Taxonomy of money, based on "Central bank cryptocurrencies" by Morten Linnemann Bech and Rodney Garratt
Digital currency (digital money, electronic money or electronic currency) is a type of currency available in digital form (in contrast to physical, such as banknotes and coins).
It exhibits properties similar to physical currencies, but can allow
for instantaneous transactions and borderless transfer-of-ownership.
Examples include virtual currencies, cryptocurrencies, and central bank digital currency. These currencies may be used to buy physical goods and services, but may also be restricted to certain communities such as for use inside an online game.
Digital currency is a money balance recorded electronically on a stored-value card or other devices. Another form of electronic money is network money, allowing the transfer of value on computer networks, particularly the Internet. Electronic money is also a claim on a private bank or other financial institution such as bank deposits.
Digital money can either be centralized, where there is a central point of control over the money supply, or decentralized, where the control over the money supply can come from various sources.
History
In 1983, a research paper by David Chaum introduced the idea of digital cash. In 1990, he founded DigiCash, an electronic cash company, in Amsterdam to commercialize the ideas in his research. It filed for bankruptcy in 1998.
e-gold
was the first widely used Internet money, introduced in 1996, and grew
to several million users before the US Government shut it down in 2008.
Users of the e-gold mailing list used the term "digital currency" to
describe peer to peer payments in various instruments. In 1997, Coca-Cola offered buying from vending machines using mobile payments. PayPal launched its USD-denominated service in 1998. In 2009, bitcoin
was launched, which marked the start of decentralized blockchain-based
digital currencies with no central server, and no tangible assets held
in reserve. Also known as cryptocurrencies, blockchain-based digital
currencies proved resistant to attempt by government to regulate them,
because there was no central organization or person with the power to
turn them off.
Origins of digital currencies date back to the 1990s Dot-com bubble. Another known digital currency service was Liberty Reserve,
founded in 2006; it lets users convert dollars or euros to Liberty
Reserve Dollars or Euros, and exchange them freely with one another at a
1% fee. Several digital currency operations were reputed to be used for
ponzi schemes and money laundering, and were prosecuted by the U.S.
government for operating without MSB licenses. Q coins or QQ coins, were used as a type of commodity-based digital currency on Tencent QQ's
messaging platform and emerged in early 2005. Q coins were so effective
in China that they were said to have had a destabilizing effect on the
Chinese Yuan currency due to speculation. Recent interest in cryptocurrencies has prompted renewed interest in digital currencies, with bitcoin, introduced in 2008, becoming the most widely used and accepted digital currency.
Comparisons
Digital versus virtual currency
According to the European Central Bank's
2015 "Virtual currency schemes – a further analysis" report, virtual
currency is a digital representation of value, not issued by a central
bank, credit institution or e-money institution, which, in some
circumstances, can be used as an alternative to money.
In the previous report of October 2012, the virtual currency was
defined as a type of unregulated, digital money, which is issued and
usually controlled by its developers, and used and accepted among the
members of a specific virtual community.
According to the Bank for International Settlements'
November 2015 "Digital currencies" report, it is an asset represented
in digital form and having some monetary characteristics.
Digital currency can be denominated to a sovereign currency and issued
by the issuer responsible to redeem digital money for cash. In that
case, digital currency represents electronic money (e-money). Digital
currency denominated in its own units of value or with decentralized or
automatic issuance will be considered as a virtual currency.
As such, bitcoin is a digital currency but also a type of virtual
currency. Bitcoin and its alternatives are based on cryptographic
algorithms, so these kinds of virtual currencies are also called
cryptocurrencies.
Digital versus traditional currency
Most of the traditional money supply is bank money
held on computers. This is also considered digital currency. One could
argue that our increasingly cashless society means that all currencies
are becoming digital, but they are not presented to us as such.
Types of systems
Centralized systems
Currency can be exchanged electronically using debit cards and credit cards using electronic funds transfer at point of sale.
Mobile digital wallets
A number of electronic money systems use contactless payment
transfer in order to facilitate easy payment and give the payee more
confidence in not letting go of their electronic wallet during the
transaction.
