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Published on: Sep 12, 2024
#Crypto 360
A digital currency exists only virtually. It has no physical form and is available only in digital form.
➔ Digital currency is also known as electronic currency, electronic money, or cyber cash.
➔ Though digital currency is different from physical currency, it has the same utility and can be used to buy and sell goods or services.
➔ Digital currency facilitates quick transactions across borders.
Digital currency is an innovation that arose out of the fusion of finance and technology. A fintech revolution, digital currency is gaining widespread adoption across the globe. Let's learn more about digital currency, how it works, its types and examples in this blog.
A digital currency is a currency that exists in exclusively digital or electronic form. It is not tangible and has no physical form. But it has the properties of money, just like physical or fiat currency. It means that digital currency can be used to buy or sell goods and services.
Note that you can access fiat currency stored in your savings account in digital form over an online banking account or ATMs. It is also called e-currency. But the fact that it has a physical form disqualifies it from being designated as digital currency.
• Digital currency can only be accessed on computers or mobile devices connected to the internet.
• Digital currency is created, stored and exchanged in an online environment only.
• Digital currency cannot exist outside a digital or virtual environment.
As digital currency exists only in an online environment, it is created, stored and exchanged digitally. As you put your banknotes and coins in a physical wallet, you can put your digital currency in a digital wallet in a virtual environment. You can transfer your digital currency from one wallet to another to purchase certain products or services, such as gaming skins, community membership, or virtual shows. So, digital currency works entirely in an internet-enabled digital environment where all transactions are settled virtually.
In a traditional finance (TradFi) environment, you store most of your fiat currency in a bank account and keep a small amount in the form of banknotes and coins physically with yourself for day-to-day expenses. In a decentralised finance (DeFi) environment, you store your digital currency in a digital wallet in a virtual setting.
A digital wallet is nothing but an electronic device, an online application or software that lets you store and transfer digital currency. A digital wallet keeps a record of all your transactions in a secure and private manner exactly like a ledger. An important component of the digital economy, digital wallets have made physical wallets, credit and debit cards etc. redundant in technologically advanced parts of the world.
A digital wallet can be used to store:
• Digital money
• Gift cards
• Membership cards
• Loyalty cards
• Coupons
• Event tickets
• Travel tickets
• Hotel reservations
• Identification cards
• Car keys
Digital currency aims to address the tyranny of distance and time when it comes to money related matters.
A digital currency:
► makes transactions faster and easier at low costs.
► makes cross-border transactions hassle-free and economical due to no outside, centralised control.
► is available 24x7, even during weekends and holidays. A blessing for urgent monetary requirements!
► grants financial access to the marginalised sections of society who still remain unbanked or underbanked.
Primarily, there are four types of digital currency:
A cryptocurrency or crypto is a type of digital currency that is decentralised, is based on blockchain technology, and is secured by cryptography. It is not issued by a central monetary authority and lies outside the purview of the control of governments. It is used both as a medium of exchange and a store of value.
Cryptocurrency has shown an appreciation in its value that is unparalleled. But it also highlights its extremely volatile nature. Besides, cryptocurrency is largely unregulated across the world as it lies outside the control and regulation of government bodies.
Image: How a Cryptocurrency Transaction on a Blockchain Works, by GeeksForGeeks
The first cryptocurrency is Bitcoin (BTC) that debuted in 2009. It is the largest cryptocurrency in the world with a market cap of $1.1 trillion. Other popular cryptocurrencies are Ethereum (ETH), Solana (SOL), Litecoin (LTC), and Dogecoin (DOGE). The current market cap of the entire cryptocurrency market is over $2 trillion as we are writing this article.
A blockchain is a decentralised, distributed, and often public digital ledger consisting of records called blocks that record transactions across many computers. Cryptography is the process of hiding information in a code so that only the person a message is intended for can read it.
A stable cousin of cryptocurrency, a stablecoin is a type of digital currency the value of which is pegged to a national currency or a commodity.
Since a cryptocurrency is very volatile in its price movement, users looking for a stable digital currency didn’t have a real choice until stablecoins arrived. A stablecoin is a digital currency that is a stable alternative to the usually volatile cryptocurrency. It facilitates transactions more quickly and economically than other digital currencies.
