Digital currency encompasses any currency or money stored and transacted through digital computer systems, such as the Internet. In other words, digital currencies only exist in electronic form. Three popular examples of digital currency are cryptocurrency, virtual currency, and central bank digital currency. Digital currencies serve a similar purpose to physical currencies, allowing individuals to buy goods and pay for services.
Digital currencies can take two forms: centralized and regulated (central bank digital currencies) or decentralized and unregulated (cryptocurrencies and virtual currencies).
What is a central bank digital currency?
Central bank digital currencies (CBDCs) are a type of digital currency issued by a country’s central bank. The value of this electronic currency is established by the central bank and is typically equivalent to that country’s fiat currency.
Fiat currency is traditionally physical currency, e.g. coins and banknotes, whose value is backed by the government that issued it rather than by a physical commodity (i.e., gold or silver). This value is based on the stability of the country’s government and supply and demand. The result of printing too much fiat currency however is hyperinflation.
There are typically two types of CBDCs, namely wholesale CBDCs and retail CBDCs.
- Wholesale CBDCs are like holding reserves in a central bank. An institution is granted an account by a central bank to deposit funds or settle interbank transfers. Lending and interest rates are based on reserve requirements or interest on reserve balances.
- Retail CBDCs are digital currencies used by consumers or businesses. They are backed by the government offering some type of security that private digital currency issuers may be unable to (.e.g. bankruptcy or loss of customer’s assets). Two types of retail CBDCs include token-based retail CBDCs and account-based retail CBDCs.
What are virtual currencies?
Virtual currencies are a category of digital currencies issued by private parties or developers are are usually unregulated. They are only available in electronic form and are typically used as a method of payment among members of a particular virtual community. Virtual currencies are usually grouped into closed virtual currency and open virtual currency.
A closed virtual currency is typically used in a private ecosystem and cannot be exchanged for any other virtual currency. An example would be the currencies used in gaming systems. In this instance, the specific currency would only be available for use in a particular game and cannot be converted for fiat (real world) currency. Another example is airline miles which again, cannot be converted into physical monetary value.
An open virtual currency is also known as a convertible virtual currency as it can be exchanged for other types of money. Examples are stablecoins and cryptocurrencies. Bitcoin for instance can be exchanged for other cryptocurrencies or certain fiat currencies.
It is important to note that, unlike cryptocurrencies that are cryptographically secured, virtual currencies do not always use cryptography to secure their networks.
What are cryptocurrencies?
Cryptocurrencies are a form of digital or electronic currency, with more than 23k types of cryptocurrencies in the world today. So popular is this form of digital currency that collectively, they are said to be worth somewhere in the region of US$1 trillion.
Cryptos are highly volatile which is attributed to a lack of regulation and the collapse of major crypto firms amounting to trillions of dollars in losses. However, they remain a sought-after form of digital currency for several reasons.
For one, cryptocurrencies allow for a faster and cheaper way to execute transactions. This is large because of their decentralized structure that removes the need for third-party intermediaries. This also typically puts them outside the scope of government or central authority control.
Secondly, cryptocurrencies offer individuals residing or working in regions that lack robust financial infrastructures the ability to transact in global markets.
Third, cryptocurrencies are also popular among traders looking to diversify their trading portfolios.
Fourth, crypto enthusiasts seek to invest in cryptocurrencies because of the level of security that they offer by means of cryptography. Fifth, investors also use crypto to hedge against market fluctuations that come about because of currency devaluation, inflation, and more.
Popular cryptocurrencies
As already mentioned, there exist more than 23 thousand forms of cryptocurrencies globally. Let’s look at the top 3.
Bitcoin (BTC)
- Bitcoin: Bitcoin (BTC) is probably the most renowned cryptocurrency in the world, undoubtedly the OG as far as electronic currencies are concerned. Launched in 2009, Bitcoin has since become the world’s largest cryptocurrency in terms of market cap (approximately US$1 trillion). It can be purchased through different crypto exchanges but it is created, distributed, traded, and stored on the blockchain. One bitcoin is divisible to eight decimal places and the smallest unit is called Satoshi (probably a tribute to the currency’s alleged creator Satoshi Nakamoto).
Ether (ETH)
- Ether: Ether (ETH) is the world’s 2nd most popular cryptocurrency in the world and is the native coin of Ethereum. Launched in 2015, Ethereum is said to be worth around US$190 billion (market capitalization). As of August 2023, there were said to be around 120.2 million Ethereum coins in circulation. Ethereum has a twofold purpose, it can be used to create secure digital technology and can also be used to pay for goods and services. Ethereum users use a wallet that holds private keys that are similar to passwords when initiating a transaction. Each ether has its own private key. The key is required for accessing the ether.
Tether
- Tether: Third on the list of popular cryptocurrencies is tether (USDT) which has a market cap of approximately US$89 billion. Tether is also known as the issuer of the world’s largest stablecoin. In May 2023 it was announced that Tether was aiming to invest 15% of its net profit into Bitcoin to diversify the reserves that back its USDT token. This amounted to approximately US$222 million. CNBC reported that “USDT is the largest stablecoin in the market, with a circulating supply of more than $82.8 billion, according to CoinGecko data. It competes with Circle’s USD Coin and Binance’s BUSD.”
Digital Currency and Cryptocurrency CFDs
Trading CFDs has gained immense popularity in the crypto space. CFDs are Contracts for Difference that allow traders to trade a variety of assets (cryptocurrencies, stocks, forex, indices, commodities) without having to own the underlying asset. Rather, a trader will speculate or predict in what direction the asset’s price will move, i.e., the price of the cryptocurrency, and then go long (buy) or short (sell), based on their prediction.
CFD trading is renowned for offering high liquidity which in turn provides access to more competitive spreads. Traders can also make use of leverage when trading crypto CFDs. Leverage is essentially borrowed funds that enable the trader to open or handle larger positions than what their account balance would typically permit.
However, leverage is incredibly volatile and will it offers the potential for maximising profits, it can also exasperate losses, resulting in huge loss of funds. As a result, traders who make use of leverage will also implement proper risk management techniques, like stop loss and take profit orders, to safeguard their funds. Additionally, traders are advised to consider their budget and tolerance for risk before making decisions on the amount of leverage they intend to use.
Disclaimer: This material is for general informational and educational purposes only and should not be considered investment advice or an investment recommendation. T4Trade is not responsible for any data provided by third parties referenced or hyperlinked in this communication.