- In 1994 Mondex and National Westminster Bank provided an "electronic purse" to residents of Swindon
- In about 2005 Telefónica and BBVA Bank launched a payment system in Spain called Mobipay which used simple short message service facilities of feature phones intended for pay-as-you-go services including taxis and pre-pay phone recharges via a BBVA current bank account debit.
- In January 2010, Venmo launched as a mobile payment system through SMS, which transformed into a social app where friends can pay each other for minor expenses like a cup of coffee, rent and pay a share of the restaurant bill when one has forgotten their wallet. It is popular with college students, but has some security issues. It can be linked to a bank account, credit/debit card or have a loaded value to limit the amount of loss in case of a security breach. Credit cards and non-major debit cards incur a 3% processing fee.
- On 19 September 2011, Google Wallet released in the United States to make it easy to carry all one's credit/debit cards on a phone.
- In 2012 Ireland's O2 (owned by Telefónica) launched Easytrip to pay road tolls which were charged to the mobile phone account or prepay credit.
- The UK's O2 invented O2 Wallet at about the same time. The wallet can be charged with regular bank accounts or cards and discharged by participating retailers using a technique known as 'money messages'. The service closed in 2014.
- On 9 September 2014, Apple Pay was announced at the iPhone 6 event. In October 2014 it was released as an update to work on iPhone 6 and Apple Watch. It is very similar to Google Wallet, but for Apple devices only.
Decentralized systems
A cryptocurrency is a type of digital asset that relies on cryptography for chaining together digital signatures of asset transfers, peer-to-peer networking and decentralization.
In some cases a proof-of-work or proof-of-stake scheme is used to create and manage the currency.
Cryptocurrencies allow electronic money systems to be decentralized. The first and most popular system is bitcoin, a peer-to-peer electronic monetary system based on cryptography.
Virtual currency
A virtual currency has been defined in 2012 by the European Central Bank
as "a type of unregulated, digital money, which is issued and usually
controlled by its developers, and used and accepted among the members of
a specific virtual community". The US Department of Treasury
in 2013 defined it more tersely as "a medium of exchange that operates
like a currency in some environments, but does not have all the
attributes of real currency". The key attribute a virtual currency does not have according to these definitions, is the status as legal tender.
Law
Since 2001, the European Union has implemented the E-Money Directive "on the taking up, pursuit and prudential supervision of the business of electronic money institutions" last amended in 2009.[28] Doubts on the real nature of EU electronic money have arisen, since calls have been made in connection with the 2007 EU Payment Services Directive
in favor of merging payment institutions and electronic money
institutions. Such a merger could mean that electronic money is of the
same nature as bank money or scriptural money.
In the United States, electronic money is governed by Article 4A of the Uniform Commercial Code for wholesale transactions and the Electronic Fund Transfer Act for consumer transactions. Provider's responsibility and consumer's liability are regulated under Regulation E.
Regulation
Virtual currencies pose challenges for central banks, financial
regulators, departments or ministries of finance, as well as fiscal
authorities and statistical authorities.
U.S. Treasury guidance
On 20 March 2013, the Financial Crimes Enforcement Network issued a guidance to clarify how the U.S. Bank Secrecy Act applied to persons creating, exchanging, and transmitting virtual currencies.
Securities and Exchange Commission guidance
In May 2014 the U.S. Securities and Exchange Commission (SEC) "warned about the hazards of bitcoin and other virtual currencies".
New York state regulation
In July 2014, the New York State Department of Financial Services proposed the most comprehensive regulation of virtual currencies to date, commonly called BitLicense.
It has gathered input from bitcoin supporters and the financial
industry through public hearings and a comment period until 21 October
2014 to customize the rules. The proposal per NY DFS press release
"sought to strike an appropriate balance that helps protect consumers
and root out illegal activity".
It has been criticized by smaller companies to favor established
institutions, and Chinese bitcoin exchanges have complained that the
rules are "overly broad in its application outside the United States".