However, the stability of a stablecoin’s value is not independent. A stablecoin is stable only as long as the underlying asset it is tied to is stable. Popular stablecoins are Tether (USDT) and USD Coin (USDC). The value of both is pegged to the U.S. Dollar, meaning that the value of 1 USDT or 1 UDSC is 1 USD each.
Recommended Read: Breaking Down Blockchain Technology
A central bank digital currency (CBDC) is a type of digital currency that is a virtual representation of the fiat currency issued by a central government in a nation.
The goal of a CBDC is to provide businesses and consumers privacy, transferability, convenience, accessibility, and security while engaging with financial transactions. It also simplifies the financial system and reduces cross-border transfer costs. Besides, a CBDC is a digital representation of the national fiat currency; so, there is no fear of price volatility and manipulation.
• As per the Atlantic Council, 134 countries & currency unions, representing 98% of global GDP, are exploring a CBDC.
• 19 of the G20 countries are now in the advanced stages of CBDC development.
• 3 countries have fully launched a CBDC—the Bahamas, Jamaica and Nigeria.
The founding members of BRICS, namely Brazil, Russia, India, China, and South Africa, are in the pilot phase of CBDC exploration.
Image: CBDC Tracker, by Atlantic Council
A virtual currency is a type of digital currency that is created and controlled by developers of a virtual organisation or a group. It is distributed among or sold to the stakeholders of the group. Virtual currency is mostly used in online games or metaverse to buy skins, weapons, farms etc.
It is very useful for gaming enthusiasts who want to take their games to the next level and are willing to invest money in it. The financial infrastructure offered by virtual currencies in a metaverse is a model worth emulating for future innovations. Among the most popular virtual currencies are The Sandbox (SAND), Decentraland (MANA), and My Neighbor Alice (ALICE).
The chief advantages of a digital currency are:
It takes relatively less time to execute transactions involving digital currency. Since it doesn’t require the permission of an intermediary like a central bank to allow fund transfers, the whole transaction becomes simpler, easier and faster. In contrast, money transfers via online banking can take a few minutes as it requires the permission of a central authority.
Due to its nature of direct interactions, digital currency can be transacted at lower costs. If two users are over a network, they can transfer digital money without any intermediary at very low transaction costs. In contrast, money transfers via online banking cost a lot.
Digital money can be used to make cross-border transactions easily, quickly and securely. If a user is from a remote region and is unbanked or underbanked, digital money is just the right financial instrument for them. A simple mobile device with an internet connection is all one needs to make cross-border transactions at low costs.
Physical infrastructure is nearly absent in the environment of digital money. There is no need to manufacture physical banknotes or coins in mints or for buildings to house monetary authority and banks. However, users must have access to internet enabled mobile or computer devices to engage with digital money.
Digital currency generally lies outside the control of any government or international bodies and organisations. Being decentralised, digital currency is immune to censorship and manipulation by the governments or the Big Tech. The user is in complete control of their stored digital currency and no outside force can control or restrict its flow.
The anonymous nature of digital money makes it private for users who value the principles of freedom and liberty. Digital money is best if you want to keep your financial transactions private and confidential.
The main disadvantages of a digital currency are:
While there is no requirement for a physical infrastructure, digital money requires a robust digital infrastructure. A user needs a mobile device, digital wallet, and other necessary software, along with an internet connection, to access and use digital money.
Not every person has access to such advanced technology to access digital money. The security and integrity of this digital infrastructure is of utmost importance, given how common scams and hacks are.
Digital money can be highly technical to understand and as it advances, it’s going to be difficult for noobs to use it due to its steep learning curve. Digital money is an implementation of fintech. But the tech part is getting so advanced that the finance part finds little currency among the customers.
Digital money, as is common to the entire digital world, is vulnerable to scams and hacks. Your money can be stolen from your digital wallets and transferred to untraceable accounts, making recovery nearly impossible. Neither custodial nor noncustodial wallets are secure. In fact, over $1.38 billion worth of crypto has been stolen by June 2024 as per TRM Labs.
