Digital Currency Fundamentals – Understanding the Technology


This article will briefly summarise the most basic information about Digital Currency. This information is essential for any Tech-Savy person, especially those aware of this ever-evolving monetary technology. So, without further ado, let’s begin.

Definition of Digital Currency

Often called cybercash, digital money, electronic currency, or electronic money, digital currency is a form of currency that is available in just electronic or digital form. This currency, money, or money-like asset is primarily stored, managed, or exchanged on digital computer systems. especially over the world wide web (internet).

Five Facts about Digital Currency

(1) Digital currencies are currencies that exist electronically and can only be accessed via computers or mobile phones.
(2) Using Digital currencies is the most cost-effective way to trade currencies as they do not require intermediaries.
(3) While all cryptocurrencies can be described as digital currencies, not all cryptocurrencies can be considered digital currencies.
(4) Digital currencies have the advantage of allowing seamless value transfer and making transaction costs more affordable to the user.
(5) The major disadvantage of Digital currencies is they can be volatile and easy to hack.

Comparing Digital and Physical Currency

Digital currencies are not physical like coins and paper money and they can only be accessed in digital format. Transactions which digital currencies are made using electronic wallets which are connected to the internet or a designated network.

On the other hand, physical currencies, like banknotes and minted coins, are tangible. This means you can touch them and they have definite physical characteristics and attributes. Transactions involving physical currencies are made possible only when the exchangers have physical possession of the amount of currency needed for the transaction.

Digital currencies are similar to physical currencies as both are used to purchase goods and pay for services. Both can also be used among certain online communities, such as social networks, gaming sites, and betting portals.

With Digital currencies, instant transactions can be seamlessly executed across borders. For example, it is very possible for a person located in the United States to make payments (in digital currency) to another person residing in the United Kingdom, provided they are both connected to the same network.

What are the Characteristics of Digital Currencies

(1) First, digital currencies can only exist in digital form. There is no physical equivalent attached to the currency.
(2) Secondly, Digital currencies can either be centralized or decentralized. Fiat currency, which is the currency that exists in physical form, is a centralized system. It is produced and distributed by a country’s central bank and government agencies.

(3) Prominent cryptocurrencies like Bitcoin and Ethereum, are perfect examples of decentralized digital currency systems.
(3) Digital currencies are capable of transferring a value. This means that digital currencies are capable of causing a mental shift in the existing framework for currencies. For example, a gaming network token is capable of extending the life of a player and also providing them with some extra superpowers. This gaming token does not mean a purchase or sale transaction. Rather, it uses a digital currency and represents a transfer of value.

The Different Types of Digital Currencies

In most cases, digital currency can be used to describe different types of currencies which exist in the electronic realm. Basically, there are three different types of digital currencies:

(1) Cryptocurrency

Cryptocurrencies are the most popular digital currencies. The technology uses cryptography to secure and verify transactions in a network. Cryptography is also used to control the creation and manage such currencies. The most popular cryptocurrency is Bitcoin and Ethereum.

Depending on an individual’s jurisdiction, cryptocurrencies may or may not be regulated. Cryptocurrencies are widely considered virtual currencies owing to the fact that they are unregulated and can exist only in digital form.

(2) Virtual Currency

A Virtual currency is an example of an unregulated digital currency that is controlled by developers or a founding organization. This organization has various stakeholders involved in the process of its virtual currency creation. Virtual currencies are capable of being algorithmically controlled by a defined network protocol. A perfect example of virtual currency is a gaming network token, whose economics is designed, defined, and controlled by developers.

(3) Central Bank Digital Currency

Central bank digital currencies, known as the CBDCs are regulated digital currencies. They are issued by the central bank of a given country. Central Banks use CBDC as a supplement or a replacement to a country’s traditional fiat currency. Unlike fiat currency, that can exist in both physical and digital form, Central Bank Digital Currency only exists in digital form. Countries like Nigeria, England, Sweden, and Uruguay are examples of countries that have considered plans to launch a digital version of their native fiat currencies.

What is the difference between Digital Currencies, Cryptocurrencies, and Virtual Currencies

Digital Currencies: This currency exists as regulated or unregulated currency and it is available only in digital or electronic form.

Virtual Currencies: This currency exists as an unregulated digital currency that is controlled only by its defined network protocol, developer(s), or founding organization.

Cryptocurrencies: This is a virtual currency that uses cryptography to verify and secure its transactions, as well as to control and manage the creation of new currency units.

Advantages of Digital Currencies

Find below, some advantages of digital currencies.

(1) Digital currencies have the fastest transfer and transaction times
This is because Digital currencies generally exist within the same network. They can accomplish their transfers without needing intermediaries. And the amount of time required for transferring digital currencies is the fastest.

As payments involving digital currencies are made directly between the transacting parties. This payment is done without the need for any intermediaries. Digital currency transactions are low-cost and very instantaneous. This is generally better compared to traditional payment methods which involve the use of banks or clearinghouses. Also, there is better record keeping and transparency in dealings with Digital-currency-based electronic transactions.

(2) Producing digital currencies does not require physical manufacturing and cannot be soiled
Many requirements needed for the production of physical currencies, such as the establishment of physical manufacturing facilities, are absent for digital currencies. Unlike digital currencies, physical currencies are also immune to physical defects or soiling.

(3) They can ease the implementation of monetary and fiscal policy
In most countries, the Federal government works through a series of intermediaries—like banks and financial institutions—to circulate money into their economy. CBDCs can help circumvent this mechanism as they can make disburse payments go directly to citizens. In addition, they also simplify all production and distribution methods by removing the need for physical manufacturing and the transportation of currency notes between locations.

(4) Digital currencies can make transaction costs cheaper
Digital currencies favor a direct interaction within a network. For example, a customer can only pay a shopkeeper directly (for a service) as long as they are both on the same network. Also, the costs involving digital currency transactions between different networks are relatively cheaper than those with physical or fiat currencies. By simply cutting out the middlemen (people who economic rent from processing transactions), digital currencies can make the overall cost of a transaction to be very cheap.

Disadvantages of Digital Currencies

Find below, some of the disadvantages of digital currencies:

(1) Digital Currencies do not solve all storage and infrastructure problems
While they don’t require people to carry physical wallets, digital currencies have their own set of requirements for both storage and processing. For example, an Internet connection is needed, as well as smartphones, computers, and services related to their provisioning. Also, online wallets with robust security features are also necessary to store digital currencies.

(2) They are susceptible to hacking
As long as they exist on the internet, digital currencies are susceptible to hacking. A Hacker can steal digital currencies from a victim’s online wallets. They can also change the protocol for digital currencies, by making them unusable. Since their existence, they have been numerous cases of hacks in cryptocurrencies. Securing digital systems and their currencies is a work-in-progress.

(3) They can be volatile in value
Digital currencies can have wild price swings, especially those used for trading. The decentralized nature of cryptocurrency has led to the birth of capitalized digital currencies whose prices are prone to sudden changes – which are based on investor whims. Some digital currencies are known to have a volatile price trajectory during their initial days.

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