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How to understand the concept of digital currency, why is it needed, and what is it?

How to understand the concept of digital currency, why is it needed, and what is it?

Today, the financial industry is undergoing the most changes in terms of technological innovation. Blockchain, cryptocurrencies, P2P-transfers, crowdsourcing, micropayments – in our time, a completely different number of new concepts are created and developed as quickly as possible. Even though most financial innovation occurs in the private sector, national banks have decided to keep up and push digital currencies to the forefront ofcustom biometric solutions development.

A digital currency is an electronic form of existing fiat money issued by a central bank that can act as legal tender. Analysis of their characteristics will help better understand the essence of modern digital currency and theirUI UX design architecture.

The electronic form of money

Today's digital currency functions electronically, which means it's mostly made up of zeros and ones. This distinguishes digital currency from banknotes and coins and makes digital currency similar to cashless funds, cryptocurrencies, and electronic money. Digital currency is stored in an electronic wallet on a user's device, such as a smartphone. It will also be possible to pre-load such an electronic wallet to pay with digital currency without an Internet connection. The technological basis of digital currency can be traditional databases or distributed ledger technology (DLT); it is called a blockchain.

Fiat money available

Digital currency is the electronic equivalent of existing currency. The digital currency has appeared along with cash and non-cash forms. At the same time, one unit of digital currency is equivalent to one branch of the same currency in other states. The connection of digital currency with traditional money makes it similar to the so-called stablecoins — cryptocurrencies whose rate is tied to traditional currencies (Tether or Diem). The difference is that only a central bank can create digital currencies.

Digital currencies are issued exclusively by the central bank.

Only a central bank can issue digital currencies. This fundamental property of digital currency distinguishes it from cryptocurrencies. Anyone can own cryptocurrency, while only a central bank can issue digital currencies. Digital currency is fully integrated into the financial industry and payments landscape, and this is required by law when accepting payments for goods, services, or work. The world of finance is changing rapidly, and these changes have accelerated during the pandemic with the development of online commerce and payments. A computer code instead of a banknote or a wallet is becoming commonplace on the Internet. Until recently, cryptocurrencies like Bitcoin – money outside the official system that promised fast, cheap, and secure financial transactions – were new. Cryptocurrencies are now increasingly being used by various people as a primary settlement currency.

Supporters of innovation received something new – state digital currencies. Digital bank money can significantly revolutionize the financial industry. Opponents of digital currency point to risks associated with the loss of confidentiality of transactions and the spread of energy-intensive blockchain technology. 90% of the world's central banks are considering launching their own cryptocurrency. People are mostly optimistic about the prospects of introducing digital money. Digital currency is promising: legitimate digital money can supplant fictitious private digital money and improve the efficiency and security of the financial system. At the same time, the cryptocurrency market remains confidential; the state regulates financial innovations to protect users from abuse.

Features and key benefits of digital currency

From an end-user perspective, the key benefits of using digital currency are increased reliability and reduced computational complexity. Central banks, issuers, and custodians of digital currencies are always solvent; unlike conventional commercial banks, they never go bankrupt. Therefore, funds in major bank accounts are always more protected than retail ones. By removing intermediaries from payment transactions, digital currencies should be cheaper. This applies to cross-border payments, transfers between cards of different banks, cash withdrawals from ATMs of other banks, etc. Central banks could benefit more from adopting digital currencies. Central banks are the leading proponents of digital currencies for a good reason. Digital currencies are the most practical tools in the monetary policy industry. Digital currency can be issued with just a few clicks, which is much faster than influencing the money supply by buying government bonds. Under such a scenario, the central bank strengthens its role in monetary policy, eliminating the significant influence of various commercial banks.

An essential point of the digital currency industry is the ease of accounting, that is, the complete absence of anonymity. Each denomination of digital currency can have its unique identifier (similar to the serial number on banknotes), and its movement can be tracked. Proponents of digital currencies say that in this way, they will facilitate the fight against corruption and money laundering. Digital currencies can be “programmed” in a certain way. For example, a central bank could issue a digital currency with a specific expiration date to encourage consumers to spend it as soon as possible, stimulating economic growth. There is a real possibility of digital programming currency being used only for certain goods and services. Digital currency will be a completely new ecosystem different from traditional monetary systems. In the new world of digital currencies, commercial banks, payment systems, and other intermediaries play a much smaller role.

The disadvantage of using digital currency

The lack of anonymity is the biggest drawback of digital currencies. The ability to program digital currencies for certain goods/services from sellers/suppliers can also be considered a disadvantage. From the perspective of central banks, the risks associated with the proliferation of digital currencies are that they transfer sluggish public functions to central banks, and capital outflows can reduce the liquidity of commercial banks. Today, the relatively limited advantages of digital currencies do not outweigh the risks of implementation and the enormous costs of creating the proper infrastructure. It is not surprising that most countries are cautiously exploring the possibility of introducing digital currencies. Central banks are still very reluctant to legalize digital currencies. This is primarily due to the unpredictability of the results and the potentially huge costs associated with building this infrastructure. If digital currencies begin to develop actively, banks will have to solve several important issues. These problems include identifying users of digital currencies, establishing specific settlement limits, conducting financial monitoring, and the possibility of keeping bank secrecy, in particular, determining the role of commercial banks, payment systems, and other financial service providers in the ecosystem of digital currencies. Digital currency is a relatively new phenomenon. Regulators are happy to scrutinize the potential of digital currencies and assess the risks associated with their implementation. Digital currencies may not be able to replace traditional cash, and non-cash altogether means shortly, but the growth of this industry is already there.