The explosion of new technologies, which also covers the world of finance, showers market participants not only with new products, but also with new concepts. There are so many of them that the average consumer can get confused. We often use the terms digital money and virtual money interchangeably. Wrong. And what are the differences? One by one.
Traditional, but online
The most common form of digital currency is electronic money. It is nothing more than a representation of fiat money, i.e. the official currency (also called fiat), established by the authorities, not based on a physical raw material such as gold or silver. As explained by the National Bank of Poland, in accordance with Polish and EU law, “electronic money means monetary value stored electronically, including magnetically, issued, with the obligation to redeem it, for the purpose of making payment transactions, accepted by entities other than solely the issuer of electronic money.”
It can be said that electronic money is the so-called network money, “stored” on electronic information carriers such as payment cards or smartphone applications. It can be issued not only by banks, but also by other entities – electronic money institutions (an example is Revolut, which is becoming more and more popular).
The paradox of official cryptocurrency
Central banks are also increasingly considering bolder entry into this digital world – a discussion on central bank virtual currencies (CBDC – Central Bank Digital Currency) has been going on for several years. They would be made available to individuals and entrepreneurs and treated as a commonly available and acceptable means of cash in retail payments.
On the one hand, it would be a solution related to cryptocurrencies – because current discussions point to CBDC being based on blockchain technology, on the other – their complete opposite. While cryptocurrencies are decentralized and provide anonymity, CBDCs would be regulated by authorities and their value, set by a central bank, would be tied to the country’s fiat currency.
Experts point out that the recording of transactions by the central bank raises concerns about possible privacy breaches. The authorities have access to all trade details, which can be used in many ways.
The widespread introduction of CBDC would also most likely have consequences for the traditional financial system – in principle, digital currencies eliminate intermediaries, so one can imagine the marginalization or perhaps even elimination of banks.
CBDC is a wolf in sheep’s clothing
Łukasz Żeligowski, one of the founders of the Kanga brand / photo: press materials
Central Bank Digital Currency is seemingly something convenient and friendly. Electronic money that lowers (potentially) costs, speeds up transactions and allows for many useful solutions, e.g. easy control of what money is spent on. The truth is, however, that no government will resist the possibility of using this solution to control citizens.
There are many mechanisms of such control, both politically and affecting the ways in which money is used by ordinary citizens. Theoretically, many are already available because most transactions are made using payment and credit cards. The introduction of CBDC will facilitate the use of these mechanisms.
For cryptocurrencies, the introduction of CBDC is not that important, although it also determines greater control of the government over our money. This may mean a lot of difficulties for ordinary people, which will be implemented, of course, under the guise of ensuring safety or comfort. The actual goal, however, will be completely different. It may result from the intentional action of the authorities or be the result of overzealous officialdom. In an extreme situation, we may even witness a situation where society begins to use cryptocurrencies or other forms of payment as a substitute.
Money “from nothing”
Virtual currencies are often equated with cryptocurrencies – only partially rightly. While cryptocurrencies are considered to be currencies based on decentralized blockchain technology, the concept of virtual currency is much broader. In other words, every cryptocurrency is virtual, but not every virtual currency is crypto.
Examples of virtual money that are not cryptocurrencies would be those from computer games, such as tokens in World of Warcraft, payment cards in GTA Online or FIFA points in the EA Sports game of the same name. This money usually functions within the game’s ecosystem and is used, for example, to unlock additional content such as new items or animations.
How fluid the border between a virtual currency and a cryptocurrency can be can be demonstrated by the (already somewhat forgotten) case of Facebook, which five years ago announced the creation of its own cryptocurrency, Libra (later renamed Diem; the project was eventually sold), which, although actually based on based on blockchain technology, it was supposed to be centralized.
Tokens, coins and altcoins
Similar misunderstandings as when distinguishing virtual currencies and cryptocurrencies arise from tokens, coins and altcoins. Coin is a cryptocurrency native to a given blockchain. Altcoins, in simple terms, are cryptocurrencies other than bitcoin. Tokens are often equated with altcoins, but in reality there are significant differences. Altcoins, like bitcoin, are a completely independent form, having their own separate blockchain, and the tokens are based on the solutions of a different network and another cryptocurrency.
To make things not too simple, differences between altcoins are also noted. They offer a diverse range of options, each tailored to specific goals and functions in the digital finance ecosystem. These variants can be broadly grouped based on their underlying mechanisms and goals.
One of the main differences between them lies in the consensus mechanisms. Altcoins often use Proof-of-Work (PoW) or Proof-of-Stake (PoS) mechanisms. PoW requires participants to solve complex cryptographic puzzles to validate transactions, which consumes a significant amount of energy. PoS allows holders to “stake” their coins as collateral to confirm transactions, emphasizing ownership and reducing energy consumption. In return, they regularly receive a certain amount of a given cryptocurrency.
Tokens are also divided into several categories. They can be utilitarian, intended for specific practical purposes. They are used to manage cryptocurrency projects, including: to pay prizes, dividends, and even implement loyalty programs. They are also used to obtain investment capital. These include payment (or currency) tokens that were created as a means of settlement.
Security tokens have a slightly different function. In terms of economic value, they are similar to stocks, bonds and derivatives. Through the tokenization process, real-world assets such as real estate are transformed into digital tokens that can be traded on cryptocurrency platforms or digital stock exchanges. Their value depends on the underlying assets.
Due to their nature and similarity to traditional securities, security tokens are subject to the purview of regulatory bodies such as the Securities and Exchange Commission (SEC). Their main function is to provide investors with an asset-backed digital representation of their rights to the underlying instrument.
Finally, we have stablecoins – a digital asset linked to another asset with a fixed market value, e.g. a fiat currency. Due to the lower volatility of rates, they are intended to improve security and reduce the risk associated with investing in other cryptocurrencies. All cryptocurrencies can be converted into stablecoins.
Already the wealth of instruments shows that in the 15 years since the creation of bitcoin, a huge ecosystem based on cryptocurrencies has been developed and a serious step towards decentralized finance has been made. The rapid development of technology can only accelerate this process, because abandoning it is out of the question.
This is something you need to know
• Altcoin – short for “alternative coin” is a cryptocurrency created as an alternative to bitcoin. This term comes from the time when it was the only digital currency in the world. This type of digital money differs from bitcoin in many respects, including technology, consensus algorithm, market availability, applications and purposes for which it was created. Some were created with technological improvements in mind compared to bitcoin – the idea was to solve the problem of certain limitations related to transaction speed or scalability. Others focus on providing specific features, such as smart contracts, transaction privacy or asset tokenization.
• Stablecoin – a digital asset linked to another asset with an established market value, e.g. FIAT currency, gold, US dollar or bitcoin. By design, it is characterized by lower price volatility, is intended to improve security and reduce the risk associated with investing in other cryptocurrencies.
• CBDC – is a form of digital currency issued by the central bank of a given country. It is based on the same technology as cryptocurrencies. The main difference between cryptocurrencies and CBDCs is that the former are decentralized and provide a certain level of anonymity, while the latter are regulated by the authorities: their value is set by the central bank and is tied to the fiat (official) currency of the country.
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photo: press materials