Is digital currency the future of money?
Currency is the anchor of modern society. Bartering which started off with items like animal skins, salt, weapons, etc., gave way over time to currency, the paper and coins-based medium of exchange.
The evolution of money has given birth to digital currency. Digital currencies are an overall superset for currencies such as digital money, electronic money, e-money, electronic currency, cybercash, and virtual currency, which includes cryptocurrencies. Digital currency can also mean traditional monetary assets in digital format.
In legal terms, there are broadly speaking, two types of digital currencies; Central Bank Digital Currency (CBDC) denominated to a sovereign currency, that is issuing a digital form of its fiat money and Non-Central Bank Digital Currency controlled by developer(s), founder(s) or a defined network protocol.
What is Virtual Currency?
Virtual currency is a currency created and held within the blockchain network with no central control or centralized banking authority. Virtual currency transactions are usually instantaneous and run at lower costs compared to traditional payment methods which need banks or clearing houses to guide transactions.
Virtual currency-based electronic transactions do not have any central clearinghouses but are backed by necessary record-keeping, ensuring transparency in all transactions. Virtual currencies could be cryptocurrency, coupon, or rewards-linked monetary systems. The first cryptocurrency, Bitcoin, was created in 2009 by unidentified person/s using the alias, Satoshi Nakamoto. Cryptocurrencies are not regulated and rely on cryptography as a system of management, control, verification, security, and the mechanism for creating new currency. Apart from Bitcoin and Ethereum, other virtual currencies are Litecoin (LTC), Cardona (ADA), Polkadot (DOT), Bitcoin Cash (BCH), Stellar (XLM), ChainLink, Binance Coin (BNB), Tether (USDT), Monero (XMR) etc.
Cryptocurrencies are open to the public at large, and anyone can join and start a transaction. The volatility and lack of control in this sphere, however, means unscrupulous persons can create situations to defraud persons. Further, cryptocurrencies are unstable. A way to deal with this is by using so called stablecoins, for example, a reserve asset (external reference) such as the U.S dollar or commodity price like gold which makes use of different methods to achieve price stability. Also, some entities back cryptocurrency, for instance Facebook’s currency called Diem (formally known as Libra).
What is Central Bank Digital Currency (CBDC)
CBDC is a digital currency issued by and regulated by a central bank as the legally mandated monetary authority for a particular territory. CBDC is centralized and uses an electronic record or token issued by a central bank. The Bank for International Settlements (BIS) recommends 14 characteristics for CBDC with the overriding feature being that it aligns with the financial stability goal of a central bank as a country’s critical monetary institution.
Many central banks are still working through how to issue CBDC. China is ahead of the curve and recently started issuing CBDC to its citizens as a pilot programme. According to https://www.atlanticcouncil.org/cbdctracker/, which tracks 83 Countries/Currency Unions in terms of CBDC status, revealed the following: 5 countries have now fully launched a digital currency, 14 countries are at Pilot phase, 16 countries at development phase and 32 countries at the research phase, ten countries are inactive, two have canceled, and four countries are still working through options. The Bank of Ghana is expected to start piloting digital currency fully backed by the cedi in 2021.
Virtual currency versus Digital currency
Virtual currencies are different from digital currency in a number of ways. Digital currency is just a digital form of currency issued by a bank in digital format, such as a digital dollar, digital euro, or digital yuan. Secondly, virtual currencies are more volatile and do not have the security offered by digital currency since central banks do not back them. Digital currency can be issued by central banks without any limit in comparison to cryptocurrency like Bitcoin, which is constrained since the number of Bitcoins cannot be more than 21 million, a limit encoded in Bitcoin’s source code and enforced by nodes on the network. Lastly, cryptocurrency price is set by supply and demand, whereas digital currency value is based on legal tender.
It is this writer’s expectation that more and more countries will begin to issue CBDC, and this is likely to run alongside traditional currency. Ultimately, the prediction is that this CBDC will be the country’s official currency in the long run. Traditional paper-based currency and coins are getting closer to the end of their lifespan, and there will be a fierce contest between CBDC and cryptocurrency as replacements. At the end of the day, one form of digital-based currency either regulated or unregulated will surely win the day.