What is the difference between Cryptocurrencies, Digital Currencies, and Tokens?

What is the difference between Cryptocurrencies, Digital Currencies, and Tokens?

To fully understand blockchain, knowing and being clear about the basics is essential.

The first module in the course introduces digital assets such as digital currencies, tokens, and cryptocurrencies.

The world of digital assets is becoming increasingly popular. From the basics, we'll explore how these different types work to their benefits and risks that you should be aware of before deciding to invest. 

What are Cryptocurrencies?

Cryptocurrencies are digital or virtual currencies designed to use cryptography to secure transactions.

Even though use cases are few, cryptocurrencies can ease the purchase of real-world goods and services. However, most people invest in cryptocurrencies like other assets such as stocks.

One of crypto’s most unique features is that any central authority does not issue them, and this attribute makes them immune to intermediary interference like - government manipulation.

Some cryptocurrencies include Ethereum, Litecoin, and Bitcoin.

How do Cryptocurrencies Work?

Cryptocurrencies operate on software networks known as decentralized networks. These networks are connected but not under the control of any one individual or organization.

Decentralized networks serve two purposes. First, to process transactions and maintain the database meant to record and store transactions.

Cryptocurrency Benefits

1. Accessibility

Cryptocurrency gives the unbanked easy access to financial services—all without the need for a financial institution.

Using crypto means a user doesn’t go through document verification, only an internet connection. This makes it more accessible for people who cannot access traditional financial services.

2. Fast and Affordable Transactions

Transactions batch in blocks and connect in chronological order in an uninterrupted chain. Hence the name ‘blockchain.’ So, transactions are completed in less time and fees than TradFi because networks jump fewer loops to verify them within minutes.

Some blockchain transactions can be costly due to high network demands. Regardless, median transaction fees usually remain lower than standard bank transfers.

3. Security and Privacy

Transactions are pseudonymous, meaning wallet addresses are not associated with any specific information. So you can transact with cryptocurrency without being identifiable on a blockchain.

Cryptocurrencies Risks

1. Susceptible to Human Error

Users always bear the responsibility for their asset’s safekeeping - so the user has to store their details in an encrypted crypto wallet. Unfortunately, if you lose this key or forget it, you will lose your assets forever!

2. Price Volatility

Price booms and busts have become part and parcel of the cryptocurrency landscape. Unfortunately, this can make predicting their long-term price performance very hard.

3. Regulatory Issues

Cryptocurrencies are unregulated and decentralized, exposing investors to higher risks without legal protection if theft occurs.

What are Digital Currencies?

These are also known as electronic currencies or digital money.

A digital currency is any currency, money, or money-like assets managed, stored, or exchanged on digital computer systems. Digital currencies are recorded on distributed databases, and however, they’re also stored on centralized databases owned by the government or financial institution.

Examples of digital currencies include the central bank digital currency (CBDC) and cryptocurrency.

How do Digital Currencies Work?

Digital currencies, like pure cryptocurrencies, have some similarities.

They are generally not physical and allow instantaneous transactions over the internet.

Digital currencies are also libertarian because they don’t need to be issued by a government.

Digital Currencies Benefits

Digital currencies can impact financial inclusion and economic growth. Here are some benefits.

1. Alternative to Physical Cash

Central bank-issued digital currencies could provide a modern alternative to physical cash.

2. Financial Inclusion

Safe money accounts in the central banks are vital instruments for financial inclusion. This is because they allow residents to access free or low-cost basic bank accounts.

3. Digitized Records

Digital records provide proof, eliminating problems related to theft and conflicting testimonies. Also, following the proverbial money trail makes it much easier to spot criminal activity.

Digital Currencies Risks

Payment fraud is a severe risk attributed to the increasing use of digital money. It includes fraudulent or unauthorized transactions completed by cybercriminals.

What are Tokens?

Tokens are digital assets developed on top of existing blockchain networks. They have applications in dApps and are compatible with cryptocurrencies, but they are a separate digital asset class.

Crypto tokens represent an asset developed for a specific use. And are often created for (ICOs) or (IDOs) to raise money for development.

Tokens allow developers to create cryptocurrencies without building an underlying blockchain, which is complicated. So instead, these assets are usually developed on native blockchain networks like Ethereum.

Ethereum has its native token, Eth, but it still allows other tokens to use their blockchain. Famous examples include Shiba Inu (SHIB) or Uniswap (UNI).

How do Tokens Work?

Crypto tokens are programmable and controllable through software protocols composed of smart contracts. For example, they could symbolize an interest or share in a company or function as tools for committee voting rights.

But are often used to raise funds in a crowd sale, hence why people refer to them as crypto equity.

Token Benefits

Other than the benefit of earning a passive income, tokens also have many other benefits.

1. Financial Markets Value Addition

With the help of tokenized assets, people can trade any asset in the world without any intermediary. This creates a frictionless market and removes many barriers from the system.

2. Funding for Startup Projects

Crypto-tokens have become a popular way for blockchain startups to fund their projects early in the development cycle. They have also made it easier for regular users to invest in and say how the future manifests.

Token Risks

1. Market Inefficiency

Community tokens like Dogecoin or Shiba Inu, for example, have no real-world applications. Still, they’ve rallied to astronomical valuations based on hype and a dedicated community.

Financial analysts can’t place tokens, and neither can users. Deciding amongst a sea of ever-growing token options to pick a winner is non-viable.

2. Rise in DeFi Fraud

Crypto-tokens paved the way for DeFi. Technologies and processes are meant to replace traditional intermediaries with an efficient financial system.

While positive, a rise in DeFi projects facilitated by more crypto tokens has contributed to a worrying surge in fraud.

Lesson Summary

Cryptocurrencies, digital currencies, and tokens are all different financial products. Cryptocurrencies are digital units using cryptography, a technique meant to secure transactions. Digital currencies are similar to coins, people and businesses can exchange them without the need for a traditional bank or financial institution. And lastly, Tokens are digital units that represent a share of a company or organization. They are created to raise money during an ICO or IDO.

Resources

1. DeFi: Risk, Regulation, and the Rise of DeCrime: https://www.elliptic.co/resources/defi-risk-regulation-and-the-rise-of-decrime
2. Blockchain Networks: Token Design and Management Overview: https://nvlpubs.nist.gov/nistpubs/ir/2021/NIST.IR.8301.pdf
3. Tiered CBDC and the financial system: https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2351~c8c18bbd60.en.pdf
4. Digital currency: https://en.wikipedia.org/wiki/Digital_currency
5. ‍Digital currencies and the future of the monetary system: https://www.bis.org/speeches/sp210127.pd