What Is Digital Money?

Digital money (or digital currency) refers to any means of payment that exists in a purely electronic form. Digital money is not physically tangible like a dollar bill or a coin. It is accounted for and transferred using computers. One well-known form of digital money is the cryptocurrency Bitcoin.

Digital money can also represent fiat currencies, such as dollars or euros. Digital money is exchanged using technologies such as smartphones, credit cards, and online cryptocurrency exchanges. In some cases, it can be transferred into physical cash, by withdrawing cash from an ATM, for example. 

Key Takeaways

  • Digital money is a currency that exists in a purely digital form. It is not a physically tangible asset like cash or other commodities like gold or oil.
  • Most of the digital money owned in the world is owned by banking institutions. In addition, online payment providers like Alipay, WeChat Pay, and M-Pesa can be considered digital money.
  • Banks have been able to keep their cost of business lower thanks to digital money because they do not need to pay rent on as many physical locations or keep paying for retail employees they don't need.
  • Cryptocurrencies are a special kind of digital money, which is controlled by cryptographic algorithms. Because it is decentralized, cryptocurrency comes with its own set of advantages and disadvantages.
  • Both cryptocurrencies and centrally controlled digital money are popular targets for online theft and scams.

Understanding Digital Money

The concept of digital money has existed since the earliest age of the Internet. Several digital cash companies were founded in the early 1990s, the earliest and best known of these being DigiCash. However, most of these early initiatives failed or declared bankruptcy quickly because ecommerce had hardly integrated into the Internet and there were few retailers that would accept them. The advent of PayPal brought forth the idea of easy-to-make digital financial transactions. 

Financial services companies facilitate digital money transfers and foster online transactions between complete strangers across long distances. Without digital money, many online retail websites would operate far less efficiently. Digital money also makes it possible to bank online or via smartphone, eliminating the need to use cash or to visit a bank in person.

Banks have felt the effect of the accessibility of digital money, and in response, closed branches and fired many retail employees. This can be seen as a double-edged sword. Because the retail employees are no longer needed, the bank can lower their cost structures because their overhead will be much lower. However, banks are then unable to upsell retail customers who come into their locations with items like car loans, financial planning services, and other in-person sales opportunities.

Examples of Digital Money

The most common example of digital money is money issued by banking institutions that they hold electronically, either to trade or invest. Banks have liquidity requirements that mean they have to have a certain amount of physical money on-site, but there are no requirements for digital money, so it moves around much more. Most banking institutions have departments that handle sums in the millions and sometimes billions, never seeing any physical cash.

Another example of digital money is cryptocurrency. Crypto is a kind of digital money that exists within a blockchain network, a network that some consider more secure than any other because there is no oversight from financial authorities. Cryptocurrency is mined, traded, or bought, and kept in digital "wallets" until the owner is ready to spend or redeem it. Common examples include Bitcoin, Ethereum, Litecoin, and Ripple.

Digital Money vs. Cryptocurrency

Cryptocurrency, or virtual currency, is an unregulated digital currency that is secured by cryptography, typically on a blockchain or similar distributed ledger. Cryptocurrencies are usually decentralized, meaning that no single entity has control over transactions or account balances.

Cryptocurrencies are distinct from central bank digital currencies or corporate payments systems such as M-Pesa, Alipay, or Venmo. Unlike cryptocurrencies, they are controlled by a single body, which has the ability to freeze and reverse transactions.

Warning

Unlike centrally issued digital money, cryptocurrencies cannot be recovered if lost or stolen. Follow all recommended security protocols when storing virtual currency.

Advantages and Disadvantages of Digital Money

One major advantage of digital money is the ease of payment, allowing users to make payments online or through social media applications as easily as using cash. There are also security advantages because it is easier to steal cash than hack a digital wallet.

Cryptocurrencies have the additional advantage of being censorship-resistant, meaning that it is impossible to seize or censor transactions. Some use encryption to make it difficult to trace transactions. For this reason, many people use cryptocurrency to evade tax regulations or capital controls or to use darknet markets. Some cryptocurrencies have their own specific disadvantages, such as transaction fees and environmental impacts.

However, decentralization is also a major liability because there is no central authority to restore lost or stolen cryptocurrencies. Digital money is commonly used in online frauds or ransomware attacks, such as the Colonial Pipeline hack.

Advantages of Digital Money
  • Facilitates fast, long-distance transactions without compromising credit card or bank account information.

  • Reduces the cost of cash accounting and storage.

  • In the case of cryptocurrencies, digital money allows cross-border transactions that cannot be taxed, frozen, or censored.

Disadvantages of Digital Money
  • May incur extra costs, such as Paypal fees or Bitcoin transaction fees.

  • Digital money is a common target for hacks and scams.

  • Because there is no central authority, cryptocurrencies cannot be recovered if lost or stolen.

Digital Currency FAQs

Where can you buy digital currency?

Digital currencies can be bought online, through a digital currency exchange, or offline at a digital currency ATM. Some wallet services, such as Coinbase, also allow digital currency purchases. Centralized digital currencies, such as M-Pesa, may also be purchased from the issuer or from qualified retailers.

Which is the most popular digital currency?

Although Bitcoin is the most well-known virtual currency, Tether is the most widely used cryptocurrency in terms of transaction volume, moving $73.8 billion every day, according to CoinMarketCap. Outside of cryptocurrencies, Alipay is leading the field with $17 trillion in annual payments volume in mainland China alone.

How can you invest in digital currency?

The simplest way to invest in digital currency is to buy cryptocurrency on an exchange (after thorough research) and move it to your digital wallet. Much like investing in securities, day trading is an easy way to lose money, so long-term holding may be the most reliable strategy for novice investors. Unlike the stock market, it's very easy for cryptocurrencies to be lost or stolen, so it's important to thoroughly study the security protocols to keep your digital currencies safe.

What is digital currency mining?

Mining is a cryptographic process used to limit the issuance of cryptocurrencies such as Bitcoin and Ethereum. In order to incentivize participation, users who execute transactions can receive a reward of new cryptocurrency tokens.

How can you create your own digital currency?

Most blockchain protocols are open source, meaning that anyone can create their own version by changing a few variables. In addition, token standards such as Ethereum's ERC-20 allow anyone to create their own digital tokens on an existing blockchain with little effort.

The Bottom Line

Digital money is a major innovation in financial technology, allowing people to send and spend money online, across borders, or even through social media applications. Unlike credit card transactions, there is no danger of compromising your account information, but you can still fall victim to hacks or scams. Cryptocurrencies such as Bitcoin require complex security protocols in order to be safely stored.