Adoption by governments
As of 2016, over 24 countries are investing in distributed ledger
technologies (DLT) with $1.4bn in investments. In addition, over 90 central banks are engaged in DLT discussions, including implications of a central bank issued digital currency.
- Hong Kong’s Octopus card system: Launched in 1997 as an electronic purse for public transportation, is the most successful and mature implementation of contactless smart cards used for mass transit payments. After only 5 years, 25 percent of Octopus card transactions are unrelated to transit, and accepted by more than 160 merchants.
- London Transport’s Oyster card system: Oyster is a plastic smartcard which can hold pay-as-you-go credit, Travelcards and Bus & Tram season tickets. An Oyster card can be used to travel on bus, Tube, tram, DLR, London Overground and most National Rail services in London.
- Japan’s FeliCa: A contactless RFID smart card, used in a variety of ways such as in ticketing systems for public transportation, e-money, and residence door keys.
- The Netherlands' Chipknip: As an electronic cash system used in the Netherlands, all ATM cards issued by the Dutch banks had value that could be loaded via Chipknip loading stations. For people without a bank, pre-paid Chipknip cards could be purchased at various locations in the Netherlands. As of 1 January 2015, payment can no longer be made with Chipknip.
- Belgium's Proton: An electronic purse application for debit cards in Belgium. Introduced in February 1995, as a means to replace cash for small transactions. The system was retired in 31 December 2014.
In March 2018, the Marshall Islands
became the first country to issue their own cryptocurrency and certify
it as legal tender; the currency is called the "sovereign".
Canada
The Bank of Canada have explored the possibility of creating a version of its currency on the blockchain.
The Bank of Canada teamed up with the nation’s five largest banks
— and the blockchain consulting firm R3 — for what was known as Project
Jasper. In a simulation run in 2016, the central bank issued CAD-Coins
onto a blockchain similar Ethereum. The banks used the CAD-Coins to exchange money the way they do at the end of each day to settle their master accounts.
China
A deputy governor at the central bank of China,
Fan Yifei, wrote that "the conditions are ripe for digital currencies,
which can reduce operating costs, increase efficiency and enable a wide
range of new applications".
According to Fan Yifei, the best way to take advantage of the situation
is for central banks to take the lead, both in supervising private
digital currencies and in developing digital legal tender of their own.
Denmark
The Danish government proposed getting rid of the obligation for
selected retailers to accept payment in cash, moving the country closer
to a "cashless" economy. The Danish Chamber of Commerce is backing the move. Nearly a third of the Danish population uses MobilePay, a smartphone application for transferring money.
Ecuador
A law passed by the National Assembly of Ecuador
gives the government permission to make payments in electronic currency
and proposes the creation of a national digital currency. "Electronic
money will stimulate the economy; it will be possible to attract more
Ecuadorian citizens, especially those who do not have checking or
savings accounts and credit cards alone. The electronic currency will be
backed by the assets of the Central Bank of Ecuador", the National
Assembly said in a statement.
In December 2015, Sistema de Dinero Electrónico ("electronic money
system") was launched, making Ecuador the first country with a state-run
electronic payment system.
Netherlands
The Dutch central bank is experimenting with a bitcoin-based virtual currency called "DNBCoin".
India
Unified Payments Interface (UPI) is an instant real-time payment
system developed by National Payments Corporation of India facilitating
inter-bank transactions. The interface is regulated by the Reserve Bank
of India and works by instantly transferring funds between two bank
accounts on a mobile platform.
UPI is built over Immediate Payment Service for transferring funds.
Being a digital payment system it is available 24*7 and across public
holidays. Unlike traditional mobile wallets, which takes a specified
amount of money from user and stores it in its own accounts, UPI
withdraws and deposits funds directly from the bank account whenever a
transaction is requested. It uses Virtual Payment Address (a unique ID
provided by the bank), Account Number with IFS Code, Mobile Number with
MMID (Mobile Money Identifier), Aadhaar Number, or a one-time use
Virtual ID. An UPI-PIN (UPI Personal Identification number that one
creates on the UPI app of the bank) is required to confirm each payment.
