the bimetallic standard and went off the gold standard in 1971. This decision resulted in a pure fiat currency that relies on good faith as its backing.

Fiat money derives its value from supply and demand rather than physical reserves. However, it carries the risk of becoming worthless due to hyperinflation. The likelihood of the U.S. dollar collapsing is very low.

While the terms banknotes, currency notes, and bills are sometimes used interchangeably, currency notes are more commonly used in everyday transactions.

Keeping one’s savings in the form of banknotes can pose inflationary risks. Savings accounts or certificates of deposit can help earn a small amount of interest.

Polymer Banknotes and the Bank of England

The Bank of England considered introducing polymer banknotes in 2013. These plastic-like banknotes, also used in Canada and other countries, provide enhanced security features and are harder to counterfeit. They offer advantages such as longer durability, waterproofing, dirt-resistance, and lower negative environmental impacts.

However, introducing polymer banknotes into Britain’s monetary system presents challenges such as higher manufacturing costs, counting difficulties, challenges in folding, and potential compatibility issues with existing vending machines and auto-payment systems.

What Is the Difference Between a Banknote and Regular Money?

Today, there is little difference between the term "banknote" and other forms of currency. Historically, "bank note" referred to paper currency issued by banks and backed by gold and silver deposits. Central banks usually have the authority to print banknotes, although some countries delegate this authority to commercial banks.

How Do You Tell if a Banknote Is Real?

Most central banks incorporate various anti-counterfeiting measures in their printed notes, such as raised type, watermarks, and threaded paper. The specific measures depend on the currency and date of issue. For U.S. currency, the Secret Service provides a helpful list of existing security features.

How Can I Replace a Damaged Banknote?

If you have mutilated U.S. currency, you can easily redeem your notes by sending them to the Bureau of Engraving and Printing.

The Bottom Line

Banknotes, as paper bills, are a form of currency. Initially, they were promissory notes backed by gold and silver. Today, they are the main physical manifestation of money, although digital payment systems may eventually replace them.