When we hear the phrase digital currencies, some of us think of cryptocurrencies like Bitcoin and Ethereum. However, there are differences between what makes a digital currency and what makes a cryptocurrency. So, what are the differences, and what role will these two currencies play in the future of money?
What is currency?
Currency is something many of us are familiar with, as we use it every day 🙂 A currency is a system of money in a particular region that is used to facilitate the exchange of goods and services as well as assets. When money is left at the bank it is a store of wealth.
Here in Australia, we use the Australian Dollar, the USA use the US Dollar, and the European Union use the Euro as a means of exchange.
While in the not that distant past transactions existed almost entirely in paper form, most transactions that take place today use digital forms of exchange, such as credit cards online, or bank transfers as a method of storing and moving money through an economy.
What is Fiat currency?
Fiat money is government-issued currency that is not backed by a physical commodity (such as gold or silver) but rather by the government that issued it. This means because the AUD, USD and EURO are no longer backed by gold, they are in fact fiat currencies, and Central banks can create money, like it is created out of thin air. This is what they have done during recent times as part of stimulus packages to support economies. Sometimes it is called printing more money, but that is very 1990s. Nowadays, it is digitally added to the banking system.
When currencies were not fiat, before 1970s countries found it very difficult to print more money and would devalue their currencies against the US dollar.
What is a digital currency?
Digital currency is a form of currency that is only available in digital form and issued by Governments or Central Banks. Like cash, they can be used to pay for goods and services and can enable instant cross border transactions, However, unlike cash, one can only exchange this currency electronically.
So, if so many transactions today are digital why do we need a digital currency? Excellent question 😊 The reason being is that the banking systems is still antiquated for a digital world and doesn’t have instant settlement. For example, a credit card transaction on the weekend may take a few days to settle into your bank account. A digital currency brings instant settlement!
However, for a digital currency all transactions are recorded instantly into a ledger/register/database. This makes money laundering and terrorist financing more difficult. And because every transaction is recorded, the Central Bank, tax office and government have more information on how when and who you spend or earn your money.
So now you may understand why China is one of the first to introduce a digital currency 😬
What makes a digital currency a cryptocurrency?
While digital currency refers to the electronic form of money issued by governments or Central Banks, cryptocurrencies or crypto assets are a store of value in a decentralised system not controlled by a central authority, and often referred to as digital coins. There are many digital coins, with some of the more well-known ones being Bitcoin, Ether and Dogecoin.
It is become easier to use coins like Bitcoin for everyday transactions and some poorer countries are adopting it as legal tender to assist the transfer of money back into that country from offshore workers.
The key difference between a digital currency and a digital coin is that a coin is decentralized, meaning a government or Central Bank does not back it or have access to the transaction information and cannot increase or decrease the supply.
Many of the digital coins have a finite supply inbuilt into the known algorithm that allocates out the coins as rewards to “miners” over time, meaning that it is impossible to dilute the value of the coins by printing or creating more.
Is there more digital currency, crypto currency or physical currency in circulation?
There’s about $40 trillion of paper currency in circulation around the world, whereas there are only several trillion dollars of digital and crypto currency in circulation.
Will digital currency replace physical currency?
In the end, digital currencies will likely win as the information they provide governments for taxing and monitoring is invaluable. In a recent crypto survey, more than half the experts predict that Bitcoin will be more widely used than fiat currency by 2050.
For the average consumer where most transactions occur electronically the move to digital currencies will not be noticeable. There is also the likelihood that physical cash will be overtaken by digital currencies in the coming decades and physical cash will disappear entirely. Au revoir, chequebook 👋
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