Russia
Government-controlled Sberbank of Russia owns Yandex.Money – electronic payment service and digital currency of the same name.
Sweden
Sweden
is in the process of replacing all of its physical banknotes, and most
of its coins by mid-2017. However, the new banknotes and coins of the Swedish krona will probably be circulating at about half the 2007 peak of 12,494 kronor per capita. The Riksbank
is planning to begin discussions of an electronic currency issued by
the central bank to which "is not to replace cash, but to act as
complement to it". Deputy Governor Cecilia Skingsley
states that cash will continue to spiral out of use in Sweden, and
while it is currently fairly easy to get cash in Sweden, it is often
very difficult to deposit it into bank accounts, especially in rural
areas. No decision has been currently made about the decision to create
"e-krona". In her speech, Skingsley states: "The first question is
whether e-krona should be booked in accounts or whether the ekrona
should be some form of a digitally transferable unit that does not need
an underlying account structure, roughly like cash." Skingsley also
states: "Another important question is whether the Riksbank should issue
e-krona directly to the general public or go via the banks, as we do
now with banknotes and coins." Other questions will be addressed like
interest rates, should they be positive, negative, or zero?
Switzerland
In 2016, a city government first accepted digital currency in payment of city fees. Zug, Switzerland,
added bitcoin as a means of paying small amounts, up to CHF 200, in a
test and an attempt to advance Zug as a region that is advancing future
technologies. In order to reduce risk, Zug immediately converts any
bitcoin received into the Swiss currency. Swiss Federal Railways, government-owned railway company of Switzerland, sells bitcoins at its ticket machines.
UK
The Chief Scientific Adviser to the UK government advised his
Prime Minister and Parliament to consider using a blockchain-based
digital currency.
The chief economist of Bank of England, the central bank of the United Kingdom, proposed abolition of paper currency. The Bank has also taken an interest in bitcoin.
In 2016 it has embarked on a multi-year research programme to explore
the implications of a central bank issued digital currency.
The Bank of England has produced several research papers on the topic.
One suggests that the economic benefits of issuing a digital currency on
a distributed ledger could add as much as 3 percent to a country's
economic output.
The Bank said that it wanted the next version of the bank’s basic
software infrastructure to be compatible with distributed ledgers.
Adoption by financial actors
Government attitude dictates the tendency among established heavy
financial actors that both are risk-averse and conservative. None of
these offered services around cryptocurrencies and much of the criticism
came from them.
"The first mover among these has been Fidelity Investments, Boston based Fidelity Digital Assets
LLC will provide enterprise-grade custody solutions, a cryptocurrency
trading execution platform and institutional advising services 24 hours a
day, seven days a week designed to align with blockchain's always-on
trading cycle". It will work with Bitcoin and Ethereum with general availability scheduled for 2019.
Hard vs. soft digital currencies
Hard electronic currency does not have the ability to be disputed or
reversed when used. It is nearly impossible to reverse a transaction,
justified or not. It is very similar to cash. Advantages of this system
include it being cheaper to operate, and transactions are instantaneous.
Western Union, KlickEx and Bitcoin are examples of this type of currency.
Soft electronic currencies are the opposite of hard electronic
currencies. Payments can be reversed. Usually, when a payment is
reversed there is a "clearing time." This can take 72 hours or more.
Examples of soft currencies are PayPal and any type of credit card. A hard currency can be "softened" with a third party service.
Criticism
Many existing digital currencies have not yet seen widespread usage,
and may not be easily used or exchanged. Banks generally do not accept
or offer services for them. There are concerns that cryptocurrencies are extremely risky due to their very high volatility and potential for pump and dump schemes.
Regulators in several countries have warned against their use and some
have taken concrete regulatory measures to dissuade users. The non-cryptocurrencies are all centralized. As such, they may be shut down or seized by a government at any time. The more anonymous a currency is, the more attractive it is to criminals, regardless of the intentions of its creators. Bitcoin has also been criticised for its energy inefficient SHA-256-based proof of work.