The price movement of digital currency tends to be highly volatile, except for stablecoins. For example, Bitcoin has been swinging within the range of $53K and $64K over the last 30 days. Now, a range of $10K is too volatile for the price movement of the largest cryptocurrency. The pattern gets manifested across the whole spectrum of digital currency without any deviation.
Since digital currency is generally not accepted as legal tender in any country, its adoption remains very limited. Most retailers refrain from accepting digital money, so users don’t find it useful to keep digital money. Digital money therefore primarily remains relevant in a digital-only environment such as virtual games or metaverse.
Transactions involving digital money are irrevocable which means they cannot be altered once done. Suppose you transfer a certain amount of digital money from your wallet to an unintended wallet mistakenly, you cannot correct your mistake. The irrevocable transfer has been made and unless the stranger returns your currency out of kindness, there is no way you can get it back. In contrast, you can always request your bank to reverse a transaction if done mistakenly via online banking. This is where a central authority has an important role to play.
Digital currency is lucrative because it lies entirely online, is decentralised, and remains outside the purview of any intermediary such as the governments or the Big Tech. But that is exactly where it faces challenges.
Anytime something goes wrong with digital money (and there are plenty of things that go wrong), customers create noise on social media, appeal to the authorities and usually nothing comes of it. It is so because governments generally caution against the wide adoption of decentralised digital currency such as cryptocurrency due to price volatility, hacks, scams etc.
Several retail traders lose millions of dollars every year in the crypto market as the price movement of most digital currencies is very volatile. Stablecoins are considered stable, but the issuers have at times invested in risky ventures, violating the integrity of the whole exercise.
It is very difficult to track and reclaim stolen digital currency, given how sophisticated hacking networks are these days. Hidden in a distant corner of the world, hackers steal and transfer digital currency to untraceable accounts and investments.
Governments are intervening by trying to bring digital currency under the regulation of financial regulators. The controversy has led to long court battles in the U.S. Several governments have introduced CBDCs such as India’s e-Rupee. Privacy is not a high priority there. However, even the CBDC system can fail in the face of a potential collapse of a national economy.
Nonetheless, as far as the future of digital currency is concerned, there is going to be increased government intervention — if not control — over the next few years.
Digital currency gives you access to an unparalleled financial system where you are the king of your money. There is no government whose permission you need to make transactions. There is no way that suddenly, your account has been frozen out of nowhere. It’s an alternative financial order waiting for you to unravel its gifts. But there are a few inherent risks, too.
If something goes wrong, you are largely on your own. A theft of your funds, an attack on your wallet, a transaction gone wrong — it’s you who must deal with all such issues. Sure, you can go to the authorities, but it takes a lot of time for the police to crack such cases and generally, there is no hope of fund recovery. In addition, you cannot completely replace fiat currency with digital currency as the latter has very limited adoption.
Digital currency is primarily used as a store of value or as a speculative investment. At present, this is how you engage with digital currency in most parts of the world unless you are in a country like El Salvador where Bitcoin is a legal tender.
A digital currency is a currency that exists in exclusively digital or electronic form. It has no physical form, but it can be used just like fiat currency to buy or sell goods and services.
A digital wallet is an electronic device, an online application or software that lets you store and transfer digital currency. It can also be used to store gift cards, membership cards, loyalty cards, tickets etc.
There are four types of digital currency:
• Cryptocurrency
• Stablecoin
• CBDC
• Virtual currency
The main advantages of digital currency are:
• Faster transactions
• Lower transaction costs
• Cross-border transactions
• No physical infrastructure
• No outside control
• Privacy
The disadvantages of digital currency are:
• Robust digital infrastructure is required
• Highly technical to understand
• Scams and hacks
• Volatility
• Limited adoption
• Irrevocable transactions
This article is for informational purposes only and not intended as investment or financial advice. It contains opinions and speculations that are subject to change without notice.
The author and publisher disclaim any liability for decisions made based on the content of this article. Readers are advised to conduct their own research and consult a financial advisor before making investment decisions.
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