Digital currencies (theoretically) perform all the functions of fiat money, in that users can pay for goods or services with them.
However, they present a number of potential advantages. These can include faster transaction speeds, lower transaction costs, greater transparency, and the potential for decentralization.
Digital currencies have a history almost as long as the internet. The prototype for digital currencies, DigiCash, was developed in the late 1980s. However, they tended to suffer from an intractable problem known as double spend — and it was impossible to ensure that each unit of a currency could only be spent once during each transaction.
Bitcoin was the first digital currency to solve the problem of double spend, using blockchain technology to create an immutable record of each transaction. It became the first digital currency to operate as a medium of exchange, an accounting unit, and a store of value.
Today, digital currencies are one of the most important developments in finance. The number of cryptocurrencies in the market has exploded, and new protocols are being introduced to solve problems such as the lack of scalability associated with Bitcoin.
One of the most high-profile, and controversial, digital currency projects has been Facebook’s Diem stablecoin — formerly known as Libra. It faced intense scrutiny from regulators, and a concerted pushback at the central bank level has forced Facebook to scale back its plans.
However, central banks are convinced by blockchain technology, and they are also developing their own digital currencies (CBDCs). Unlike most cryptocurrencies, CBDCs would be based on a centralized ledger operated by the central bank in question. This would allow the central bank to exercise control over monetary supply in the same way it does in the conventional economy.
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