Digital Money: Complete Definition, Functioning, and Economic Implications in 2025
Digital money represents over 90% of the monetary mass in circulation in our modern economies today. Unlike the physical money we all know (coins and banknotes) issued by central banks, digital money exists solely as accounting entries in the computer systems of banks. This article offers an in-depth exploration of this fundamental concept of contemporary economics, essential for understanding the functioning of the current financial system.
Definition and Nature of Digital Money
Digital money, also known as bank money or book money, refers to the total amounts of money recorded on current accounts held by customers at banking institutions. It takes the form of a simple accounting entry, a numerical representation of value rather than a physical substance.
In contrast to physical money managed and issued by central banks, digital money is created and managed by commercial banks. It has no tangible physical form, making it entirely dematerialized money. When you check your bank balance on your mobile app or at an ATM, you are viewing digital money.
This distinction between physical money and digital money is crucial for understanding how modern monetary economies function. While coins and notes are material signs of value, digital money relies solely on trust in banking institutions and the settlement systems they have established.
Main Characteristics of Digital Money
Digital money possesses several distinctive characteristics that differentiate it from other forms of money:
Immaterial Character: Digital money exists only as electronic entries. It cannot be physically handled, stored in a wallet, or directly used for the exchange of goods.
Convertibility: At any time, digital money can be converted into physical money. A customer can request their bank to withdraw funds in the form of cash, although this practice is becoming increasingly rare in contemporary societies.
Electronic Circulation: Digital money circulates exclusively through electronic transactions: credit card payments, transfers, debits, checks, and other forms of dematerialized payment methods.
Bank Creation: Unlike physical money whose creation is the monopoly of the central bank, digital money is created daily by commercial banks during their lending operations.
Functioning and Mechanisms of Digital Money
To fully understand digital money, it is essential to know the concrete mechanisms that govern its day-to-day functioning.
Basic Functioning of Transactions
The functioning of book money relies on an accounting system between bank accounts. When someone makes a payment by credit card, bank transfer, or check, no physical bills change hands. Instead, the payer's bank debits the customer's account and credits the recipient's account.
Let's take a concrete example: you buy a phone for 500 euros using your credit card. Your bank simply performs an accounting operation: it deducts 500 euros from your account and adds them to the seller's account (or more precisely, to the seller's bank account, which then adds them to the seller's account). This transfer of book money takes place in just a few seconds, without any physical object being exchanged.
This compensation system works through a complex network of interconnected banks, managed in Europe primarily by centralized payment systems that ensure the proper execution of cascading transactions.
Means of Payment in Book Money
Every time you do not use cash, you are using book money. The main means of book money payment are:
Credit Card: This is the most widely used means of book money payment today, representing approximately 90% of book money transactions. Whether it is debited immediately or later, the credit card transmits a payment order to your bank which performs an accounting entry.
Bank Transfer: A transfer allows for the direct transfer of book money from one account to another, whether at the same bank or a different one. It is a reliable and traceable means of payment.
Direct Debit: Direct debit authorizes a creditor to debit directly the debtor's account according to a predefined schedule. It is a widely used means of payment for recurring bills (electricity, insurance, subscriptions, etc.).
Check: Although less used than before, the check remains a means of book money payment. It functions as a written payment order that the recipient presents to their bank to obtain the credit for the amount.
Other Means: Commercial instruments such as promissory notes and drafts also constitute means of book money payment, although they are mainly used in commercial transactions.
Creation of Book Money by Banks
A fundamental and sometimes misunderstood aspect of book money concerns its creation process. Unlike what many people imagine, banks do not merely lend the money entrusted to them by customers. They actively create book money.
The Mechanism of Monetary Creation Through Credit
When a commercial bank grants a loan to a customer, it does not withdraw this money from a vault full of bills nor debit another customer's account. It simply records the loan amount on the borrower's account. At that precise moment, new book money is created. Economists call this "ex nihilo" monetary creation, meaning out of nothing.
Let's take an illustrative example: you want to buy a car for 15,000 euros, but you only have 5,000 euros in savings. You request a loan of 10,000 euros from your bank. The bank does not go looking for this money elsewhere; it simply writes "+10,000 euros" on your bank account. At that moment, 10,000 euros of new scriptural money are created. This money did not exist before; it was created by the act of lending itself.
Later, when you repay this loan, the money you pay is gradually "destroyed." It disappears from the bank's accounts as you make payments. Thus, the corresponding money supply decreases in inverse proportion to its initial creation.
Importance of Fractional Reserve Requirements
In order to create scriptural money, commercial banks must meet certain legal requirements. They cannot create money without limit. Financial regulatory authorities, including central banks, require banks to keep a fraction of their deposits as reserves.
The so-called "fractional reserve system" works as follows: when a customer deposits 1,000 euros in cash into a bank, the bank must keep a portion of this amount as reserves, typically around 10% according to regulatory requirements. In this example, the bank must keep 100 euros.
