What is Money? A Primer on Fiat, Central Bank Money & Commercial Bank Money
Understand the three forms of money in the modern financial system before diving into stablecoins.
Key Takeaways
- Money exists in three forms: central bank money, commercial bank money, and physical cash.
- Fiat currency derives its value from government backing, not a physical commodity.
- Stablecoins attempt to digitize the properties of money on public blockchains.
The Three Forms of Modern Money
Most people think of money as the notes and coins in their wallets—but that physical cash accounts for only a tiny fraction of the money supply in any modern economy. To understand stablecoins, you first need to understand the three distinct forms that money takes today.
Central Bank Money (M0)
At the apex of the monetary system sits the central bank — think the US Federal Reserve, the European Central Bank, the Bank of England, or the Bank of Japan. Central banks create base money (also called M0 or reserve money) in two forms:
- Physical banknotes and coins — the cash you carry.
- Reserve accounts — electronic balances that commercial banks hold at the central bank. When you make an interbank transfer, it ultimately settles by moving reserves between these accounts.
Central bank money is the safest form of money because it is a direct liability of the state. It cannot default.
Commercial Bank Money (M1–M3)
When you deposit $1,000 at a commercial bank, that bank records a liability to you and an asset in its vault. It then lends most of those funds to a business. That business deposits the loan proceeds at another bank, which lends again. This fractional-reserve process creates new money. The $1,000 deposit effectively becomes $8,000–10,000 in broad money (M2/M3) circulating in the economy.
Commercial bank money is what you see in your bank app balance. It is a claim on the bank, not on the state—which is why bank failures matter.
Why This Matters for Stablecoins
Stablecoins aim to create a fourth form of money: programmable digital money that lives on a blockchain, settles instantly and globally, and maintains a stable value relative to a reference asset (usually the US dollar). Whether a stablecoin succeeds depends critically on how its reserve structure maps onto these foundational money concepts—and how regulators classify it.