What is the difference between a digital currency and cryptocurrency?

Yes, it does not take long to guess whether cryptocurrencies are digital: after all, the entire premise behind a cryptocurrency is that it sits directly on a digital ledger.

But is a digital currency by default cryptographic? This is where many new observers of cryptocurrencies begin to stumble.

Beyond the semantics, the core differences between a full cryptocurrency and traditional fiat currencies made through digital transactions represent stark differences in end user rights and platform goals: from the unique features of decentralised oversight to compatibility when making payments online, the two alternatives are more polarised than you might expect.

 What makes a digital currency ‘digital’?

In short: a digitised medium does not mean a decentralised currency platform. Fiat currencies, whether transferred in cash or online, are still bound to the traditional regulatory oversight and restrictions imposed on any national currency: interest rates can be tampered, and the profit-driven interests of financial institutions do not always have the best interests of their users in mind.

Ultimately, although the digital mediums of payment gateways and contactless terminals can be enhanced these compromises for fiat currencies, the regulatory framework dictating modern and traditional fiat transactions is exactly the same.

Cryptocurrencies: a key difference in objectives

Founded in 2009 in the aftermath of the financial crisis, the arrival of Bitcoin brought these restrictions of a centralised government-regulated currency to light: Bitcoin now provided a decentralised alternative that lacked these same restrictions.

From the uptake of cryptocurrency seen in Greece to avoid the fluctuations of their standard fiat, to the blockchain enthusiast seeking to ride the tide of increasing crypto value; cryptocurrencies have a completely different objective.

In the short-term, the rapid, albeit volatile, growth of cryptocurrencies means a convenient plan b currency for online purchases. In the long-term however, cryptocurrencies may represent a currency immune from the bureaucracy of centralised financial bodies; almost a ‘way out’ from the centralised corruption and manipulation that led to the financial crash of 2008 in the first place.

By exchanging the combination of manual and digital monitoring of checks and balances used by traditional banks, the consensus algorithms used by cryptocurrencies automate this verification process using a ‘chain’ of blocks that render any single point of failure almost impossible; and without the need for any organisation to supervise it.

Crypto funds: the difference is not in the digital

When we consider the fund-raising scenario: the web and payment technology presented to contributors and token buyers could be mistaken to be the same. Platforms mature, business models advance; but this doesn’t change the key differences in regulatory structure for fiat and crypto-based transactions.

On the one hand, just as regular consumers may be attracted to cryptocurrency for its removal of third party centralisation, this goes further to incentivise entrepreneurs seeking to create a fund to raise capital; but without the traditional hoops and bureaucracy of traditional hedge funds and IPOs.

Welcome to the ICO, or ‘Initial Coin Offering’: unlike an IPO, where entrepreneurs can raise capital in fiat currency for their tech startup following a range of checks and regulations, the cryptocurrency behind ICOs falls outside this regulatory perimeter. In theory, this would seem like the perfect platform for entrepreneurs to ride the unprecedented increase in value of the currency without the bureaucracy of fiat-based funds.

However, this is not without its challenges: just as many investors may rejoice at the lack of checks and approvals needed to start with an investment portfolio, this same enthusiasm could dwindle when it comes to the basic legal underpinning of what defines investing to begin with: the legal right to underlying equity in the firm. This is because an unregulated currency is unable to distinguish between mere ‘utility tokens’ and equity shares.

In theory, this could enable an ICO to deceive users that they are investors, when in fact they are mere token buyers.

Ultimately, this would mean that – in order for the advantages of decentralisation in cryptocurrencies to truly outweigh the short-term hurdles for the consumer – current algorithms and automated measures may need to be updated to replicate this same legal guarantee. 

Conclusion: a remaining dilemma for the investment scenario

Overall, when it comes to the differences between fiat currencies enhanced with a digital interface and cryptocurrencies fully divorced from regulatory bodies through a decentralised blockchain ledger: although transparency and risk of central manipulation may define their unique objectives, these are yet to guarantee these same outcomes when it comes to theoretical investment scenarios.

Ultimately, for the ICO token buyer in the short-term, this means weighing the advantage of a high-growth currency against the lack of legal oversight to grant ownership over your growing equity share.

Bibliography

Diemers, D. (2017). Initial Coin Offerings A strategic perspective on ICOs. PWC.

Reul, F. (2017). A Global View of Token Regulation. Linklaters.

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