Digital currency, as the name suggests, refers to any currency that exists primarily in electronic form. Devices like computers and smartphones store and manage digital currencies and exchange them using the internet.
Digital currencies are not physical objects like printed banknotes or coins. Henceforth, governments or central banks generally don’t issue or regulate digital currencies. This stands true for most (not all) digital currencies.
A distributed database, owned by a company or even a bank mostly records these digital currencies.
Recently, digital currencies have gained much attention. It is because they have become one of the easiest and sometimes cheapest methods for trading currencies.
There are two main types of digital currencies: cryptocurrencies and central bank digital currencies (CBDCs).
Cryptocurrencies
The most popular cryptocurrency has been Bitcoin, which was created in 2009. Then, Dogecoin, Ether, Binance Coin (BNB), etc. started making waves. Currently, there are several kinds of Cryptocurrencies in the market.
They use cryptography to create and secure cryptocurrencies as well as verify transactions in a network. Cryptography is a process that makes counterfeiting or double-spending difficult. Cryptographic techniques control the creation of new units and ensure the integrity and authenticity of transactions. This makes them resistant to fraud and counterfeiting.
As said earlier, central authorities such as the government or central bank do not usually back up digital currencies, especially cryptocurrencies. Instead, they operate on a distributed database which is a network of computers at several geographical locations. It is known as a blockchain and a chain of computers over a network stores them. It ensures transparency and security.
Blockchain technology also ensures the immutability of the transaction history, that is, it cannot be changed or erased.
The advantages of blockchain-enabled cryptocurrency are that it helps in accurate tracking, cost reduction, increased transparency and permanent ledger.
Central Bank Digital Currencies (CBDCs)
Unlike decentralized cryptocurrencies like Bitcoin or Ethereum, a central authority, typically the central bank of a country issues and controls CBDCs.
Many countries have been exploring the potential benefits of CBCDs. In India, the government has also rolled out its own CBDC in the form of a digital token. The (RBI) Reserve Bank of India launched the digital Rupee’s pilot in 2022 in the retail segment. The Government of India (GOI) has named it ‘e-RUPI (e₹)‘ and has designed it in the form of e-vouchers. The ‘e-RUPI (e₹)’ has its components based entirely on blockchain technology.CBDC pilot launched by the RBI
This cashless and contactless payment can further boost digital payments in India. It can foster faster modes of payment with round-the-clock availability by being more cost-effective.
Likewise, while some nations are experimenting, a couple of countries have concrete plans for CBDCs. For instance, China launched the digital Yuan as a pilot project and may expand it. Some nations have already made CBDCs available like Sand Dollar by the Central Bank of The Bahamas, DCash by the Eastern Caribbean Central Bank, e-Naira by the Central Bank of Nigeria and JamDex by the Bank of Jamaica (JamDex).
CBDCs are a digital equivalent of physical cash. In a dual system, they can coexist alongside physical cash, banknotes and other traditional forms of money. It will allow individuals and businesses to choose between using digital or physical currency for their transactions.
As the government or the central bank backs up CBDCs, it provides a level of stability. Moreover, it has the trust of citizens, similar to traditional currencies. CBDCs are typically recognized as legal tender. This means that people can use them to settle debts, pay taxes, and for general transactions within the issuing jurisdiction.
Advantages and Challenges
Digital currencies, including cryptocurrencies and CBDCs, can help facilitate transactions in a transparent and traceable manner. It can be faster, cheaper (especially the global transfers) and more efficient. It will be a great support to the unbanked and underbanked strata of society in a country. With CBDCs, they can access their money and pay bills without extra charges.
However, it also has many challenges like building a robust technology for security and operations. In addition to building robust technology, it will have the challenge of costs associated with it. Digital currencies still raise questions about surveillance and privacy. The fact that multiple digital devices over a network store/manage data and exchange it over the internet puts a question mark on confidentiality. Moreover, with so many digital currencies around, there has to be a way out for interoperability, especially for cross-border transactions. With so many cryptocurrencies and CBDCs, price volatility can also be an issue.
While digital currencies can help reduce fraud by controlling counterfeiting, there is still a lack of regulation. Needless to say, there is limited acceptance of digital currencies as of now.
