Cryptocurrency and digital currency: what is the difference? A complete guide

17, Jun - BLOG

You've probably heard the terms "cryptocurrency" and "digital currency" more than once. In the modern world, where technology permeates all areas of our lives, finance is no exception. We are accustomed to cashless payments, online banking, and even our physical money is increasingly turning into numbers on the screen. But when it comes to cryptocurrencies like Bitcoin or Ethereum, and something newer, such as digital currencies issued by central banks, a logical question arises: are they the same thing or is there a fundamental difference? Often these concepts are confused, used as synonyms, which is fundamentally wrong. We will break down these terms to understand once and for all what their key differences are and why understanding this difference is so important for anyone interested in the future of money.

What is digital currency?

Let's start with the simplest, but often misinterpreted concept - digital currency. What is digital currency? Essentially, it is any means of exchange that exists exclusively in electronic form. This does not necessarily mean something revolutionary or new. It is important to understand that digital currency is not always something exotic and incomprehensible. Your money on a bank card, funds in an electronic wallet PayPal or Yandex.Money - all these are examples of digital currency. They do not have a physical embodiment in the form of banknotes or coins, but at the same time they represent real fiat money issued by the state, just in digital form. Thus, digital currency has long been a familiar element of our financial life.

However, recently the term "digital currency" has increasingly come to mean the so-called CBDC (Central Bank Digital Currency) - digital currencies of central banks. This is a completely new type of money, which is intended to become the third form of fiat money, along with cash and non-cash funds in bank accounts. The main thing here is that the issuer is the central bank of the country, and not a private company or a decentralized network. Such a digital currency is an obligation of the central bank, just like cash. Digital currency is a state project aimed at modernizing the financial system, increasing the transparency and efficiency of settlements.

Types of digital currencies

When we say "digital currencies", it is important to understand that this is a fairly broad concept that includes several forms of money:

• Traditional electronic money: These are funds in your bank accounts and electronic wallets (such as PayPal, WebMoney, Qiwi). In fact, these are the fiat money we are used to (rubles, dollars, euros), stored in electronic form. They depend on the infrastructure of commercial banks and are regulated by banking legislation. For many, digital currency is, first of all, the convenience of cashless payments and fast transfers.
• Central bank digital currencies (CBDC): This is a fundamentally different category. These are direct obligations of the central bank, similar to cash, but existing exclusively in digital form. An example is the Digital Ruble, Digital Yuan or Digital Euro, which are actively being developed or are already being tested by many countries. The main difference is that they are not private money or "ciscoins", but national money issued by the state in a new format. Such digital currencies can have different architectures, but their essence is the same - it is fiat, but in a different guise.
• Tokenized assets: These are digital representations of real assets (e.g. stocks, real estate, gold) on the blockchain. Although not a currency in the strict sense, they function in the digital space and are sometimes mistakenly associated with digital currencies. It is important to remember that tokenization is just a way of representing an asset in a digital environment.

To summarize, the main types of digital currencies that we encounter are:

• Traditional electronic money: Funds in your bank accounts and e-wallets, which are a digital form of fiat currencies.
• Central bank digital currencies (CBDC): A new generation of national money issued directly by central banks, which have the status of a government obligation.
• Tokenized assets: Digital representations of real assets (e.g. shares, real estate), although not a currency in the strict sense, but functioning in the digital space.

What is cryptocurrency?

Now let's move on to cryptocurrencies. Cryptocurrency is a completely different entity. It is a type of digital currency that uses cryptography to secure transactions and control the creation of new units. Unlike traditional digital currencies, most cryptocurrencies are decentralized, meaning they are not controlled by any one authority (bank, government). They run on blockchain technology, a distributed ledger maintained by a huge number of computers around the world. This makes the system extremely resistant to hacking and censorship.

Bitcoin, created by Satoshi Nakamoto, was the first and most famous cryptocurrency. Thousands of others followed, each with its own features, technologies, and goals: Ethereum with its smart contracts, Ripple for interbank settlements, Litecoin, Cardano, and many others. The key here is their decentralized nature, the absence of a central issuer, and reliance on cryptography and consensus mechanisms to confirm transactions. Each cryptocurrency is an independent digital asset, not directly tied to any fiat currency (although their price is often expressed in fiat currencies). The digital currencies we have discussed above have centralized control, which is their fundamental difference from cryptocurrencies.

Key Differences: Cryptocurrency vs. Digital Currency

So, to finally dot the i's and cross the t's, let's highlight the key differences between cryptocurrency and what we call digital currency, especially in the context of CBDCs.

