What is Digital Currency?
As technology advances, so, too, does digital currency. An early form of digital-based money was the electronic exchange of cash between bank accounts or an electronic payment utilizing credit. This still takes place mostly by debit or credit card, with bank-to-bank electronic wires, an online payment system, or the use of a smartphone that carries a user’s payment information.
Digital currency is any currency that’s available exclusively in electronic form. Electronic versions of currency already predominate most countries’ financial systems. In the U.S., for instance, the physical U.S. currency in circulation is only about one-tenth of the overall money supply; the remainder is held in various bank deposits in electronic form.
Digital money today still mostly facilitates the movement of fiat currency — those issued and backed by a government such as the U.S. dollar, the Canadian dollar, or the euro. But digital currency now also includes cryptocurrencies. Bitcoin is the original cryptocurrency and was privately developed as a means of exchange on the internet.
Following the successful launch of decentralized cryptocurrencies like Bitcoin and Ethereum, which store value but are not managed by any central authorities, governments and central banks around the world are researching the possibility of creating their own digital currencies, commonly known as central bank digital currencies.
How is digital currency formed?
Money in digital form (like dollars sitting in your bank account) is not exactly a digital currency in the truest sense of the term. The reason is that it can be converted into physical cash (for example, via an ATM) when making a withdrawal. Traditional money in its digital form can be used to facilitate electronic payments by card at physical merchants and online, but there are some differences between it and an actual digital currency.
Money in its current form — including digital forms of cash on deposit at the bank — is created and distributed by a central bank (like the U.S. dollar, which is printed by the U.S. Treasury and distributed by the Federal Reserve). In a centralized process, a system of serial numbers is usually used to make sure each note is unique. Bank partners are used to distribute cash into the economy.
A digital currency, however, makes use of an electronic ledger system to create a network of computing nodes to process transactions. Cryptography is often used to anonymize user identity and transaction details. A digital currency can also bypass bank and financial institution intermediaries and be provided directly to users.