The rest of the money, which is 900 euros, can be lent to other customers. These 900 euros then become new scriptural money created by the bank. If the person who borrowed these 900 euros deposits them again in another bank, the process repeats: 90 euros are kept as reserves and 810 euros can be lent again. This multiplier effect allows the money supply to increase far beyond the initial amount of cash deposits.
This mechanism, though peculiar at first glance, is not only legal but also necessary for the functioning of modern economies. It enables banks to finance the economy by creating credit, which stimulates investment, consumption, and economic growth.
Control of Money Creation by the Central Bank
Although commercial banks create most of the scriptural money, they do not do so entirely freely. Central banks exert powerful indirect control over the amount of scriptural money in circulation.
Central banks use several tools to regulate money creation: setting the discount rate, fixing reserve requirements, open market operations, and prudential supervision of commercial banks. For example, by raising the discount rate, the central bank makes borrowing more expensive for commercial banks, which encourages them to reduce their loans and thus slow down the creation of scriptural money.
Economic Importance of Scriptural Money
Scriptural money plays an absolutely central role in the functioning of contemporary economies, often underestimated by the average citizen who sees only coins and bills.
Representation in the Money Supply
Currently, digital money represents more than 90% of the total money supply in circulation in the eurozone and most developed economies. This proportion is increasing regularly as digital transactions become the norm and the use of cash declines.
This predominance of digital money is not insignificant. It reflects the evolution of payment practices, the generalization of banking, and the growing confidence in electronic payment systems. In large urban centers, it is now virtually unnecessary to carry cash for daily transactions.
Advantages of Digital Money
Economic Efficiency: Digital money allows for much faster and more efficient circulation of resources. Transactions that would have taken days or even weeks with cash can now be completed in just hours or even in real-time.
Traceability: Each transaction in digital money leaves a digital trace. This traceability is beneficial for combating fraud, financial crime, and tax evasion.
Security: Transporting large amounts of cash presents risks. Digital money eliminates these risks of theft or loss.
Convenience: Digital money can be divided infinitely, which facilitates transactions of all sizes, from micropayments to transactions in millions of euros.
Fundamental Distinction: Digital Money vs. Fiat Money
It is important to clearly distinguish these two forms of money that coexist in our economic system:
Fiat Money: Coins and banknotes are issued exclusively by the central bank. Their creation is strictly controlled and limited. They have a tangible physical form and their value rests on the collective trust in the issuing institution.
Digital Money: It is created by commercial banks during their lending operations. It has no physical form and exists only in the form of book entries. Its value also rests on trust, but also on the banking clearing system.
The two forms of money are complementary and necessary for the functioning of the financial system. Fiat money allows for occasional cash transactions, while digital money supports massive and continuous economic flows.
Challenges and Prospects of Digital Money
Digital money currently faces several major challenges that will likely reshape its role in the future economy.
Impact of New Technologies
The emergence of cryptocurrencies and central bank digital currencies (CBDCs) raises interesting questions about the future of digital money. Some fear a disintermediation of banks, meaning that citizens would no longer need commercial banks to hold and exchange money.
However, it is important to note that even commercial banks are exploring blockchain technology and digital payments to modernize their infrastructure. Many now offer bank cards allowing payments with cryptocurrencies, although these transactions are converted into book money at the time of payment.
Progressive Decline of Cash
In many countries, including Sweden and the Scandinavian countries, the decline of cash is spectacular. Some businesses no longer accept cash at all. This trend reinforces the dominant position of book money in the economy.
However, this decline of cash also raises social questions. People excluded from the banking system, older populations less comfortable with digital technology, and those who wish to preserve some anonymity in their transactions risk being marginalized.
Regulation and Financial Stability
Financial regulatory authorities are paying increasing attention to the stability of the money creation system. Past financial crises have shown the risks of excessive credit creation by commercial banks. That's why rules limiting leverage and bank capitalization were strengthened after 2008.
Conclusion
Book money is more than just an abstract economic concept. It is the foundation of modern economics, the blood circulating through the veins of today's financial system. Representing over 90% of the money supply in circulation, it enables billions of transactions each day that support global economic activity.
Unlike paper money which has existed for millennia, book money is a historically recent phenomenon born with the development of banking and communication technologies. Its success rests on mutual trust in the banking system and financial regulatory institutions that oversee it.
Understanding book money is essential for anyone wishing to have a deep understanding of how the contemporary economy works. It is a powerful tool for wealth creation and investment financing, but also a system that requires constant regulation to avoid excesses and financial crises.
At a time when digital technologies and cryptocurrencies are challenging the traditional role of book money, it is more important than ever to understand this fundamental mechanism. The future of book money will depend on its ability to adapt to these technological challenges while maintaining the stability and trust that are at the heart of its operation.