Digital currency has become something of a buzzworthy topic in recent months. It’s served as the subject of countless news stories, provided fodder for endless online conversations and set more than one person down the path to a new financial approach.

At the same time, for many people digital currency remains a mystery.

At Central Bank, we’re firm believers that the best way to approach any emerging trend is to go in fully informed. Here, our financial experts cover the digital currency basics every person should know, regardless of whether they plan to dabble in it or not. Read on to learn the basics of this growing trend, how it works and key issues to consider.

Going Back to Basics: What is Digital Currency?
What is digital currency? At its most basic, it’s money that is purely electronic. Unlike traditional funds you can access through online or mobile banking — and then transform into physical currency via bank or ATM withdrawal — digital currency has no physical, tangible component.

Another key difference is the fact that digital currency is based on a “trustless” system. As the American Bankers Association notes, this approach allows people to handle transactions directly, without facilitation or support from a trusted third party such as a bank or credit card company.  

There are three general types of digital currency out there today:

• Cryptocurrency: A form of digital currency that is not backed by a government’s central bank or related agency. Instead, it is distributed and overseen by online users with help of blockchain technology. Bitcoin is a well-known example of cryptocurrency.

• Central Bank Digital Currency (CBDC): Not to be confused with your favorite independent Houston bank, this is the virtual version of fiat money that is backed and issued by the government. As the U.S. Federal Reserve notes, CBDCs are widely available to the public and serve as a liability of a country’s central bank.

• Stablecoin: A type of digital currency whose monetary value is linked to fiat currency — or currency issued by the government. That link to a tangible asset is likely behind stablecoin’s name. It’s all about adding improved price stability.

How Do You Use Digital Currency?
So, you know what it is, but how do you use digital currency? Much of it depends on the type of digital currency in your possession.

• Certain cryptocurrencies feature debit card options which make it possible for you to spend money at stores and restaurants, and even withdraw funds from specific ATMs. While convenient, we understand this can also be a bit confusing. After all, the main idea behind digital currency is that it doesn’t have a tangible element.

• Some retailers and service providers allow you to make online payments using digital currency, either by inputting your cryptocurrency debit card information or going through your digital wallet. It’s important to note, however, that additional fees typically come into play.

• You might also be able to send money directly to an individual through the cryptocurrency app, much like you can through Venmo or PayPal. Such transactions often involve the quick scan of a QR code, then data input to determine exactly how much money to send — and where to send it.

What Are the Pros and Cons of Digital Currencies?
Every financial approach has its positive points, as well as considerations that might be cause for pause. Digital currencies are no exception. Here’s a look at a few points that should come into play for anyone considering digital currencies.

Advantages Digital Currencies Offer

• No Middlemen: As we’ve mentioned above, digital currencies allow people to handle transactions themselves, without going through banks and the like. This can make for quicker, lower-cost money transfers. It also offers options for the “unbanked”, or people who prefer not to maintain accounts with financial institutions.

• Less Clutter: Digital currency’s electronic nature means there’s no physical money to hold onto. In other words, there’s no need to mess with money clips, wallets or vaults to keep funds protected.

• Increased Privacy: Depending on the type of digital currency in use, people can enjoy anonymity when opting for digital currency. This is especially true for cryptocurrency, which can’t be tracked by authorities or governments.

• Easy Electronic Recordkeeping: Because digital currencies are just that, digital, all transaction records are easily available online. At any given time you should be able to determine exactly where your money is with just a couple of clicks.

Disadvantages Associated with Digital Currencies

• Security Considerations: Hackers are always developing new ways to access people’s data and finances, and digital currency's online nature makes it especially susceptible. Unlike an account with a traditional bank, where teams will often research fraud and refund lost finances, with digital currency a loss often means you’re out of luck.

• Limited Use: Although digital currencies are becoming accepted in more places all the time, they still aren’t universal. Not every financial institution facilitates transferring digital currency into traditional accounts, for instance, and many in-person retailers and restaurants don’t accept digital currencies, either. This is a stark difference from cash or traditional debit and credit cards, which are accepted nearly anyplace you go.

• Increased Volatility: As we’ve mentioned, most digital currencies are not tied to a country’s central bank or fiat money. For that reason, values can go up and down quite quickly, leaving a person at risk of losing money, regardless of whether they’ve actually spent anything.

• Unclear Path Forward: Digital currencies are likely here to stay, but as for what they’ll look like down the line? That has yet to be seen. Because digital currency is still in its relative infancy, governments and regulators are still working things out. It’s likely that new laws will come into play in the future that dictate the use and management of such funds.

Digital currency is a whole new frontier, and it will be interesting to see how it shapes financial practices moving forward. If you have questions about any of the above, or if you’re interested in determining how digital currencies might factor into your overall approach, feel free to contact the Central Bank team. Our experts are here to help, and we look forward to hearing from you!