What Is a Banknote?

Banknotes Explained

A bank customer uses an ATM machine
•••

Eclipse_images / Getty Images

A banknote is a bill that can be used as legal tender and/or exchanged for the value denoted by the bill. In the past, private banks created their own banknotes. But today in the United States, banknotes typically originate from the federal government and end up in your wallet as cash.

Definition and Examples of Banknotes

A banknote is typically a piece of paper with a redeemable value. Banknotes are largely the same as cash. A dollar bill, for example, is a type of banknote printed by the U.S. Treasury Department and distributed by the Federal Reserve. The U.S. circulates banknotes in denominations of $1, $2, $5, $10, $20, $50, and $100.

Individuals can use banknotes as currency. If you want to buy a coffee for $2, you might hand over two banknotes in the form of two $1 bills. Or you might hand over one $5 banknote and receive three $1 banknotes in change.

A banknote doesn’t have intrinsic value; it represents a promise from a bank that the note can be redeemed for the value stated on the bill.

 Suppose you help a friend move and they give you a $100 gift card as a thank you. You can’t take that $100 gift card to a bank and deposit it into your checking account or exchange it for five $20 bills, for example. But if your friend gave you a legal $100 banknote, then you could deposit that bill into your bank account or exchange it for currency or items of equal value based on a promise of its worth.

  • Alternate names: Federal Reserve note, bill, note

How Do Banknotes Work?

Generally speaking, governments or banks issue banknotes, which represent a promise of value that’s mutually agreed upon by society as a form of legal currency. In the U.S., the Treasury Department prints banknotes ordered by the Federal Reserve (the central bank of the U.S.). The bills are sent to regional Federal Reserve branches, and private banks place orders for them so they can stock their ATMs, for instance. Along with cashing checks, this process provides individuals access to cash, which then gets distributed throughout the country.

If you examine a bill up close, you’ll notice it has a unique identifier that indicates which regional branch of the Federal Reserve it came from. For example, a $1 bill contains a circle with a letter in it and the name of the branch in small type inside the seal. There are 12 regional Federal Reserve Banks, so your banknote might show it originated from the Federal Reserve Bank of Atlanta or the Federal Reserve Bank of San Francisco.

The origination point for banknotes in denominations other than $1 or $2 bills isn’t so obvious. However, these banknotes contain a printed code that includes a letter between A-L and a number between 1-12 that indicates the branch it came from. For example, G7 indicates the banknote came from the Federal Reserve Bank of Chicago.

A banknote is a promise that the piece of paper can be used as a representation of the corresponding value printed on it, regardless of where it’s presented throughout the U.S. For example, a $20 banknote might make its way from the Federal Reserve Bank of New York to a New York City bank, then to your wallet. While visiting Texas, you might spend that same $20 bill at a store, and the store owner might deposit that cash with their own local bank, which accepts the bill, knowing they can ultimately deposit it with the Federal Reserve Bank of Dallas.

The flow of money isn’t typically so direct, but these are essentially the underlying components that give banknotes their value and allow them to be used as a legal currency in a society.

History of the Banknote

U.S. banknotes used to be backed by precious metals such as gold and silver. In 1971, the government decided to go off the gold standard, and U.S. banknotes became what’s known as a “fiat currency,” meaning they’re backed only by good faith.

In the 1800s, long before banknotes were managed by the Federal Reserve, private banks often created their own banknotes. Customers would make a deposit with gold coins, for example, and receive banknotes in return. The banknotes served as a guarantee that an individual could go back to that bank and exchange them at any time for their gold coins.

In some cases, the banknotes had a time and interest component. In other words, a private bank would pay interest on the banknote for a fixed amount of time, at the end of which the individual could turn in their banknote and get their gold coins back.

Since there weren’t many small bills in circulation, the banknotes created by private banks were highly sought after. Having private banknotes allowed individuals to exchange items like gold coins for small bills. Today, however, it’s typically easy to exchange cash at a bank in whatever denomination you need; for example, you can ask a bank to give you five $10 bills in exchange for a $50 banknote.

Do I Need a Banknote?

The short answer is yes, if you want to use cash to pay for goods and services in countries such as the United States, which relies exclusively on banknotes as the legal tender. However, you may not need physical banknotes in hand, thanks to alternative forms of payment such as debit and credit cards. You do need to represent your banknotes in some way, for instance, through the balance in your bank account, to back up your ability to use another form of payment in place of cash.

Alternatives to Banknotes

If you don’t want to use physical banknotes, you have other options to gain access to spending power. Credit and debit cards are widely used as cash substitutes, and they are accepted by most merchants. In addition, you could write a check as payment, as long as you have sufficient funds in your bank account.

Apps such as PayPal, Venmo and Cash App give you the ability to make near-instantaneous payments, but you must have access to cash to back up those transactions.

Cryptocurrencies like Bitcoin are also becoming more popular as a form of payment. However, cryptocurrency generally isn’t as stable as banknotes, and it isn’t universally accepted.

Key Takeaways

  • Banknotes are a form of legal tender backed by a promise that a bill can be redeemed for a certain value.
  • Today, banknotes are typically synonymous with cash.
  • In the U.S., banknotes usually make their way into circulation via the Federal Reserve.
  • Historically, banknotes were backed by and could be exchanged for precious metals such as gold and silver.
  • Alternatives to banknotes include credit and debit cards, checks, payment apps, and cryptocurrencies.