Explainer: digital currency versus cryptocurrency


A group of young people discuss the concept of central bank digital currency. PHOTO | POOL

The Central Bank of Kenya proposes introducing a digital currency in the country in a move that could ease cross-border payments and complement mobile money in the local market.

The proposed Central Bank Digital Currency (CBDC) will be a virtual version of the shilling, exchangeable on a one-to-one basis with physical cash.

The introduction of CBDC has been under debate globally for the last few years, with some countries racing ahead to roll them out, such as Nigeria and The Bahamas.

China, Ghana, South Africa are among those running pilot tests. Beijing, for instance, aims to fully digitise the yuan by this year and replace it in the longer term.

Overall, almost 100 countries are actively evaluating CBDCs, according to the IMF.

Are digital currencies cryptocurrencies?

To many people, they are.

The idea of CBDCs, indeed, came from cryptos. Bitcoin and Ethereum have gained popularity in recent years, raising fears for central banks over losing grip on money supply and payment systems and economic stability.

However, the two are different in use, regulation, volatility, stability and circulation.

In a nutshell, a digital currency is the electronic form of fiat money that a government issues to facilitate trade. In contrast, cryptocurrency is a store of value often secured by encryption.

Here are some of the key distinctions between these forms of digital money.

Centralised versus decentralised

CBDCs - Issued by central banks, hence are legal tender and centralised.

The government has control over the amount of CBDCs in circulation. This ensures no shortage or oversupply of digital currency, likely leading to deflation or inflation.

Cryptos - Generated by users themselves through a process called “mining”.

While accepted in some transactions, lack of backing by central banks means they aren’t legal tender. However, some corporations back them, like Diem, created by Facebook owner Meta. Such backing, often by an asset reserve of the corporation, makes them relatively reliable.

Regulated vs unregulated

The centralisation of digital currencies allows the central bank to address problems or issues arising from transactions. The regulator has the power to freeze, flag or cancel certain transactions that violate financial laws.

Decentralised cryptocurrencies are regulated by their respective communities. Authorities have no control over how and when they are used. 

Stable vs volatile

The central bank maintains the value of CBDC to minimise fluctuations that could upset the market/economy. This is done through a series of fiscal policies, usually in relation to other currencies, to stabilise the economy.

For cryptos such as Bitcoin, Ethereum or Dogecoin, their value is determined by the laws of demand and supply. The more people buy a given cryptocurrency, the higher it is likely to cost.

The absence of a central authority to control stability makes them highly volatile. In addition, experts say that high volatility is also caused by a speculative “immature” market in which the cryptos operate.

Universal acceptability

Digital currencies, the electronic form of physical money, can be operated between different banking systems. Hence, globally acceptable.

For instance, one can exchange a Kenyan CBDC with a different currency, say, the naira.

Cryptocurrencies can only be operated within the same blockchain that created them. This means that a Bitcoin cannot be converted into Ethereum, for example.

At the same time, only select businesses across the world accept payment for goods and services in crypto.

Confidential vs transparent

Since cryptos use a decentralised ledger, details of all transactions are in the public domain. Anyone can access and track payments and transfers from one wallet to another.

For digital currencies, transactions are only available to the sender and the receiver and the host bank. This information is private and can only be made public through a court order.