If you've been wondering how digital currencies differ from cryptocurrencies, this article may help you. Are they the same thing? They are different forms of money.
What is a Cryptocurrency?
According to Wikipedia, cryptocurrencies are digital assets designed to work as a medium of exchange. The ownership of an individual coin gets stored in a ledger in a special database that uses cryptography to protect the record and control the creation of new coins and verify transactions.
They do not exist physically, as with paper money, and typically are not issued by any central authority or bank. When developers implement decentralized control, each cryptocurrency operates through a distributed technology, usually a blockchain, which serves as a public database for its operation.
Bitcoin was the first of these open-source software released in 2009 to create a decentralized cryptocurrency. Since then, several projects have originated that seek to copy or improve this solution. Cryptocurrencies are currencies created from algorithms used as tokens in certain online communities backed by specific technologies, assets, or projects.
They are primarily used to carry out peer-to-peer payments, but some extend into the real world to pay for goods and services. Some cryptocurrencies are considered secure, reliable, and trusted, as they use decentralization and cryptography. A technology that is a blend of different sciences has mathematics as its basis. The fact that they use a decentralized blockchain prevents a single person or central authority from being able to control the actions on the network.
What is Digital Money?
According to Wikipedia, a digital currency is a balance stored in a distributed database on the Internet, in a database on a computer, within a file, or on a stored-value card. For example, digital money includes cryptocurrencies (because they are digital), virtual currencies, Central Bank Digital Currencies (CBDC), and electronic money.
Electronic money exhibits properties similar to other currencies but does not share the same physical characteristics as paper banknotes and coins. It can instantly be involved in transactions because it does not have a physical form. But since a government entity does not consistently issue them, digital currencies are not considered legal tender and allow transfers across country borders.
According to a 2015 European Central Bank report, digital currencies are a digital representation of value, not issued by any central banks or credit institution, which, in some cases, can be an alternative to money. In other words, digital money is another name for currencies used to pay for certain goods and services on the Internet.
As we have already seen, digital money is entirely digital. It has no physical equivalent in the real world. But in some ways, it works similarly to traditional fiat money. We can receive, transfer and exchange this digital currency for another. For example, you can use it to pay for goods and services in an online store without political or geographic boundaries.
Some argue that this distinction is becoming somewhat blurred as we move to a cashless society. The rationale is that the physical money we use to pay online from our bank account should also be considered digital money.
Differences between Cryptocurrency and Digital Money
But while we have seen that one definition encompasses the other, the reality is that specific differences between them help us to differentiate them better. A cryptocurrency can be seen as digital money because it exists only in its digital binary form. Still, other characteristics make it very different from the typical examples of digital money, such as PayPal or other applications that use the dollar or euro as a denomination.
The most crucial difference between cryptocurrencies and digital money is who controls their monetary value or the number of coins that may exist (money issuance). In the case of digital currencies, the central bank and the government, banks, and other intermediaries establish the value of the currency in question.
The centralized rule is why we see how some currencies collapse after their governments created and replicated them almost to infinity. Central banks exercise control over the new creation and the laws they impose for its use and exchange with other goods. At least some cryptocurrencies follow a transparent path. Developers generate them in a controlled manner through crypto mining or other mechanisms.
In addition, decentralization prevents a single person or central power from determining certain events that lead to a change in value. The market and its adoption determine when it is worth it.
Although both types of currencies use encryption for something, cryptocurrencies are ahead in this field because they make greater use of this technology for different issues. Digital currencies use cryptography to protect against a hacker's ability to modify specific values. But cryptocurrencies, despite doing so, use it for other things, such as the random generation of private, public, and address keys and mining.
In the first case, the system only uses encryption so that the one who controls the coin remains the only one. Cryptocurrencies use encryption to give the users more power and decentralization.
Some cryptocurrency advocates cite the transparency of the platforms as something good and desirable. Every detail involving a transaction is public knowledge thanks to a blockchain-distributed ledger. When it comes to a digital currency, only the banks and the intervening parties can know who is sending, receiving, and the amounts involved.
While in one, we get more privacy, in another, we get transparency that can be useful to avoid corruption cases. In the end, corruption occurs with the government's intervention, which is precisely the one with the power to review these transactions, hiding this information through very complex bureaucratic processes.
Transparency is also an essential part of decentralization since it makes it possible not to trust any third party and thus operate without a central entity.
Digital currencies are usually stable and easy to manage, and the international community accepts them as legal tender. Digital currencies, after all, are digital representations of fiat money, so the vast majority of people understand and accept them when making a purchase or sale, making them more stable when compared to new technologies, such as cryptocurrencies. Although they are gaining wider adoption, the general public has not yet accepted them.
It is also interesting to talk about the price volatility of cryptocurrencies as a reason for the lack of stability. Something that will eventually diminish as there is more liquidity in the market.
Most countries are seriously analyzing making cryptocurrencies legal and accepting them for different purposes. Because governments or any government-controlled entity does not back them, traditional legal frameworks do not find them valuable.
However, the increased adoption by citizens has pushed their governments to think seriously about them and see this new form of money as a new way to make transactions. Some countries, such as El Salvador, made Bitcoin legal.
Discussions are already underway, and we will have new cryptocurrencies accepted as legal tender by new countries sooner. Especially those countries that need more stability because their currency depreciates faster than more volatile cryptocurrencies.