1. Centralization vs. Decentralization:
   • Digital Currencies (CBDCs): Centralized. Issued and controlled by a country's central bank. All transactions are monitored and regulated by government authorities. This makes them similar to traditional fiat money, only in digital form.
   • Cryptocurrencies: Decentralized. Have no central authority. Operate based on consensus among network participants. This is the fundamental difference that defines the entire philosophy and functioning of cryptocurrencies - freedom from intermediaries.
2. Technology:
   • Digital currencies (CBDC): Can use distributed ledger technology (DLT), similar to blockchain, but most often it will be a closed, controlled registry. They can also be implemented based on traditional centralized databases, where records are kept by one authority.
   • Cryptocurrencies: Almost always based on blockchain technology or other decentralized registries (for example, DAG). This ensures transparency, immutability and security of transactions, since the data is not stored on one server, but distributed across many nodes.
3. Issuer:
   • Digital currencies (CBDC): Issued exclusively by the central bank. These are public money, and are the responsibility of the government.
   • Cryptocurrencies: Are created (mined) or issued by decentralized networks or private entities (for some altcoins and tokens). No government entity is responsible for their issuance, which creates both opportunities and risks.
4. Volatility:
   • Digital Currencies (CBDC): Are intended to be stable and pegged to a national fiat currency (1 CBDC = 1 unit of fiat currency). They aim to be stable and predictable, like cash.
   • Cryptocurrencies: Most are highly volatile. Their price can change significantly in a short period of time, influenced by market sentiment, news, and speculation. The exception is stablecoins, which are pegged to fiat currencies, but even they are not CBDCs and do not have a government guarantee.
5. Privacy and anonymity:
   • Digital currencies (CBDC): Provide a high degree of transaction traceability for the central bank and government agencies. Anonymity is usually excluded or minimized to combat money laundering and terrorist financing. The government will know about your every transaction.
   • Cryptocurrencies: Many offer a high level of pseudo-anonymity (transactions are public, but the identities of the owners are hidden behind wallet addresses). Some cryptocurrencies (Monero, Zcash) provide increased anonymity. However, it is often possible for authorities to track transactions on the blockchain if they have enough data.
6. Regulation:
   • Digital currencies (CBDC): Are fully regulated by the state and are subject to existing laws on money and finance. They are integrated into the legal framework of the country.
   • Cryptocurrencies: Regulation varies greatly from country to country, often in a "gray area" or is completely absent. This creates legal uncertainty and risks for users and investors.

To solidify the understanding, here is a quick comparison of the key features:

• Issuer: Central bank for CBDC, decentralized network for cryptocurrencies.
• Control: Fully centralized for CBDC, decentralized or distributed for most cryptocurrencies.
• Peg to fiat: Direct peg (1:1) for CBDC, market price for cryptocurrencies (except stablecoins).
• Technology: Can be any (centralized databases or DLT) for CBDC, mainly blockchain for cryptocurrencies.
• Purpose: Modernization of national finances for CBDC, alternative financial system/innovation for cryptocurrencies.

Similarities and the Future

Despite all their differences, cryptocurrencies and digital currencies have some common features that make them part of the same big evolution of money. Both concepts are electronic forms of money designed to make transactions faster, cheaper, more accessible, and possibly cross-border. Both can be powerful tools for financial innovation and for the inclusion of those who are excluded from traditional banking services in the global economy. Their digital nature opens up new opportunities for programmable money and the creation of more complex financial products.

In the future, we will most likely see the coexistence of all forms of money: cash, non-cash, cryptocurrencies, and CBDCs. Each of them will occupy its own niche, offering unique benefits and responding to the specific needs of users and economies. Central banks are aware of the potential of digital technologies, and their efforts to create CBDCs are a response to the challenges of the time and the growing popularity of cryptocurrencies. The goal of government-issued digital currencies is not to replace cash or bank transfers, but to complement them by offering a new, more efficient and controllable form of national money. This is an important step for the financial system, which can improve its stability and resilience.

Despite their differences, cryptocurrencies and digital currencies share potential benefits that are attracting the attention of regulators and users:

• Transaction efficiency: Transfers can be made faster and cheaper than traditional banking systems by eliminating intermediaries and automating them.
• Accessibility: Potential for increased financial inclusion, especially for the unbanked, by being able to transact via mobile.
• Innovation: Stimulates the development of new financial products and services based on digital technologies, such as smart contracts and decentralized applications.
• Transparency (for some systems): The ability to more easily track the flow of funds on a digital ledger, which is important for fighting crime (especially for CBDC).

Conclusion

So, we have figured out that "cryptocurrency" and "digital currency" are not synonyms. Although they both exist in digital form, their fundamental principles, emission mechanisms, regulation and control are fundamentally different. Cryptocurrencies are decentralized, often volatile assets based on the blockchain, without a central issuer. This is a revolutionary phenomenon that challenges traditional financial systems by offering an alternative, intermediary-free way to exchange value. But digital currency, especially in the context of CBDC, is a controlled and centralized form of national money issued by the state. It is rather an evolution of fiat money, designed to make it more efficient and secure in the digital age. We have considered that digital currency is an important tool for the state, which can help in modernizing payment systems and improving control over money flows. The concept of digital currencies is broader and includes various electronic forms of money, while cryptocurrency is just one type of digital asset with its own unique characteristics.

Hopefully, this article has helped you clearly define the difference between these two important concepts, and now when you hear about them, you can confidently distinguish between them. The future of finance is digital, and understanding its basics means being prepared for the changes to come.