What Is Electronic Money?

Electronic money refers to money that exists in banking computer systems that may be used to facilitate electronic transactions. Although its value is backed by fiat currency and may, therefore, be exchanged into a physical, tangible form, electronic money is primarily used for electronic transactions due to the sheer convenience of this methodology.

Key Takeaways

  • Electronic money is currency that is stored in banking computer systems.
  • Electronic money is backed by fiat currency, which distinguishes it from cryptocurrency.
  • Various companies allow for transactions to be made with electronic money, such as Square or PayPal.
  • The prevalence of electronic money has led to the diminishing use of physical currency.
  • Although electronic money is often considered safer and more transparent than physical currency, it is not without its risks. 

How Electronic Money Works

Electronic money is used for transactions on a global basis. While it may be exchanged for fiat currency (which, incidentally, distinguishes it from cryptocurrencies), electronic money is most commonly utilized through electronic banking systems and monitored through electronic processing. Because a mere fraction of the currency is utilized in physical form, the vast percentage of it is housed in bank vaults and is backed by central banks.

For this reason, a primary function of the U.S. Federal Reserve and its 12 supporting banks is to manage the fiat currency in physical form and control the money supply through monetary policies and open market operations. 

Because of the transparency that is inherent to electronic money, many have speculated that the increase of its use could lead to a significant decrease in inflation risk.

Special Considerations

Currency in Circulation

Electronic money can be held in various places. Most individuals and businesses store their money with banks that provide electronic records of the cash on deposit. However, prepaid cards and digital wallets like PayPal and Square likewise allow users to deposit fiat currency for electronic money. Such companies will make their profit by charging a percentage on any amount that is withdrawn from accounts or converted from electronic money back into fiat currency. 

Electronic Payment Processing

Many Americans process transactions electronically in a multitude of ways. This includes receiving paychecks through direct deposits, moving money from one account to another via electronic fund transfers, or spending money with credit cards and debit cards

While physical currency is still advantageous in certain situations, its role has gradually diminished over time. Many consumers and businesses believe electronic money is more secure and convenient because it cannot be misplaced, and it is widely accepted by merchants nationwide. The U.S. financial market has consequently established a robust infrastructure for transacting electronic money, which is primarily facilitated through payment processing networks, such as Visa and Mastercard.

Banks and financial institutions partner with electronic money networking processors to issue their customers branded network cards that facilitate these electronic transactions from bank accounts to merchants. Electronic money is also easily transacted through e-commerce, letting consumers conveniently shop for goods and services online.

Criticisms of Electronic Money

Although electronic money is quickly becoming the norm and is often hailed as the more secure and transparent alternative to physical currency, this does not mean that it comes without its own set of risks and vulnerabilities. For instance, fraud becomes an issue when money can be transferred from one party to another without the necessity for the physical verification of the original owner’s true identity. 

Electronic transactions also lend themselves to being more discreet and, thus, easier to hide from the IRS, making electronic money a potential and unwilling accomplice to tax evasion. Lastly, the computer systems that are responsible for carrying out electronic transactions are not perfect, meaning that electronic money transactions can sometimes go awry simply due to system error.