By now, you may have learned about the success of bitcoin. There has been a lot of talk over the years that bitcoin would eventually replace the U.S. dollar or it would be a form of money that would skirt law enforcement. The reality, however, is that bitcoin and other digital currencies will probably co-exist in the entire financial framework and serve more as a disrupter than a destroyer. So, what exactly is a digital currency and what does the future have in store?
What Are Digital Currencies?
Digital currency is a form of money that can only be used with a computer or mobile device. A digital currency has the same attributes as physical money, except that it is connected to the internet or a designated network.
There are generally three types of digital currencies:
- Virtual Currency: An electronic and unregulated version of money.
- Cryptocurrency: A medium of exchange that uses cryptography to complete transactions, regulate the creation of new units, and confirm the transfer of assets.
- Central Bank Digital Currency (CBDC): A digital form of fiat currency that maintains legal tender status and is issued by the government.
Although digital currencies are unregulated, many aspects of the marketplace have created restrictions on how electronic money is used.
Digital Versus Physical
The distinction between digital and physical money rests on centralization versus decentralization. Digital currency is money that is created, recorded, and stored electronically. It can be centralized, so there is a central point of control over the supply of digital currency, or it can be decentralized, when there is zero or very little control over the money supply. Regulation may even originate from many different sources.
Physical currency, meanwhile, is printed, issued, and regulated by the federal government. The free market is prohibited from creating money out of thin air (counterfeiting), and everyone is required to adhere to legal tender laws outlined by the authorities.
And Then There Was Currency
In the 1990s, legendary economist Milton Friedman had predicted the rise of e-cash (digital currency). Although the internet was still in its infancy stage when he made this comment, he could see how the online world would shape both the economy and the government. One thing Friedman realized was that the internet would eliminate the need for a middleman, noting that “you can transfer funds from A to B, without A knowing B or B knowing A.”
Many people are aware of bitcoin, dogecoin, Ethereum, Monero, and Ripple, but the very first digital currency was born in the early 1990s: DigiCash. However, because e-commerce had yet to really begin using digital currency, DigiCash and its competitors failed.
It was not until money transfer website PayPal arrived that digital financial transactions became prevalent. And, it was not until 2009 that a digital currency became a successful innovation on the internet, which spawned variations.
Is the Future of Money Digital?
All over the world, societies are gradually going cashless. A physical Swedish krona or a Danish krone is hard to come by as these countries have adopted the latest technology to replace money that you can touch. Many marketplaces already depend on mobile devices, plastic cards, digital units, and technologies to perform commerce. It is only a matter of time before governments adopt digital currency – central banks are beginning to experiment with CBDCs.
Will bitcoin or litecoin replace the U.S. dollar or other traditional currencies? Unlikely. That said, digital currencies are here to stay, and they will inevitably complement the entire system. Whether this is a positive development or a negative trend, the market will ultimately be the decider of its fate.
Cryptography: A system of secret codes.
Fiat currency: Money that is backed by a government.
Legal tender: Money that is valid for payment of a debt, according to the law.