Differences between a digital currency and a cryptocurrency

digital currency and a cryptocurrency

Digital currencies backed by central banks, such as the possible digital euro and digital yuan, may be a reality in the next few years. Unlike cryptocurrencies such as Bitcoin and Ethereum, these currencies promise lower volatility and higher security. In addition, they will have the support of their respective monetary institutions, in charge of ensuring financial stability.

The European Central Bank (ECB) studies and analyzes the creation of the digital euro, under the concept of Central Bank Digital Currency (CDBC). It would be a “digital form of money from the central bank that is different from the balances in the traditional reserve or settlement accounts” and that depends directly on the institution, according to the Bank for International Settlements (BIS, in its acronym in English). ) in the report ‘ Central bank digital currencies: foundational principles and core features ‘.

From the ECB they work with caution and it is believed that the first studies and tests could be carried out in mid-2021. One of the possibilities is to implement formulas based on ‘ blockchain ‘ technology, the same one used by cryptocurrencies such as bitcoin and ether. This would allow Europe to have tools to have greater transparency and monitoring of the information, transactions, and movements that are made, according to the report ‘ Digital currencies issued by central banks: characteristics, options, advantages, and disadvantages ‘, by BBVA Research with cryptocurrency prices.

Centrally issued and backed by central banks

Unlike these two cryptocurrencies, which also have DLT (distributed ledger technology), officially supported digital currencies will be issued centrally and will be backed by their central banks. “One of the differences between a digital euro and a Bitcoin is the way it is issued. While the operations, in the case of the euro, are centralized and the only one that can issue is the ECB, in the case of Bitcoin it is totally different”, highlights Alberto Muñoz Cabanes, professor at the Department of Applied Economics and Statistics at the Spanish Distance University (UNED).

In turn, Muñoz Cabanes refers to the mining of cryptocurrencies by users. A distributed process and radically different from the issuance of currency by a central bank, since states can issue without a limit; while, for example, the money supply of ‘bitcoin’ is predefined and will not exceed 21,000,000.

However, with cryptocurrencies, something different happens. To begin with, being created by the users themselves, only after the creation of the blocks and their verification do new coins enter circulation. From there, its value is marked by the market. “From an economic point of view, the native cryptocurrencies of decentralized and non-permission networks, such as bitcoin or Ethereum, are not anchored to the value of a legal tender, but rather are subject to the price set by supply and demand.

It is another of the main differences that a digital currency backed by a central bank would have: its low volatility, compared to that exhibited by cryptocurrencies today. This is due, as Professor Muñoz Cabanes explains, to the fact that while central banks ensure financial stability through monetary policies, in relation to the value of other currencies, bitcoin is a volatile currency because it acts in an immature market, not supported and full of expectations. Although the economist points out that this may change the more the use of cryptocurrencies becomes popular.

Corporate-backed cryptocurrencies

Also worth mentioning are digital currency projects not backed by central banks but by corporations subject to regulation, such as Libra, now Diem, the Facebook-backed cryptocurrency project. “There are other types of solutions that seek to combine the innovative functionalities found in cryptocurrency networks with greater guarantees for users,” explains Español.

These types of coins are backed by a reserve of assets from the entity that issues them and can be less risky than cryptocurrencies as a means of payment. “However, we must bear in mind that, given the novelty of these proposals, the authorities are currently analyzing

Characteristics of digital currencies

In order to issue a digital currency backed by central banks, called by the acronym CBDC, the Bank for International Settlements (BIS) lists up to 14 characteristics that make this type of currency a platform that is aligned with the financial stability objectives that govern the international monetary institutions. The highlights of CBDCs, according to the BIS, are:

  1. The conversion and value will be the same as with physical money and volatility will be avoided.
  2. They will be accepted and available for all types of online and offline transactions 24/7.
  3. Its cost will be low and almost zero at the time of creation and final distribution of money.
  4. They will constitute at all times a secure and resilient system against possible cyber attacks, system crashes or disruptions.
  5. They may be operable between different banking systems.
  6. We will talk about robust and legal currencies thanks to the backing of a central bank.

In search of primacy in digital currencies

The race for the leadership of digital currencies has already begun and both Europe and China want to take the lead and prevent unregulated cryptocurrencies from being the main player in the world of digital payments. “These digital currencies respond to the interest on the part of central banks to keep themselves updated to guarantee the fulfillment of their objectives and functions. Many central banks are investigating the impact of issuing a CBDC on the financial system, while others have opted for the issuance of this instrument and are in the development phase.

The People’s Bank of China, Europe’s equivalent of the ECB, has been running tests of its digital currency since April with the help of four banks in the country. Given the strength that the two Asian technology giants, WeChat and Alipay, have acquired in the digital payment environment, China wants to take control from now on, once it has seen how well these payment methods have worked in the country. The aspiration is for the digital yuan to be fully operational by 2022. In the longer term, the Chinese government aims to have its digital currency replace physical currency throughout the country.

At the international level, the Asian giant looks towards a hypothetical scenario in which its digital yuan becomes the reference currency. “The fact of being the first to launch your digital currency allows you to eliminate internal problems, such as black money, increase your tax efficiency since tax payments would be immediate, while it would speed up trade because payments are instant”,