Forbes Advisor has provided this content for educational reasons only and not to help you decide whether or not to invest in cryptocurrency. Should you decide to invest in cryptocurrency or in any other investment, you should always obtain appropriate financial advice and only invest what you can afford to lose.
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Accurate at the time of publication.
Digital currency has the potential to completely change how society thinks about money. The rise of Bitcoin (BTC), Ethereum (ETH) and thousands of other cryptocurrencies that exist only in electronic form has led global central banks to research how national digital currencies might work.
What is digital currency?
Digital currency is any currency that’s available exclusively in electronic form, such as Bitcoin. Electronic versions of fiat currency already dominate most countries’ financial systems. One of the differences between digital currency and electronic currency that’s already in our bank accounts is that digital currency never takes physical form.
You can go to a cashpoint right now and easily transform the electronic record of your currency holdings into physical cash. Digital currency, however, never leaves a computer network, and it is exchanged exclusively via digital means.
There are three main varieties of digital currency: cryptocurrency, stablecoins and central bank digital currency, known as CBDCs.
Blockchain technology, which provides the foundation for cryptocurrency, is the most common form of distributed ledger used by digital currencies. According to CoinMarketCap, there are more than 9,000 cryptocurrencies available.
What is a central bank digital currency (CBDC)?
A central bank digital currency is a digital currency that is issued and overseen by a country’s central bank. Think of it like Bitcoin, but if Bitcoin were managed by the Bank of England and had the full backing of the UK government.
More than 100 countries are exploring CBDCs at one level or another, according to the IMF. But as of 2023, only a handful of countries and territories have CBDC or have concrete plans to issue them.
Some places CBDC is already available include the Central Bank of The Bahamas (Sand Dollar), the Eastern Caribbean Central Bank (DCash), the Central Bank of Nigeria (e-Naira) and the Bank of Jamaica (JamDex), to name just a few.
How would a CBDC work?
A CBDC would function similarly to actual cash. If someone gave you CBDC, it’d be similar to handing you physical money, like a £50 note. You’d have that money in your account and the giver couldn’t get it back from you without your permission. This is different from other electronic payments, such as PayPal.
Another key advantage of CBDC is that it could be deemed legal tender. That means all economic actors must accept it for any legal purposes. You can pay for goods and services with it, and merchants/vendors are legally required to accept it.
This contrasts with other digital currencies, such as cryptocurrencies like Bitcoin, which are not legal tender in the UK.
How have digital currencies worked around the world?
According to the Atlantic Council’s GeoEconomics Center’s Central Bank Digital Currency (CBDC) Tracker, 10 countries have fully launched a digital currency, and China is on course to expand from its pilot CBDC in 2023.
China’s digital yuan, one of the largest CBDC programs, launched its pilot project in 2014. While it’s not at a national scale yet, once China has the platform ready, it will expand through banks and mobile providers like Alipay.
The central banks of China and the United Arab Emirates are also working on a project to use blockchain and CBDC for regional payments between nations. If these projects are a success, they could give more motivation to other nations to create their own CBDC.
Benefits of digital currency
- Faster payments. Using digital currency, you can complete payments much faster than current means
- Cheaper international transfers. International currency transactions are very expensive. Individuals are charged high fees to move funds from one country to another, especially when it involves currency conversions. Digital assets could disrupt this market by making it faster and less costly
- 24/7 access. Existing money transfers often take more time during weekends and outside normal business hours because banks are closed and can’t confirm transactions. With digital currency, transactions work at the same speed 24 hours a day, seven days a week
- More efficient government payments. If the government developed a CBDC, it could send payments like tax refunds, universal credit and child benefit to people instantly.
Disadvantages of digital currency
- Steep learning curve. Digital currencies require work on the part of the user to learn how to perform fundamental tasks, like how to open a digital wallet and properly store digital assets securely. The system needs to get simpler for digital currencies to be more widely adopted
- Expensive transaction. Cryptocurrencies use blockchain, where computers must solve complex equations to verify and record transactions. This takes considerable electricity and gets more expensive as there are more transactions. However, this would probably not exist for CBDC since the central bank would likely control it and complex consensus processes are not needed
- Price volatility. Cryptocurrency prices and values can change suddenly. With CBDC, though, the value is much stabler, like paper currency, and cannot fluctuate like this.
How to invest in CBDC?
CBDCs are no different than an issuing nation’s existing monetary supply. This means the only way to invest in a CBDC is to hold the currency in your account. In other words, investing in CBDCs is just like holding a nation’s physical cash in your hand today.
However, right now, foreign nationals can’t hold the CBDCs of any other government in their digital wallets. In other words, a UK citizen can’t currently access Bahaman “sand dollars.”
You need a verified username and bank account to hold a CBDC from any nation today. This means citizens of different countries can’t have a foreign nation’s CBDC distributed to them. Some experts believe, though, that this will change as more CBDCs are implemented worldwide.
Frequently Asked Questions (FAQs)
What’s the difference between cryptocurrency and digital currency?
Cryptocurrency is a form of decentralised digital currency. The reason it’s referred to as a “crypto” currency is that it requires cryptography rather than a central authority to manage its ledgers and balances since the currency is decentralised.
Today, the most common form of ledger system for cryptocurrencies to use is blockchain technology.
Digital currency, on the other hand, is any form of currency that exists solely in digital form.
How many types of digital currency are there?
There are three types of digital currency: cryptocurrency, stablecoins and CBDCs.
Cryptocurrency is a form of decentralised digital currency that isn’t pegged to any fiat currency. It uses cryptography to manage its ledger systems, and the market determines its value. Bitcoin was the first cryptocurrency.
Stablecoins are similar to cryptocurrencies; some experts even consider them a subset of cryptocurrency. They have no central authority to keep track of their ledgers. However, the major difference between stablecoins and cryptocurrencies is that stablecoins are usually pegged to a fiat currency.
On the other hand, CBDCs are a form of digital currency issued by a nation’s central bank. This makes them a form of digital currency controlled by a central authority. Governments issue them, and the particular nation’s monetary policy sets their value.
How do you buy digital currency?
Traders can buy most digital currencies (cryptocurrencies and stablecoins) on the world’s existing crypto exchanges. However, not all exchanges offer every cryptocurrency. So traders may want to research the exchange to ensure it offers the currency they’re interested in.
As far as CBDCs go, those are currently only available to residents of the countries where the specific CBDC is offered. In other words, only citizens of the Bahamas can access that nation’s sand dollar, and only Chinese citizens can access the digital yuan.
Cryptocurrencies are highly volatile investments. It’s recommended that investors speak with a financial professional before committing their money to these or any other asset classes.
How to create digital currency?
CBDCs can only be authorized and created by the world’s governments. A central bank must issue them with the full backing of that government’s treasury. Private individuals and corporations cannot create CBDCs.
Cryptocurrency is unregulated in the UK. The UK regulator, the Financial Conduct Authority, has repeatedly warned investors that they risk losing all their money if they buy cryptocurrency, with no possibility of compensation.
