What is Digital Currency?
Digital currency is money that exists entirely in digital form. Unlike cash, there are no physical notes or coins involved. It can be stored and transferred electronically and is used to move value through digital networks.
The term digital currency covers several different forms of money. This includes cryptocurrencies such as Bitcoin, stablecoins pegged to assets like the US dollar, and central bank digital currencies (CBDCs) issued by governments.
The important thing to understand is that digital currency is a broad category. Not every digital currency works in the same way, and not every digital currency is a cryptocurrency.
How Digital Currency Works?
- The word digital only tells us that money exists in electronic form. It does not tell us who controls it or how it operates. Digital currencies can broadly be understood through two categories: decentralised digital currencies and centralised digital currencies.
- Decentralised Digital Currency ( Cryptocurrency, Stablecoins, etc.) is based on no-authority, permissionless blockchains. Whereas Centralised digital currencies, including CBDCs such as India's e-rupee, run on a ledger controlled by an issuing authority (a central bank) that mints and redeems units. These are typically token-based, accessed through a digital wallet, and distributed via a two-tier model: the central bank issues them to banks, who circulate them to the public.
Types of Digital Currency
- Digital currencies can be classified into different forms depending on who maintains their value, who issues them or how they can be used.
- Cryptocurrency: A
digital currency that runs on a decentralised network rather than being issued by a central authority. Transactions are secured using cryptography and recorded on a public blockchain. Its value is driven by market demand and can rise or fall significantly. Bitcoin and Ether are common examples. - Stablecoin: A digital asset created to keep its value relatively stable. It is usually linked to a fiat currency such as the US dollar, a commodity, or another reference asset. Depending on the stablecoin, the value may be supported by reserves or maintained through an algorithm. USDT and USDC are two widely used examples.
- Central Bank Digital Currency (CBDC): A digital version of a country's official currency, issued and controlled by its central bank. Unlike cryptocurrencies, a CBDC is part of the country's monetary system and is intended to maintain the same value as the national currency. In India, this is the Digital Rupee (e₹ or e-Rupee), issued by the Reserve Bank of India.
- Retail vs Wholesale CBDC: A CBDC can be designed for different types of users. Retail CBDC (e₹-R) is meant for everyday payments made by individuals and businesses, including person-to-person and person-to-merchant transactions. Wholesale CBDC (e₹-W) is used by financial institutions, mainly for interbank settlement and large-value transactions such as government securities.
