Digital currency What is and how does it work

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What is Digital currency ?

Digital currency (digital money, electronic money or electronic currency) is any currency, money, or money-like asset that is primarily managed, stored or exchanged on digital computer systems, especially over the internet. Types of Digital currency include cryptocurrency, virtual currency and central bank digital currency. Digital currency may be recorded on a distributed database on the internet, a centralized electronic computer database owned by a company or bank, within digital files or even on a stored-value card.

Digital currency exhibit properties similar to traditional currencies, but generally do not have a physical form, unlike currencies with printed banknotes or minted coins. This lack of physical form allows nearly instantaneous transactions over the internet and removes the cost associated with distributing notes and coins. Usually not issued by a governmental body, virtual currencies are not considered a legal tender and they enable ownership transfer across governmental borders.

This type of currency may be used to buy physical goods and services, but may also be restricted to certain communities such as for use inside an online game.

Digital money can either be centralized, where there is a central point of control over the money supply (for instance, a bank), or decentralized, where the control over the money supply is predetermined or agreed upon democratically.
Source : wikipedia

What makes a digital currency

Money in digital form (such as dollars sitting in your bank account) is a type of digital currency, but it isn't the same as cryptocurrency .

The reason is that money in digital form can be converted into physical cash (for example, via an ATM) when making a withdrawal.

Traditional money in its digital form can be used to facilitate electronic payments by card at physical merchants and online, but there are some differences between it and money built as an actual digital currency.

Money in its current form -- including digital forms of cash on deposit at the bank -- is created and distributed by a central bank Think of the U.S. dollar, which is printed by the U.S. Treasury and distributed by the Federal Reserve. In a centralized process, a system of serial numbers is usually used to make sure each note is unique. Bank partners are used to distribute cash into the economy.

What is a Central Bank Digital Currency?

A CBDC is a digital form of central bank money that is widely available to the general public.

"Central bank money" refers to money that is a liability of the central bank. In the United States, there are currently two types of central bank money: physical currency issued by the Federal Reserve and digital balances held by commercial banks at the Federal Reserve.

While Americans have long held money predominantly in digital form for example in bank accounts, payment apps or through online transactions a CBDC would differ from existing digital money available to the general public because a CBDC would be a liability of the Federal Reserve, not of a commercial bank.

Types of Digital currency

Digital currency is an overarching term that can be used to describe different types of currencies that exist in the electronic realm. Broadly, there are three different types of currencies:

Cryptocurrencies

Cryptocurrencies are Digital currency that use cryptography to secure and verify transactions in a network. Cryptography is also used to manage and control the creation of such currencies.

Bitcoin and Ethereum are examples of cryptocurrencies. Depending on the jurisdiction, cryptocurrencies may or may not be regulated.

Cryptocurrencies are considered virtual currencies because they are unregulated and exist only in digital form.

Virtual Currencies

Virtual currencies are unregulated Digital currency controlled by developers or a founding organization consisting of various stakeholders involved in the process.

Virtual currencies can also be algorithmically controlled by a defined network protocol. An example of a virtual currency is a gaming network token whose economics is defined and controlled by developers.

Central Bank Digital currency

Central bank Digital currency (CBDCs) are regulated Digital currency issued by the central bank of a country. A CBDC can be a supplement or a replacement to traditional fiat currency.

Unlike fiat currency, which exists in both physical and digital form, a CBDC exists purely in digital form. England, Sweden, and Uruguay are a few of the nations that are considering plans to launch a digital version of their native fiat currencies.

Advantages that digital currency have over cash

Around the world, more and more people and businesses are recognising the benefits of digital currency. Convenient and secure, digital currency is quickly emerging as a practical alternative to traditional fiat currency, but do you know how they compare?

Below, we outline seven of the key advantages that digital currency has over cash. Continue reading to learn more.

1. Security

Digital currency transactions are irreversible once authorised. This offers exceptional protection against fraud compared to fiat currencies, which are less secure due to the personal information required to make transactions and the potential for chargebacks.

Digital currency are empowered by blockchain technology, making them virtually impossible to counterfeit or duplicate.

2. Decentralised & Autonomous

Unlike hard cash currencies, Digital currency are decentralised, meaning they are not managed by a central governing body. The absence of governments and banks in your transactions gives you more control over how your money is managed.

Your digital currency wallet works the same way the one in your pocket works; you have direct, immediate access to its contents.

Compare that to the hoops you must jump through to move your fiat currency from one bank to another, and you can quickly see the difference.

3. Fast, Mobile Payments Online

Sure, no transaction is faster than cash over the counter, but fiat currencies have their limits.

When you’re sending money internationally, for example, a payment with fiat currency can take days or even weeks to process, particularly if the payment is thousands of dollars or larger.

Digital currency payments, by contrast, are not only easy to make online via mobile devices but also functionally the same regardless of the amount or distance.

4. Peer-to-Peer Transactions

We’ve already mentioned that Digital currency are decentralised, meaning you don’t need the resources of a third party like a bank or credit company to manage them, but this also means your transactions are directly peer-to-peer.

Therefore, no third parties are necessary to guarantee the transaction.

5. Minimal Fees

Because digital currency fees are peer-to-peer, you’ll encounter fewer, if any fees when transferring funds.

The networking structure made possible by blockchain technology eliminates the need for intermediary institutions to facilitate transactions.

Not only will you pay less in fees than you would if you were transferring fiat currencies, but you’ll also find it easy to monitor the process and keep track of your funds.

