What drives competition in digital money?

After World War II, the countries faced a lot of complications due to trade wars, the Great Depression, and uncertainties around the world. During the Bretton Woods conference in July 1944, many major economies wanted to regulate the future intra-country financial flows and currency “competition” through fixed exchange rates pegged to the USD. Therefore, they decided to form the International Monetary Fund designed to bridge payment imbalances. The whole system was based around the USD that was redeemable for gold. However, the infamous Nixon Shock ended the era of fixed exchange rates between the USD and the gold. The main problem was that the United States did not have enough gold to cover the USD surplus. As a result, the United States stepped into severe deflation. This situation was the first trigger to the stability of the US economy. The second shocking moment in US history that ended the domestic gold standard was the Great Depression, which devalued the US dollar in gold terms.

The European economies faced a lot of problems with fiat currencies as well during the XX century. For example, Hungary had one of the worst cases of hyperinflation in history after the Second World War as its economy was devastated by crisis and high reparations. As a result, its inflation peaked at 1.3 × 10^16 percent per month (which means that prices doubled every 15 hours).

Deflation, hyperinflation, and other economic risks question the future of fiat currencies. With the new era of digital technologies, digital money is what everyone is talking about right now. The global economies are looking to create a transparent, secure, and faster way to exchange money. The new digital forms of finance keep spreading across the globe, making governments worry and providing an attractive opportunity to investors. So, what is likely to stay with us for an extended period, and what will turn into dust soon?

What is digital money?

At first, let's find out what digital money is. Digital currency or electronic money refers to any money that is managed, stored, or exchanged on digital systems or the Internet. There are three main types of digital currencies: cryptocurrency, virtual currency, and central bank digital currency. It would be best to remember that all virtual currencies and cryptocurrencies are digital currencies, but not all digital currencies can belong to this category.

Cryptocurrencies as a new form of money

Cryptocurrency is one of the most famous types of digital money built on cryptography mechanisms to connect digital signatures of asset transactions, peer-to-peer networking, and decentralization. In blockchain systems, either proof-of-work or proof-of-stake schemes are used to create and manage the currency. The main factor that unites cryptocurrencies is decentralization.

An invention of Bitcoin by Satoshi Nakamoto has genuinely changed the perception of money. It has three key parameters.

First, it's private as an official state authority does not issue it.
It’s decentralized. The units are issued to a decentralized group of users.
It has anti-counterfeiting solid guarantees that are conducted through a mix of cryptography and game theory.

Like other forms of money, Bitcoin acts as a medium of exchange and a unit of account. As for the store of value, which is another money function, is a somewhat questionable topic. On the one hand, bitcoin has been one of, if not the best, performing financial assets during large parts of the last decade. However, on the other hand, the upwards rise of bitcoin's price over time was accompanied by significant volatility and downturns in price, some that lasted for years.

Apart from Bitcoin, there are thousands of cryptocurrencies with a total market capitalization of more than $2.56T. They all share the same values: they are not regulated or backed by a central authority (bank), are created using a distributed ledger, and are encrypted with specialized computer code (cryptography).

Even though cryptocurrencies share the same features, they are not precisely the same. In general, all types of crypto can be divided into two major categories: coins that include Bitcoin, Ethereum, Litecoin, and tokens (Tron, Vechain, Link). While coins act as the native assets of blockchain, tokens are created on the existing blockchain with the help of smart contracts.

Central banks go digital

The breakthrough of blockchain technologies and the rapid growth of cryptocurrencies pushed central banks into action. Now, the governments are trying to regulate the crypto market and are also taking part in the development of digital currencies.

Central bank digital currency is a future solution for central banks to conduct transparent financial operations. According to research, at least 80 percent of central banks around the world are looking to create a new form of money. The reasons for that are simple: it may simplify the monetary policy decisions, eliminate third-party risks, and prevent illegal activities. However, the drawback of such innovation is obvious: it doesn't solve the problem of centralization. Ironically, the first central bank to push central bank digital currencies (CBDC) into action was the People's Bank of China, which rolled out a virtual version of the Chinese yuan in several provinces. While the regulator did it for domestic purposes, the case made other countries worry, especially the United States. The US authorities believed the digital yuan was a threat to the global economy that challenged the power of the US dollar and affected US sanctions leverage. However, for now, the Chinese yuan is still far from challenging US foreign-policy interests.

For other central banks, for example, the Bank of England, or the European Central Bank, the development of their CBDCs looks more like a project rather than a reality for now. But, for sure, if they finally implement the widespread usage of digital currencies, it will change global finance.

Challenges in the world of digital money

As you can notice in the paragraphs above, the financial systems in different countries are entering a new era, where the prior role in money exchange belongs to the digital forms of money. On the one hand, we have money issued by central banks. They are centralized; they store information in databases, which the governments can regulate. But, on the other hand, there are decentralized networks with different cryptocurrencies in their systems. They are fast, protected from regulation by cryptographic mechanisms, and they carry a unique private key that makes you the owner of this currency.

Given that governments are only working on the way to accept cryptocurrencies, the rapidly changing environment and imperfections of laws make cryptos look something like "fun and games" to regular people rather than a serious investment. However, everything is set to change. The more people and businesses accept cryptocurrency as a store of value and a medium of exchange, the faster the world will adapt to them. Among good examples of this change, we can mention PayPal, allowing it to store and operate cryptos in its wallet.

You can be among those who can already appreciate the future with FBS, as you can trade cryptocurrencies and withdraw and deposit them in your personal area.

forex exchange

Author: FBS Analyst Team

More by this author

Similar

24.08.2020 06:35 Position trading strategies: retake

Let's review what we know about position trading from a broader perspective. How effective is this strategy and how does it compare to others?

03.06.2020 12:25 Trader Vic's false breakout method

Can we earn on false level breakouts? Yes we can, and Victor Sperandeo will teach us how. Check the article to replenish your arsenal with this outstanding technique.