The history of paper money in Europe starts with the Venetian government levying a compulsory loan to pay for war

The history of modern financial instruments, and the ultimate origins of paper money, really begin with the issuing of municipal bonds—a practice begun by the Venetian government in the twelfth century when, needing a quick infusion of income for military purposes, it levied a compulsory loan on its taxpaying citizens, for which it promised each of them five percent annual interest, and allowed the “bonds” or contracts to become negotiable, thus creating a market in government debt.

The Venetians tended to be quite meticulous about interest payments, but since the bonds had no specific date of maturity, their market prices often fluctuated wildly with the city’s political and military fortunes, and so did resulting assessments of the likelihood that they would be able to be repaid.

Similar practices quickly spread to the other Italian states and to northern European merchant enclaves as well: the United Provinces of Holland financed their long war of independence against the Hapsburgs (1568–1648) largely through a series of forced loans, though they floated numerous voluntary bond issues as well.
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It was only with the creation of the Bank of England in 1694 that one can speak of genuine paper money, since its banknotes were in no sense bonds.

They were rooted, like all the others, in the king’s war debts.

This can’t be emphasized enough.

The fact that money was no longer a debt owed to the king, but a debt owed by the king, made it very different than what it had been before. In many ways, it had become a mirror image of older forms of money.

The reader will recall that the Bank of England was created when a consortium of forty London and Edinburgh merchants—mostly already creditors to the crown—offered King William III a £1.2 million loan to help finance his war against France.

In doing so, they also convinced him to allow them in return to form a corporation with a monopoly on the issuance of banknotes—which were, in effect, promissory notes for the money the king now owed them.

This was the first independent national central bank, and it became the clearinghouse for debts owed between smaller banks; the notes soon developed into the first European national paper currency.