A digital currency, (also known as crypto-currency, cyber currency, digital cash, digital currency, digital money, e-currency, e-money, electronic cash, electronic currency, electronic money) refers to money or scrip which is only exchanged electronically.
When money transfers occur as a bank wire transfer or ACH payment, or even transfers of money using services such as PayPal, the funds are sent electronically but the currency transmitted is representative money and what transfers is an underlying fiat currency.
Types of Digital Currencies
Virtual currencies are digital currencies issued electronically. Without the issuing party there is no value to a virtual currency.
Examples are gold in World of Warcraft, Second Life's Linden Dollars, or online gambling sites. All of these sites issue currency, but that currency cannot exist without the issuer.
In contrast to virtual currencies, cryptocurrencies exist independently of an issuing party. Cryptocurrencies are digital tokens that can be directly traded between two parties.
Digital Currencies have been around for about 20 years and most failed because their founders were jailed by the US legal system.
Beginning in the 1990s, entrepreneurs have been providing digital currencies to the market. Previous currencies all used a company to manage settlements between parties and also pegged their digital currency to another asset such as gold or dollars. Bitcoin is different in both those respects.
Bitcoin's creator, Satoshi Nakamoto, invented a way to avoid using a third party to settle transactions between parties. This means no company can ever go out of business and ruin bitcoin. Also there are no physical assets such as US Dollars or gold backing bitcoins. Some critics view this as a downside when actually it eliminates a liability. With no backing store of value there is no store to be confiscated, attacked, or destroyed and bankrupt the whole system.
David Chaum brought the idea of digital cash into the world in his 1982 paper “Blind Signatures for Untraceable Payments.” He was also created the first implementation of an electronic cash system in 1990 through his company DigiCash. Like bitcoin it addressed the insecurity of credit cards and the expense of sending small amounts of money to help internet payments. DigiCash had many promising offers with large companies, but due to management difficulties never achieved its full potential and eventually went bankrupt in 1998.
E-gold was the first successful online digital currency system. Each unit represented an amount of real gold stored in a secure location. E-gold was operated by Gold & Silver Reserve Inc. Users had an account on the website showing their gold balance, which they could use to pay for goods and services over the internet. E-gold was the first micropayment platform allowing transactions as small as one ten- thousandth of a gram of gold. E-gold ran into trouble because cyber criminals launched hacking, malware, and phishing attacks against users. The 2001 USA Patriot act made it a crime to operate an unlicensed money transmitter business in any state that required a license. Eventually E-Gold and its directors were prosecuted under the USA Patriot Act, plead guilty to some of the charges and were unable to continue operating.
In 2006 Arthur Budovsky incorporated Liberty Reserve in Costa Rica. Opening an account only required a name, email address, and birth date. Transactions were irreversible and the digital dollars were tied to the value of the US Dollar or ounces of gold. The service was allegedly popular with criminals and in May 2013 U.S. prosecutors arrested Budovsky and Costa Rican authorities seized the company’s assets. Like the E-Gold case Budovsky was charged under the USA Patriot Act.
Bitcoin was announced in 2008 and launched in January of 2009. Like Chaum’s Ecash bitcoin uses cryptography to send and receive payments. Unlike any of the other forms of digital cash before it bitcoin did not use a centralized clearing company. This makes it immune to having a single point of failure or attack.
Bitcoin is also the first form of digital cash that does not have another asset such as dollars or gold guaranteeing its value. This feature also reduces the liability of using bitcoin. There is no asset for a government to seize or for a criminal to steal. Further bitcoin is modeled after gold with a fixed cap of 21 million units.
- Electronic Money article on Wikipedia