Cryptocurrencies are files, bits with data – such as the popular PDF or MP3 – that seek to fulfill all the functions assigned to traditional money but using the internet as a means of transmission. Before delving into the concept, its economic conception, and its legal categorization, it is useful to distinguish cryptocurrencies from other similar concepts that invite confusion.
Digital money or digital currency is the generic name given to any intangible that is used as a means of digital payment. This should be understood as opposed to the concepts of physical money, metallic, or paper money.
Digital money is the genre that includes all the other categories: electronic money, virtual currencies, and cryptocurrencies. The concept, although too broad to be legally categorized, is of interest to economists because it includes different means of payment that could have an impact on the general price level.
Incipient studies in macroeconomics consider that digital money is a variable that should be considered in monetary theory, especially if it functions as a mechanism for the expansion of bank credit.
Electronic money, also known as e-money, is an electronic means of payment that eventually “obliges in” or gives “the right to” money in current or circulating use and that bears its name. The European Central Bank defines it as “an electronic deposit of monetary value [contained] in a technological device [software or hardware] that can be widely used to make payments to entities other than its issuer. The United States has had legislation regulating electronic transactions and, therefore, electronic money since 1978.
What distinguishes electronic money from other forms of digital money is that it requires a “contractual infrastructure” that assigns responsibilities between the parties and contains mechanisms to convert it into current money, even if these are not used in practice.
The obligations generated by electronic money are analogous to those generated by transactions of documents representing money.
With Paypal, for example, you can pay in dollars for a sale on the internet. But Paypal relies on credit cards and the contracts that support them and that assign responsibilities between the parties. This operation is not radically different from how a credit note or a check that is drawn against a checking account works.
Virtual currencies are unregulated digital currencies that serve as a means of payment on the internet. It is important not to confuse them with representative commodity mechanisms. The latter would become the “digital layer” of money based on commodities.
Virtual currencies have their own denomination and have no correspondence in the physical world.
They are not traded under the assumption that they are convertible into current money, even though secondary markets regularly allow such conversion. Their usefulness as a means of payment – their main function – is determined by what can be purchased directly with them.
Loyalty programs in-flight miles are a type of virtual currency of growing popularity. Miles and virtual currencies are so similar when used as means of payment that many airlines are exploring transforming their miles into cryptocurrencies. Even today, cryptocurrencies are increasingly used in various online casinos.
Finally, cryptocurrencies are a type of virtual currency with particular characteristics that allow them to have a universal and more widespread application.
What makes them special is that they minimize the potential value problems associated with virtual worlds in which the same scarcity rules as the real world do not operate. They are also special because they work without intermediaries to validate transactions and, additionally, because in the most popular versions they are decentralized.
Cryptocurrencies are issued and change hands in a decentralized way using cryptography to maintain fidelity, in addition to registration technologies or accounting books that are maintained and updated by thousands of computers independently to verify that there are no duplicate uses.