A Beginner’s Guide to Digital Money
Many innovations have been made in financial technology in recent years, and the emergence of digital money has been front and centre. So, what is digital money, what are the different types and what are its pros and cons? We’ll answer all these questions below.
What is digital money?
Also sometimes called digital currency, digital money is any means of payment that only exists electronically. It’s similar to traditional money in that we can use it for daily transactions, yet it doesn’t exist in a tangible, physical form such as notes and coins.
What are the different types of digital money?
There are several types of digital money, including:
- Central bank digital currencies (CBDCs) are a type of digital money that’s issued and controlled by a country’s central bank. CBDCs function most similarly to cash, because it is deemed as legal tender – meaning all merchants must accept it for transactions. While more than 100 countries are exploring them in some form, only the Bahamas, Jamaica and Nigeria have fully launched a CBDC according to the Atlantic Council.
- Cryptocurrencies are designed to work as a medium of exchange through a computer network by verifying transactions using cryptography, without being reliant on central authorities like governments or banks. Many investors buy and sell cryptocurrencies on trading platforms.
- Stablecoins are a variation of cryptocurrencies, which are designed to counter the price volatility associated with normal crypto by pegging its price to a reference asset like fiat currency or exchange-traded commodities.
What are the pros and cons of digital money?
Like all financial instruments, digital money has it’s advantages and disadvantages, including the following.
Pros
- Faster payments: Digital money allows for payments to be completed more quickly than with traditional currencies. Payments like universal credit, tax refunds and child benefits could be made instantaneously if more governments developed CBDCs.
- 24/7 access: Most banks close on weekends, making money transfers take longer than necessary. But with digital money, transactions can work at the same speed whatever the day or time.
- Enhanced security: With no need for physical storage like with physical cash, there’s no need to physically store digital money in a secure place. Blockchain-based forms also allow for greater privacy, which helps users keep their sensitive data safe. That being said, crypto is vulnerable to hacking.
Cons
- Barriers to entry: Users must invest a significant amount of effort is to learn how to carry out basic tasks with digital money, including how to open a digital wallet and store digital money securely. It’s unlikely that digital money will see widespread adoption until these processes are simplified.
- Poor sustainability: Computers must solve complex equations to verify and record cryptocurrency transactions. This uses a huge amount of energy, leading many critics to argue that digital money is terrible for the environment.
- Price volatility: Cryptocurrency prices often change in the blink of an eye, meaning that owning this form of digital money can lead to a loss of buying power in real terms.
What does the future hold?
Digital money has been a huge innovation in the financial world, overcoming many of the limitations of physical cash. But it isn’t without its own drawbacks, so the extent to which they can be addressed will play a crucial role in determining how ubiquitous digital money will be in the future.