What is Digital Currency? How Does It Work?

Digital currency is a form of currency that is available to users only in electronic or digital form. It is also commonly known as digital money, electronic currency, electronic money, or cyber cash. These are accessible only via mobile phones or computers as their existence is only in electronic form.

Digital currencies are known for not having any physical attributes as compared to minted coins and banknotes. The utility of digital currencies is similar to that of physical currencies as they can be used to pay for services and purchase goods. Digital currencies are well suited for certain digital internet-based communities such as social networks, gaming sites, and gambling portals. Another importance of digital currencies is that they are enablers of instant and global transactions.

Know Why Paper Currency is Phasing Out?

Types of Digital Currencies

Digital currency is an umbrella term and is used to collectively describe three different types of currencies.

1. Central Bank Digital Currencies (CBDCs)

These currencies are regulated by the central bank of the issuing country. A CBDC can be used in place of traditional fiat currency. While fiat currencies can exist in both physical and digital forms, CBDCs exist only in the digital format.

2. Virtual Currencies

These are unregulated digital currencies that are controlled by founding organizations or developers. A defined network protocol can also be used to algorithmically control a virtual currency.

3. Cryptocurrencies

These are digital currencies that secure and verify transactions in a network using cryptography. Cryptography is also used to control and manage the creation of cryptocurrencies.

Benefits of Digital Currency

  • Since physical manufacturing is not required, there is a lot of saving in terms of currency cost and there is no scope for soiling of the currency as compared to banknotes and coins.
  • Faster transaction times can be achieved with digital currencies as they generally exist within the same network and there are no intermediaries involved. This method is much faster as compared to banks or clearinghouses. There is also greater transparency in the transaction of digital currencies.
  • CBDCs can help to circumvent the mechanism involving banks and financial institutions and can directly enable a single government agency to enable direct payment facilities for users. 
  • Since there is no printing or minting of a digital currency and there is also no involvement of intermediaries, the transaction costs associated with digital currencies are very less.

Disadvantages of Digital Currencies

  • The volatility in digital currencies is very high as they are commonly used for trading.
  • Digital currencies are highly susceptible to hacking as they can be stolen from online wallets. Hackers can also make changes to the protocol which can render digital currencies unusable.

Final Thoughts

Digital currencies are definitely a game-changer as they are a catalyst for the enablement of global commerce using the internet as a medium. Digital currencies have drastically reduced the costs for governments, banks, and financial institutions. Yet there is much scope for improvement in terms of security and transfer protocols.

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