Financial technologists worldwide have been trying to define and differentiate among cryptocurrency, digital currency and virtual currency. A consensus seems to have emerged among various stakeholders that a currency, which can’t be produced in a physical form, is a virtual currency like Bitcoin etc. Since the virtual currency can only be stored and transferred electronically, it also becomes a kind of digital currency.
On the other hand, all real or physical currencies that can exist in digital form become digital currencies. Some experts call them real digital currencies. So, all virtual currencies are digital. However, the converse is incorrect.
One can transfer dollar or any other currency for that matter from his account to someone else’s through the internet, debit card, mobile phone, etc. which is in digital form and the same can be done in the physical form too. So the two types of currencies can be broadly divided into virtual digital currency and real digital currency. While the former is virtual, however, digital and the latter is real but digital.
Another differentiator between digital and virtual is that digital currencies are based on two digits 1’s and 0’s. However, virtual currencies are created through cryptographic algorithms, and that’s why they are also known as Cryptocurrencies.
The emergence of digital currencies
The existence of the real digital currencies in various forms can be traced much before the invention of virtual currencies. E-gold in 1996, online payment service in 1998 and Liberty Reserve in 2006 are some instances of digital holding, transfer and trading of physical currencies in electronic or digital form. The US government due to rising instances of money laundering discontinued the E-gold and Liberty Reserve. Electronic transfer of currencies was also misused when wealthy and unscrupulous people started parking money to places where they didn’t have to pay any tax on their earnings. Some experts believe that the beginning of real digital money can be traced back to 80s when some cryptographer had started experimenting with the idea.
As far as virtual currencies are concerned, they too came into existence a long ago, but besides the fact that they were entirely different from today’s Cryptocurrencies, they were used only for online entertainment and fun. They didn’t have any real value. Points earned while winning a game and redeemed against playing another game are the simplest instance of the early stage of virtual money.
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Bitcoin is known to be the first Cryptocurrency, which was created in 2009 by a pseudonymous developer called Satoshi Nakamoto. It uses SHA-256, which is a kind of cryptographic hash functions. A cryptographic hash is a data file or a signature representing a text. It’s a kind of one-way code or encryption, which cannot be decoded or decrypted back. SHA-256 algorithm creates an almost unique, fixed size 256 bit (32 byte) hash.
After Bitcoin, hundreds of Cryptocurrencies have emerged in the virtual financial world, often referred to as Altcoins, but, out of all, the most popular ones are Bitcoin, Namecoin, Litecoin, and Peercoin, etc. Experts believe that out of all, only a few will survive in the long run.
Real is centralised while virtual is decentralised
Either central bank or some other monetary authority in any country in the world regulates all physical currencies or their digital version. Depending on the fiscal policy and financial need, governments can increase or decrease the printing of physical currencies or banking ledgers in the case of digital use. These currencies are centrally controlled, and their transactions are recorded in the form of ledgers in banks. Financial institutions act as an intermediary between two or more people who transact money as they maintain a ledger of a transaction.
However, digital virtual currencies are decentralized, and no government has any role to play in their production or regulation. The transfer of virtual currencies happens between two people without the involvement of any third party unlike in the case of physical money or real digital money where third party involvement (banks) is must.
But this doesn’t mean that a virtual currency can have limitless production. The cryptographic algorithms are programmed in such a way that a definite number of virtual currencies can only be created through mathematical calculation. For instance, there is only 21 million Bitcoin that will be created by solving mathematical problems. Interestingly, most Cryptocurrencies have been designed in such a way that their production will decrease with time and after a definite period, it’s production will stop.
While in the case of transfer of physical currency, the banks maintain a ledger, similarly in the event of Bitcoin, a decentralized e-ledger, called Blockchain, is maintained with each participant of a group. Every member of the group who is part of a transacting community gets one copy of the e-ledger, and if any transaction takes place, all copies of the e-ledger are updated simultaneously.
So the ledger is not centralized with one authority, but it’s decentralized. The minors, people who help solve mathematical problems to update the Blockchain, play a crucial role in authenticating each transaction and adding it to the Blockchain.
How the line between digital & virtual currency blurring?
When Bitcoin was invented in 2009, initially it was not used by anyone to buy any real world products. It was used in a close loop system. Its use was limited to buy and sell products of the virtual world only, for instance, gaming, etc.
However, of late, many companies and business houses have started accepting Bitcoin, which blurs the line between real digital currency and the virtual digital currency.
In October 2012, European Central Bank in its report on emerging currencies said that if virtual currencies can be traded P2P and used to buy physical products and services of the real world, then these virtual currencies have a tendency to become digital currencies.
Today, retail giants, globally renowned companies dealing in e-commerce, physical stores, hospitality and real estate, bars and restaurants, and web/tech services have started accepting Bitcoin like any other physical currency in digital form.
Global computing company Microsoft started accepting Bitcoin in December 2014 as a payment option for many of its products. Some of the companies in countries across the world which honor Bitcoin are tech companies firms like Dell; retailing firms like Overstock, Newegg, Showroomprive.com, TigerDirect, Monopirx; airlines companies such as Air Lituanica, online air-ticket firms such as CheapAir.com, BTCTrip, a large jewelry chain in the US REEDS Jewelers, a UK technology exchange and retailer CeX, and a Spanish chain One Shot Hotels just to name few.
Interestingly some of the NGOs – The Sri Lanka Campaign for Peace and Justice, which is based in London and raise issues of justice, human rights and reconciliation in Sri Lanka, and Sean’s Outpost, a shelter for homeless people in Pensacola, Florida – accepts Bitcoin for donation.
Market capitalization of virtual currencies
Bit coins total market capitalization stands at $11.42 billion, and each Bitcoin costs around $700 in the open market. Ethereum and Ripple come second and third regarding market capitalization of $896 million and $291 million respectively. While one Ethereum costs around $10, Ripple trades at $0.008137, according to coinmarketcap.com.
The market cap and price of Bitcoin clearly suggests that it has taken a big lead from other altcoins in acceptance and usage across the globe. The other popular altcoins are Litecoin, Monero, Ethereum Classic, Dash, Augur, NEM to name a few. These virtual currencies are also gaining ground in the digital financial world however none of them is in the position at present to compete for the dominance of Bitcoin.
Since all the virtual currencies prices are extremely volatile in the share market, many people see investing in them as a risk and that’s one major reason why a lot of people stay away to trade in virtual currencies
Barring a few developing countries, which have banned the use of Bitcoin, the use and popularity of the virtual currency, is growing around the world. The majority of the authorities, which regulate money in various countries, have accepted that they can’t turn their eye from the new technology.
These countries might not have regulated the currency, but the majority of them haven’t termed it illegal thus allowing private parties to trade if they want. Even the European Union has recognised it as a currency rather than a commodity. Experts believe that in coming few years, virtual currencies will take the financial system by storm and governments will have to recognise it as a legal tender sooner or later.