What do you think of when you hear the word money? For most people, it conjures up images of paper bills, coins, and other types of currency that are used to buy and sell products and services on the market.
However, what many people don’t realize is that not all money comes in the form of bills and coins; some of it exists digitally on bank accounts, in credit cards, or in our virtual wallets with mobile apps like Apple Pay and PayPal.
Money Is an Idea
In his book Fiat Money Inflation in France, economist John Maynard Keynes famously said Money is a bubble on a river of swamped crocodiles. Perhaps that’s true. But where does money come from? Most people don’t really think about it.
Banks create money out of thin air when they make loans—and then charge interest for those loans. Central banks—like the Federal Reserve in America—create new currency to buy government bonds, which are essentially IOUs to other countries or (more commonly) themselves.
How Banks Create Money
When you deposit £/$100 in an account, banks don’t actually take that money and put it under your mattress. Instead, they credit your account with £/$100 worth of deposits by simply creating more money out of thin air.
Banks are allowed to do that because they have been given an incredibly lucrative privilege by our government: legal tender status (more on that later). This means that everyone who has a bank account must accept those deposits as cash.
The Fractional Reserve System
Banks lend money, but how do they get it in the first place? The Fractional Reserve System is where banks are legally allowed to loan out more money than they have on hand.
In fact, under U.S. law a bank can loan out around 10 times its actual cash on hand (up to 90% of all deposits). With only 10% of deposits kept in reserve, it becomes possible for banks to loan $10 for every $1 deposited -- up to 90% of their customers' accounts.
Digital Currency
New Technology or Digital Currency Revolution? : There are digital currencies—notably Bitcoin, a completely anonymous, peer-to-peer payment system that is not tied to any government—that may revolutionize how you interact with money.
It’s a complex topic and it's hard to know where Bitcoin fits into your financial plans. One thing is certain, though: If you aren't familiar with it already, Bitcoin will be a game changer when it comes to your finances. Read on for more information about why and how.
BitCoin and Blockchain Technology
what are they and why should you care? : The word blockchain is popping up everywhere these days. You see it in books, news articles, on television, at cocktail parties—hell, you even hear it from your barber.
But what does blockchain mean for you and your bottom line? And what does it have to do with cryptocurrencies like Bitcoin and Etherium? Before we go any further, a few words of caution:
Because cryptocurrencies were born during a time when there was no established protocol or legal framework for their use, we are currently operating in uncharted territory.
It’s important to remember that things can change quickly in cryptocurrency markets—even seemingly obvious facets of their functionality can be altered overnight. Things like... well... how they work!
Apple Pay, PayPal, Venmo
These days, it seems like you can spend money with just about anyone via an app. But where does that money come from in the first place?
In a 2014 white paper, Jeffrey Brown breaks down how cashless payments work: Cashless transactions occur when a customer uses his or her account number to directly access funds deposited in a depository institution's account at its Federal Reserve Bank.
According to Brown, cash transactions only make up about 30 percent of all financial transactions in 2013—an increase from 16 percent of transactions in 2003. However, cash is still widely used for large purchases—like cars and houses.
Where Does Money Come From - The Bottom Line
In short, money doesn’t come from anywhere—but it does need to go somewhere. If a bank makes a loan or buys bonds, for example, it will immediately have to find that money somewhere else in its portfolio of assets and liabilities—either in reserves kept at the central bank or by borrowing from another institution.
Banks make loans on both sides of their balance sheets: Deposits are liabilities (money owed to others) while loans are assets (money they can use elsewhere). At any given time, banks will have more loans than deposits; thus they need to borrow funds if they want to lend more money.
For example, when you deposit £/$1,000 into your checking account at Bank XYZ, your account becomes an asset for XYZ.