(This is part 2 of an article on crypto-currencies at Red Planet Dust. See for Part 1)

Many call Bitcoin “digital money” but not all types of digital money are also behaving as a currency, or at closer inspection are not even money: Facebook coins are no currency like bitcoins but are digital tokens all the same. But Euro, US Dollar and probably all other legal tender currencies are held in a digital manner too; just look at your bank account. To be clear, that should not be considered digital money. Actually there is no real money on your bank account: it is an administration of the credits/debits you owe in relation to your bank. You trust your bank to hand you the money when asked, and that it has sufficient real money to do so even if many people will show up at the banks (virtual) counter at the same time. With an average capitalisation rate in the single digit realm it is clear that this is a based on faith.

The term “digital money” is not defined well enough if we want to discuss the developments on initiatives like bitcoin or Ripple c.s. As I have advocated before we need to get our definitions right!

What is (virtual) currency?

The US Department of the Treasury Financial Crimes Enforcement Network (FINCEN) released a paper (FIN-2013-G001) recently on the application of its Regulations to Persons Administering, Exchanging, or Using Virtual Currencies clarifying their position on virtual currencies. This paper gives a clear definition and hence demarcation of the various types of currency. It is also the first guideline on how virtual currencies are legally seen (in the US) and therefore a milestone in their development.

Currency is the coin and paper money of any given country that

[1] is designated as legal tender and that [2] circulates and [3] is customarily used and accepted as a medium of exchange in the country of issuance. In contrast to real currency:

“virtual” currency is a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction.”

The FINCEN breaks digital currencies down into three forms:

  • 1) e-currencies (and e-precious metals) are essentially certificates for what FINCEN calls “real” currencies – that is, currencies that are, somewhere in the world, legal tender.
  • 2) digital currencies that have a “centralized repository”
  • 3) decentralized digital currencies like Bitcoin, is one “(1) that has no central repository and no single administrator, and (2) that persons may obtain by their own computing or manufacturing effort”.

If you insist on using a physical world analogy…\

The use of the word “coins” does reference the peer-to-peer and anonym aspect of physical coins. But I think this invokes the wrong analogy: coins are not numbered, paper banknotes are uniquely numbered, bitcoins ARE numbers and represent the ultimate “tokanisation” of money.

If you persist in having a analogy from the physical world (always dangerous to use analogies!) then bitcoins are more like paper banknotes then coins, but then without the limitations of paper. An oxymoron seemingly, but it is still the easiest way to describe digital currency ala Bitcoin which is not physically attached to a “carrier” like paper or mag-stripes or chips on plastic cards or secure elements on a digital device but bound to the electronic realm.

The benefits of the digital equivalent of the banknote are that you can tear them to pieces to precisely fit the amount payable and no need for other proofs of authenticity and security to prevent counterfeiting.

What is crypto-currency?

Every bitcoin consist of 64 digits that have been established via a complicated cryptographic process to create a unique number. The number is the money but only transferable when part of a complicated a replicated string distributed to other bitcoin users. You can print it on a paper, create QR codes to facilitate the usability of it but you can only transfer it via the electronic realm.

It is thus possible, just by passing on this number to someone’s bitcoin wallet; annex bitcoin, to exchange “value” directly and anonymously between parties e.g. mobile to mobile, without the intervention of third parties. The possible implications of digital currencies are enormous.

Virtual currencies are a disruptive concept

We have been using electronic means of payments on a massive scale for decades now. At the core of the electronic payment is the token to authenticate the user (actually the bank card or credit card and more recently the electronic device). Control over the token is control over the payments value chain. With crypto-currency the token is the money itself. The token is at the hart of the payments value chain. So if we change the authentication at the level of the “carrier” (to indirectly authenticate the user) to the currency itself this will invoke a new payments value chain. The 4-corner model was not the most appropriate way to describe the traditional payments value chain but in the realm of virtual currencies this model is like a dead duck in the water.

For more on Bitcoin at Red Planet Dust:
The RPD Bitcoin files