Figuring Out How Digital Currencies Works. There are various innovative money payment systems in the market today, many of which are built on platforms like the mobile phone, the Internet, and the digital storage card. These alternative payment systems have seen encouraging or even continued growth, from the likes of PayPal, Apple Pay, Google Wallet, Alipay, Tenpay, Venmo, M-Pesa, BitPay, Moven, BitPesa, PayLah!, Dash, FAST, Transferwise, and others.
Beyond payment systems that are based on fiat currency, the growing use of digital currency allows for faster, more flexible, and more innovative payments and ways in financing goods and services. One digital currency, however, stands out among the rest.
Bitcoin is one of the most well-known digital currencies today. To be specific, Bitcoin is a cryptocurrency, which is a subset of what is generally known as a digital currency. Bitcoin is a unique cryptocurrency that is widely considered to be the first of its kind. Like many created after it, Bitcoin uses the power of the Internet to process its transactions.
Digital Currency as Alternative Currency
“Digital” versus “virtual”
Although digital and virtual are often used interchangeably when describing currencies based on an electronic medium, the term “virtual” has a negative connotation. “Virtual” signals something that is “seemingly real” but not exactly “real” when referring to a currency that is stored in a “digital” or electronic register. Indeed, in languages like Chinese, the word “virtual” is interpreted as “created from nothing” (虚拟的) in the sense that it is not “physical” but computer-generated or computer-simulated. However, the currencies often described as “virtual” are very “real,” in the sense that they exist. Thus, the more neutral term digital currency is generally preferred over virtual currency.
Classifying Digital Currencies – Bitcoin
Alternative currencies refer to a medium of exchange other than fiat currency. Historically, there are various types of alternative currencies, as classified by Hileman (2014) broadly into two categories: tangible and digital. Tangible currencies, closely associated with “commodity money,” derive their value from relative scarcity and nonmonetary utility:
(a) Currencies with intrinsic utility: This class of currency includes metals and cigarettes in post-WWII Berlin and more contemporary examples are prepaid phone cards and, to some extent, cash value smart cards. This class is not dependent upon governance as in the case of monetary instruments, and more importantly, its intrinsic value is not an abstraction and it is not necessarily geographically bound.
Seventeenth-to nineteenth-century British tokens and the Great Depression scrip of the 1930’s are historical examples. More contemporary examples are local or community currencies such as Brixton Pound and Bristol Pound that are used in England, BerkShares that is circulated in Berkshire region of Massachusetts, and Salt Spring Dollar in Canada. Token has less intrinsic value as its use is more specific and usually bounded by some social contracts or agreements such as honoring them for exchange for goods or to limit the supply of goods.
(c) Centralized Digital Currencies
Examples are loyalty points from financial, telecom, or retail companies; air miles from airlines; Second Life’s Linden Dollar and World of Warcraft Gold, which is a closed system with transactions within specific entities; and Flooz and Beenz, which are open market system and can be transacted with other entities. Local currencies such as Brixton Pound, BerkShares, and Salt Spring Dollar also fall under this category besides being classified as tokens. The governance structure is centralized.
(d) Distributed and/or decentralized Digital Currencies
This includes cryptocurrencies such as Bitcoin, Litecoin, and Dogecoin. They can be transacted with any outside agents and the governance is decentralized mainly but not necessary due to open-source software. There is no legal entity responsible for the activities, and therefore, they fall outside traditional regulation.
Why alternative currencies
There are various socio-economic forces that drive the demand for alternative currencies:
(a) Localism: By promoting community commerce or “save the high street,” localism retains consumption within a group of independent retailers or within a geographic area for job creation and improved business conditions.
(b) Technology: It has become much easier to use with improved software and low entry barriers contributing to network effects.
(c) Political economy: There is disillusionment about the high pay of CEOs and bankers and the notion of traditional banks being too big to fail. With high debt and quantitative easing, there is great discomfort with economic uncertainty.
(d) Environmentalism: There are ecology concerns and the question of whether we have reached the point of maximum extraction of natural resources such as oil.
(e) Inefficiencies: Financial services are overpriced and the whole financial system is too expensive.
(f) Financial freedom: Some digital currencies such as cryptocurrencies have the advantage of transferring value through the Internet where control is weak. Such digital currencies may allow users to bypass capital controls and may provide safe harbor during a fiat currency crisis.
(g) Speculation: Buyers of some digital currencies such as cryptocurrencies are anticipating a price appreciation due to subsequent wider acceptance.
It is very easy to create a cryptocurrency as an alternative currency for free today. However, most of these new creations will cease circulation within a relatively short time. With many alternative currencies in competition, only a few will be globally adopted, reach a sufficient scale, or find a suitable market. Unless the idea of national digital currencies takes off, it is likely that many of these alternative currencies will cease circulation because of superseding advancements in technology, tighter regulation,
and insufficient demand.