Ideas: What is digital currency and what does it mean for the future?

If you’ve followed financial news at all over the past decade, there’s a good chance you’ve come across stories about the latest in the realm of digital currencies. Whether you have pondered about the price of a Bitcoin, wondered what ethereum is, or tried to work out how a digital euro differs from a regular euro, it’s likely you have grappled with the idea of a digital currency in some way. However, while digital currencies were just taking their baby steps in the 2010s, we’re going to see them reach a new level of importance as the new decade rolls on. As technology advances, the world becomes more connected, and more aspects of our daily lives are played out online, they will certainly have a huge role to play.

A digital currency is a currency that only exists electronically or digitally — it has no physical form. You can only access them using an electronic device, such as a smartphone, computer, tablet, or smartwatch. There are a few types of digital currency and their uses can differ.

As digital currency only exists electronically, it requires an electronic device and a connection to the internet (or the network it’s present on) to be transacted. Realistically, they can be used anywhere you can get online, whereas regular currency is limited by physical ownership.

And, because they have no physical form, digital currencies can be transferred much more quickly and easily. Payment can be sent across the world instantaneously provided both parties are using the same network for the currency. In addition, as the majority are (currently) not issued by a government as legal tender, they can be sent over borders with less restriction.

In most cases, a digital currency requires no intermediary — which means there’s no middle man like a bank or clearing house — making them an inexpensive way to transact. Records of all transactions can also be easily logged, which makes record keeping easier and increases transparency.

You can use a digital currency to buy goods and pay for services wherever they are accepted. There are some types, however, that can only be used within certain boundaries and aren’t transferrable. For example, an online casino may have “chips” that you buy into and can’t take out unless you carry out an exchange back into regular money. Some social networks and communities have their own digital currency too, such as Reddit “coins” or Twitch “bits”.

There are three types of digital currency: central bank digital currency (CBDC), virtual currency, and cryptocurrency. However, it’s important to remember this is a fast-paced area of technology, so there may be new types of currency that emerge in the years to come.

A central bank digital currency is a digital currency that has been issued by a central bank. Though they only really exist as a concept at the moment, there are many countries that are discussing plans to create digital versions of their national currency.

A virtual currency is any type of unregulated digital currency that is issued and controlled by those who developed it, rather than a central authority (like a CBDC). It’s only stored through certain software, apps, or digital wallets, and any transactions take place online through safe, dedicated networks. Cryptocurrencies can be considered a subset of virtual currencies, as they aren’t centrally controlled, but not all virtual currencies use cryptography, the defining feature of cryptocurrencies.

A cryptocurrency is a type of digital currency that is created and managed through cryptography technology. Through the use of a blockchain (a shared, public ledger of transactions) each coin’s movement is accounted for, which maintains its security and authenticity, as well as helping to regulate the creation of new units of currency. This is carried out over a peer-to-peer network that allows the blockchain to fully track each individual coin.

At the time of writing, there aren’t any countries that have launched a fully-fledged digital currency that is backed by a central bank (making it a CBDC). There are a few nations that are in the process of testing or soft-launching versions of their currency, but no-one has committed to fully putting the nation’s finances online. There are also a number of countries that are said to be seriously discussing the idea, with initial plans being drawn up to launch in the next few years.

If a number of nations establish their own digital currencies, we may see a transformation in the global economy that alters a great deal, from how businesses transact to where we buy currency for holidays.

For cryptocurrencies, the future is slightly less clear. They seem set to remain on the bleeding edge of digital currency technology at present, but there is tremendous potential for them to see more widespread use if interest continues to grow. Alternatively, there’s the possibility that any bubble bursting could shake the industry so hard it destroys faith, setting back the technology by years. Having said all that, cryptocurrency could easily remain on the fringes in the next decade.

At this moment in time, we’re living in a period of transition when it comes to currency. While many in the UK still use cash to pay for things on a daily basis, it is in decline: its use fell by 15 per cent and it accounted for only one in four payments in 2019 (UK Finance). There is also a lot of speculation that the COVID-19 pandemic will have forced many people out of the habit of using physical money.

So, with a greater number of people having to adjust to paying without cash over the past year, will digital currency become a big part of the future? When you consider that the world is becoming more digitised and technology is keeping us connected 24-hours a day, it seems that the answer is an inevitable yes. But just how they will change our lives remains to be seen.