What is digital currency?

Digital currency — which may also be called digital money — is considered a form of currency stored and exchanged over a computer network, which means it can exist digitally.

Digital currency isn't necessarily the same as dollars stored in an online bank account because someone can withdraw those dollars as physical cash. Digital currency, however, never leaves its electronic form unless exchanged for a fiat currency.

This guide explores what digital currency is, the types of digital currency there are, and the potential pros and cons that can come with it.

How does digital currency work?

Digital currencies are generally only available in electronic form. There may be no way to turn them into a physical currency, such as a dollar bill. Payments made using digital currencies are processed and completed via computer networks or electronic wallets.

Digital currencies can be centralized, like those created by a central bank or government body, or decentralized, like those created by a private organization. Decentralized currencies have no intermediaries, so money is transferred directly between the payer and the payee. With decentralized currencies, there is generally no bank to oversee or verify transactions either.

Digital currency types

Digital currency can come in various forms. Here are three digital currency examples:

Cryptocurrencies

Cryptocurrencies use cryptography — or encoded information — to authenticate and secure transactions. Cryptocurrencies are decentralized and self-regulated — which can mean they're created by private parties instead of a central bank.

Some cryptocurrencies like Bitcoin and Ethereum use blockchain — a digital ledger of each transaction — to secure and manage crypto payments.

Cryptocurrency is just one form of digital currency.

Central bank digital currencies

Central bank digital currencies (CBDCs) can be issued and regulated by a country's central bank. Countries around the world have started to experiment with launching CBDCs to support fast, convenient payments, especially across borders. The U.S. doesn't have a CBDC yet.

Virtual currencies

Virtual currencies are considered digital currencies created by private organizations instead of central banks.

Since virtual currencies aren't regulated, they don't have any intermediaries interrupting or monitoring payments. Though this can help speed up transactions, it can also leave the currency vulnerable to hacking and fraud.

Potential pros and cons of digital currency

There can be potential positives and negatives with digital currency. Below are some characteristics to consider when it comes to digital currency.

Potential advantages of digital currency

• Fast payments. Decentralized digital currencies can be transferred quickly and cheaply, since there are no intermediaries to regulate the transaction or impose fees.
• 24/7 access. Many digital currency markets run 24/7/365, meaning it can potentially be convenient if looking to buy or sell things like cryptocurrency at any time.
• Easy global transfers. Digital currencies have no borders since they only exist electronically and are managed by computer networks. They may make international payments quick and potentially less costly.
• Privacy. Cryptocurrencies can be built to keep personal data protected and encrypted.

Potential disadvantages of digital currency

• Volatility. The price of digital currencies can change suddenly and frequently based on supply and demand. This is known as having a volatile value.
• Infrastructure issues. Digital currency transactions normally rely on computer networks, internet connection, and access to online payment services like digital wallets. If these systems are down, people may have issues accessing and using their digital funds.
• Security risks. Since digital currencies only exist on computers, they can be vulnerable to hacking and theft.