6. Discrete & Confidential

With fiat currency, much of your financial history is documented and handled by third parties, such as credit reporting agencies, banks, collectors, and marketers.

With Digital currency, that’s not the case. The transaction history of the coin is what is recorded and stored, not the spender.

7. Safer for Merchants

Digital currency transactions are validated in seconds. For merchants, this means a reduced risk of bounced checks or attempted chargebacks.

Once a transaction is written in the blockchain, it cannot be withdrawn or reversed, offering enhanced security for businesses. Indeed, a growing number of merchants see digital currency as the future and are working to conduct more of their business with it.

Risks of Digital Money

Payment fraud is one significant risk that can be attributed to the increasing use of digital money is payment fraud. Payment fraud can be committed in many forms.

However, in general, it includes fraudulent or unauthorized transactions completed by a cybercriminal. Some common forms of payments fraud include:

Fraudulent payments
Illegal payments
Internal manipulation
Data theft
Breach of embargos and sanctions

Because money is not transferred physically, it is impossible to know who is on the other side of a transaction. It gives rise to opportunities for cybercriminals to gain access to sensitive information or scam people through digital money.

Although payment security’s been increasing, the complexity of which cybercriminals commit fraud is becoming increasingly complex as well. Payments fraud activity is continuing to rise, and it shows no signs of declining.

Modern-day cybercriminals are becoming craftier than ever, continuously exploiting new weaknesses and devising different methods of manipulating digital money.

Scammers are very persistent in their efforts to attack payment systems. If they face challenges on a particular method, they will just pivot and shift their focus to alternative payment methods.

Characteristics of Digital currency

In order to issue a digital currency backed by central banks, called by the acronym CBDC, the Bank for International Settlements (BIS) lists up to 14 characteristics that make this type of currency a platform that aligns with the financial stability objectives that govern international monetary institutions. The highlights of CBDCs, according to the BIS, are:

The conversion and the value will be the same as with physical money and volatility will be avoided
They will be accepted and available for all types of online and offline transactions 24/7
Its cost will be low and almost zero in the moments of creation and final distribution of the money
They will be a safe and resilient system at all times against possible cyberattacks, system failures or disruptions
They will be operable between different banking systems
They will be robust and legal currencies thanks to the support of a central bank

Difference between Digital Currency and Cryptocurrency

Digital Currency : is the digital format of fiat currency that you carry around in your wallet or withdraw from an ATM. It’s the same currency that is backed by an authority .

Cryptocurrency : is not backed by a central figure but derives its purchasing power from its community of users. Technically, they are pieces of code created by ‘mining’ that are managed through a digital ledger called as blockchain to ensure transparency at each stage of its journey.

Although coins like Bitcoin and Ethereum have many uses when it comes to NFTs and the upcoming metaverse, they cannot be utilised outside of blockchain .

Now that we know about them, here are five major differences between digital currency and cryptocurrency .

1 - Centralisation

The biggest difference digital currency and cryptocurrency is the question of who has control over the monetary value of your coins.

In case of digital currency, it would be the Reserve Bank Fed in the US along with the government, banks and other middlemen, all of whom would have to come together to set the value of the currency in question.

This is why you would read of the Turkish Lira’s depreciation by over 40% in 2021 or the collapse of financial systems in Myanmar and Afghanistan once the central authority is left powerless.

Cryptocurrency, on the other hand, follows a transparent procedure right from mining to ownership to transfer of crypto assets. Its value is also independent of central banking authorities and regional geopolitical problems.

2 - Encryption

Once again, cryptocurrency trumps digital currency when it comes to encryption. Digital currency are essentially e-cash that doesn’t need any special indigenous methods to encrypt them.

Cryptocurrencies, on the other hand, are stored on a blockchain and the coins themselves are stored in ‘wallets’ that offer a much higher degree of cyber security.

Also, choosing the right cryptocurrency exchange that offers the best of security features and a wide range of currencies to transact with, is the primary requirement to transact using cryptos.

WazirX is one such crypto exchange that does the job reliably and one that we highly recommend to get started on your crypto journey. Be sure to open your account here.

3 – Transparency

The biggest advocates for cryptocurrency will cite the transparency afforded by the platform. Every detail regarding cryptocurrency transactions is in the public domain thanks to the presence of a decentralised ledger that records all the blockchain details.

With digital currency, only the banking authorities along with the sender and receiver are involved in the transaction involved. In case of conflict over any asset, cryptocurrencies are easier to manage as the records are there for everyone involved to see, whereas Digital currency could involve bureaucratic hurdles and other problems in case of any conflict. This decentralisation of data is, in fact, one of the driving forces leading to the adoption of cryptocurrencies across the world.

4 – Stability

Digital currency is usually stable and also relatively easy to manage, thanks to having wider acceptance in the global market. Digital currency, being the fiat version of approved currency, is traded and understood by a vast majority of the population.

This, in turn, makes it more stable when compared to a new technology such as cryptocurrency that has started gaining attraction but isn’t mainstream yet. Added to that, the price volatility of cryptocurrencies is another aspect that hampers its stability even as new tech and features mean that it is slowly but steadily gaining traction all around.

5 – Legality

Most countries are now taking a look at the legality and acceptance of cryptocurrencies.

Since these aren’t backed by any governing body, most traditional frameworks don’t assign any value to them. However, the swift rise in the number of depositors and various use cases of blockchain today and the upcoming metaverse, where the only method of payment remains cryptocurrencies.

means that some sort of discussion around the legality of cryptocurrencies is bound to happen sooner than later. For now, countries around the world are firm in backing their own fiat currencies.