In the fast-paced world of online transactions, having money in digital form will give you the advantage of speed and flexibility. Even people who are classified as unbanked, or those who don’t keep funds in a traditional financial institution, can benefit from the ease of processing payments digitally.
Within seconds, the exchange of these intangible assets for tangible goods can happen with just the wave of a device or tap of a finger. And in a world reeling from the impact of the coronavirus pandemic, cashless and contactless payments are expected to become the norm because face-to-face transactions will likely continue to be restricted due to public health concerns.
Not all digital currencies are the same, however. Some offer greater security and transparency than others. Take cryptocurrencies for example – a form of virtual currency that runs on cryptography or algorithms that “hide” transactions from prying eyes.
This guide will help you understand the similarities and differences between digital currencies and a specific subset of “digital money” called cryptocurrencies, which have become popular thanks to the rise of bitcoin in the past decade.
What Is Digital Currency?
The term “digital currency” refers to a broad set of currencies in electronic form. They can either be issued by an authority like a central bank – also known as a central bank digital currency (CBDC) – or issued by their own developers and exchanged within communities, as seen in the case of bitcoin. As such, digital currencies can either be regulated or unregulated.
Those regulated and issued by financial institutions such as central banks are, of course, backed by the government’s legal tender, the most popular form being the national currency. This type of digital currency takes the value of fiat money (physical money) and makes it accessible through an electronic medium, whether through a digital wallet or by connecting to an online platform.
Simply put, regulated digital currencies serve as an electronic version of traditional coins and paper bills, and essentially follow the same regulations and monetary policies that govern fiat currencies. In fact, some governments also permit their citizens to open digital currency accounts as a savings or payment medium, like in the case of retail or general purpose CBDCs.
In contrast, unregulated virtual currencies are digital currencies that lack any legal tender or regulatory guarantee from the government. That means the currency is issued by private individuals or groups, most likely the developer of that digital currency. Peer-to-peer transactions that use virtual currencies operate on trust or the users’ common acceptance of the value of that currency.
The European Central Bank, for its part, defines virtual currencies as “digital money in an unregulated environment, issued and controlled by its developers and used as a payment method among members of a specific virtual community.”
The value of virtual currencies is set through mechanisms that influence their trade – such as mining and the accumulation of coins like in the case of bitcoin – as well as the “tokenization” of physical assets such as real estate and the overall activity of investors who buy into the virtual currency system.
Bitcoin is an example of an unregulated digital currency – hence, a virtual currency – since transactions are based on blockchain, a decentralized system that records the exchange between peers in a public and transparent ledger. In other words, there’s no need for central banks to regulate the exchange.
However, bitcoin and upgraded currencies such as Bitcoin Cash and Bitcoin SV – the latter being the most highly scalable – hold an advantage over most other types of virtual currencies in that they use cryptography to keep transactions secure and easily verifiable. This is why they are also classified as cryptocurrencies.
What Is Cryptocurrency?
The term “cryptocurrency” refers to unregulated virtual currencies that are protected by cryptography. The blockchain technology powering cryptocurrencies exists across a distributed network of computers. Because of this, transactions aren’t confined within a specific territory or country and, as a result, they aren’t regulated by governments or other central authorities.
Meanwhile, the fact that cryptocurrencies are protected by cryptography makes these digital assets more difficult to counterfeit – yet easier to verify between peers – than most virtual currencies.
How does cryptography for currencies like bitcoin generally work? In the use of public key cryptography, for instance, the address of a user’s crypto wallet (created on a blockchain) is always public.
However, only the owner of the wallet has the private key. This is what enables the owner to control and verify transactions. Verification using the private key is no different from affixing your signature on a check when a payment is being made. When the exchange is validated, the transaction is recorded into the ledger. All exchanges before and after are documented this way, showing traders and investors the entire transaction history.
Digital Currencies and Cryptocurrencies: Similarities and Differences
All cryptocurrencies are digital currencies, but cryptocurrencies are also a specific type of unregulated asset classes that have unique use cases and functions. Before launching into their core differences, it’s important for investors to remember a few fundamental similarities between digital currencies and cryptocurrencies.
- Digital currencies and cryptocurrencies are traded electronically.
- Both hold value that can be equated to assets in the real world, e.g. real estate or fiat money.
- Because of their value, they can be used to make transactions, such as the purchase of goods or services or the trade of other currencies.
However, blockchain and cryptographic protocols make cryptocurrencies even more attractive than most digital currencies.
- Some digital currencies are regulated by authorities such as central banks. Meanwhile, cryptocurrencies fall outside of this type of regulatory hold. The community of miners, block validators, traders, and investors play a crucial role in regulating the exchange.
- Digital currencies don’t offer transparency the way blockchain-powered cryptocurrencies do. Fund transfers using digital money don’t show up anywhere public. However, those involving cryptocurrencies are recorded on a public ledger thanks to blockchain.
- Not all digital currencies encrypt data in the exchange of currencies. However, the cryptographic protocols behind bitcoin and other cryptocurrencies make it difficult for anyone to peek into (and hack) a crypto wallet. By encrypting messages and transactions, the exchange of currencies remains secure and concealed from unauthorized parties. Meanwhile, cryptography enables those who are authorized to verify transactions almost instantly.
Conclusion: The Best of Both Worlds?
There’s certainly no reason for investors to put all their money in just one asset class. While most digital currencies may not, at present, have the advanced features of blockchain and cryptography, there are still advantages to keeping part of your cash in a regulated electronic medium and relying on the guidance of banks. In case you make a mistake with a transaction, for instance, there is a governing body that can help you reverse your actions.
Meanwhile, those looking to diversify their assets may reap the benefits of investing in cryptocurrencies such as bitcoin. Among the advantages are the ease of transaction across borders and the transparency offered by crypto communities. Whichever direction you take, remember that being a financially savvy investor requires keeping an open mind regardless of which asset class you invest your money in.