Summary: Boost your basics! Know the difference between digital currency and cryptocurrency and learn the important factors that are accepted as distinct markers of digital assets.
Bombarded with trading jargon you have no clue about? You’re not the only one. For starters, knowing enough about digital currency, Bitcoin, Ethereum, and NFTs is quite a task. On top of it, to become better at creating your strategies, it is important to know how to analyse them.
Understanding the rising class of digital assets is important now more than ever. While you look for currencies to invest in, knowing the basic technology behind them is important. To put things into perspective, we are going to dive deep into two important distinctions between the coins you may have come across. Digital currencies and cryptocurrencies are not both the same things. Let’s try to get to the definitions first.
What Is Digital Currency?
Digital currencies or cybercash is a form of money that is only available in a digital form. Usually, this form of money can be accessed via electronic devices and exchanged over trusted networks. That is what makes them different from physical cash or traditional bank notes. Digital currencies may or may not work on a blockchain. This is why, all cryptocurrencies are digital currencies but all digital currencies are not cryptocurrencies. The utility of digital currencies is similar to that of physical currencies. To purchase goods, and make convenient payments for services. They are also used in online games, gambling portals and social networks as forms of payments and rewards. Seamless international transfers are possible with digital currencies as well.
- Digital currencies available online only, one can access them via online wallets or bank accounts.
- They can be both centralized and decentralized.
- Not all digital currencies work on encryptions or blockchain. Digital currencies do not always require encryption, but users need to secure their digital wallets (banking apps) to minimise hacking risks or online frauds. Usually, it is easy to create apps via strong passwords. Users also need to secure their debit/credit cards with passwords. They can use any of these methods to make transactions in digital currency from their bank accounts.
- Virtual Currencies, Central Bank Digital Currencies and Cryptocurrencies all are subtypes of digital currencies.
Example: An electronic record or digital token of the official currency of a country is a digital currency.
What Is Cryptocurrency?
A cryptocurrency is a digital currency that has the backbone of cryptography. This technology makes it nearly impossible to double-spend or duplicate the transactions.
Major cryptocurrencies that we know of right now, such as Bitcoin and Ethereum, derive their significance in blockchain. Every transaction made on the blockchain is unique and is difficult to duplicate.
Money seems impossible to exist without a governing body. However, blockchain solves this problem by creating a ledger. Imagine it in the sense of having a $1 note with your name written on it. It is yours, when you give it to a shopkeeper in exchange for a pack of gummy bears, the name is still written on it. But now the shopkeeper can use the note. Transactions over blockchain are similar but with loads of security. By creating a chain of ownerships, each code that appears on the blockchain is saved on a different computer, with the rightful ownership. For hackers to change this data, they would have to hack all the computers that the data is stored in. This is why blockchains are so secure.
Owing to the blockchain technology, cryptocurrencies have gained much popularity and support.
Recently (at the time of writing), El Salvador has accepted Bitcoin as a legal tender, opening new doors for the future of fin-tech.
- Encryption/Cryptography – This allows privacy, pseudonymity or anonymity.This also prevents double-spend or repetition.
- Decentralization – It has to be democratic and independent, unregulated by any governing body.
- Blockchain – The code guarantees functionalities/characteristics on a public ledger.
- Cryptocurrency may not have a central authority governing it but it does have a system which it is a part of. This system comprises companies or groups of companies that manage selling or buying crypto and keep a track of the buyer or trader’s belongings.
- Some cryptocurrencies may have only a limited supply. This feature gives them a unique value and controls their economic significance in an interesting way. For example, there are some coins apart from Bitcoin that have a limited supply:
- Litecoin: Which will only ever be 84 million in supply.
- Cardano: Max supply of 45 billion, one of the highest there are.
- Stellar: Total 50 billion.
- Chainlink: Maximum supply limit of 1 billion.
In summary, cryptocurrencies can be considered as a subtype of digital currencies. Most banks are working on releasing their own digital currencies and looking for a better framework for safety. Currently, digital money (e-versions of physical cash) stored in one’s bank accounts or on one’s smartphone apps can be considered as digital currencies. Cryptocurrencies are stored hardware-based or web-based wallets.
It is important to be able to distinguish the technology of cryptocurrencies from the technology used currently for digital money. This would help any beginner realise the scopes and goals of future fintech projects – centralised or decentralized. For example, Digital Euro project recently (at the time of writing) announced by the European Central Bank is going to be a digital currency that compliments the physical cash but the development team is also researching on making it more secure while avoiding any undesirable impact on financial stability (source).
In understanding the scopes of future projects, it is also important to mention why or how certain digital assets are designed and how they might be able to change money as we know it. For a trader or a cryptocurrency enthusiast, it might be worthwhile to note how Digital Asset Frameworks are analysed.
Digital Asset Framework
While you are researching about a cryptocurrency, it could be significant to look at the framework it works on. Most of the recognized exchanges look at the Digital Asset Framework before listing the currency on their database. The framework is usually publicly released, so that both developers and holders know why an asset may or may not be traded on a specific platform.
There are 6 broad categories in a Digital Asset Framework:
- Whether the asset is an open financial system: There are considerations of who controls the asset and whether a single authority have control over it. In this regard, there are also considerations of whether the technology is fresh and solves a problem. Economic freedom is another consideration. This is usually noted by how easy it is for the members of a society to participate in the economic exchange of the asset. Decentralization and enabling of a consensus in the operations is also important.
- Assessment of the technology: Most crypto exchanges also assess technological strongholds of digital assets. Being scalable enough, and enabling the best security standards are also important considerations.
- Compliance: Legal considerations and regulations are important to meet. If you need an additional look into what these parameters can be, have a look at Hewey Test that gives a framework for further analysis of a cryptocurrency.
- Market Supply: Is the asset available the world over freely and presents no biases? Digital assets redefine boundaries. It is important that they are available without any biases. Due to some regional restrictions, it may be difficult for an asset to be available online. However, it is important to look for any inherited biases in the framework itself. Another factor to dwell into is the liquidity of the supply. Trade velocity is a term used commonly when analysing liquidity. In simple terms, it means whether the asset is able to be converted into other assets.
- Market Demand: Usually, an analysis of the demand would guide the network effects. This means that a considerable focus should be on the ‘people’ side of this asset. Important question to ask then is – what are the factors that would drive the demand for this asset and would lead to stronger network effects?
- Crypto Economics: Cryptocurrencies have an interesting economical significance. It is important to understand the reward system or the way the the parties involved get their incentives. Token utility, rewards and penalties are also studied when a coin presents it’s ICO or Initial Coin Offering. For example, Bitcoin is an interesting case of limited supply currency which works like digital gold. Every four years, the reward on mining a block reduces by half. Halving is important to control supply and make Bitcoin, in turn, even more valuable. For example, in 2009, mining a block would give the miner 50 Bitcoins. Currently, a miner would get only 6.25 Bitcoins.
Having a knowledge of the nuances of the digital asset structures and knowing how digital and crypto currencies work would be important when you actually test the waters and make your trades. Right knowledge, after all, is the basis of all predictions that may work in your favour.
A good place to start trading and putting your knowledge to practice is CoinField. We are an EU-regulated cryptocurrency exchange bringing you the most secure, most convenient and the most versatile way to trade.