What Is a Digital Currency?

By Nicholas Rossolillo – Updated Feb 22, 2025 at 11:09 AM

Key Points

Digital currencies, including cryptocurrencies, reduce transaction times and costs by eliminating intermediaries.
Investing in cryptocurrencies offers high returns but includes risks like hacking and regulatory challenges.
Technological advances may lead to more central banks issuing their own digital currencies, impacting investment landscapes.

As the digital economy continues to expand, the use of digital currency is also increasing rapidly. Digital currency is money in an electronic form exchanged for goods and services without the use of physical money such as paper bills or coins.

Technology is growing and evolving. As a result, digital currency is steadily replacing physical money. Here's what you need to know about the types of digital currencies and the advantages and disadvantages of digital currency.

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Someone holding a smartphone and credit card. — Image source: Getty Images.

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About the Author

Nicholas’ investing experience began when he opened up a retirement account shortly after finishing high school. His work experience in financial services began in 2007 in an internship position with a national brokerage firm in Arizona. While his career path led him into civil engineering and related fields, he stayed personally involved and active in the investment realm. He eventually returned to a career in investments and financial services in 2012, running a branch office for the same national brokerage firm, this time just outside of Spokane, WA. During the Great Recession, he began developing a flexible and global investing approach that could evolve with a tumultuous and ever-changing world. Wanting to offer that approach to investment management to his clients paired with a financial planning and consulting business, he founded Concinnus Financial in 2014. Nicholas grew up in a small town on the Northern California coast just a few minutes from the Oregon border. Growing up in a rainy, quiet little town, he developed a love of music and can play several instruments. He now lives with his wife Kasey and their two Humane Society-rescued dogs. Together they enjoy the outdoors all four seasons of the year, cooking, and craft beer and wine.

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Nicholas Rossolillo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bitcoin and Ethereum. The Motley Fool recommends JD.com. The Motley Fool has a disclosure policy.

Advantages and disadvantages of digital currency

As with all technology, digital currencies solve some of the problems associated with traditional money. There are also concerns and drawbacks.

Pros of digital currencies

Digital currency speeds transaction times. The modern financial infrastructure is made up of a complex web of participants. In some instances, like with a fully decentralized digital ledger system, two parties can transact business directly without any bank or financial institution intermediaries. That avoids payment settlement times that can traditionally take days or even weeks.

Digital currency can reduce costs. With the elimination of some or all intermediaries, transaction fees associated with digital payments can be greatly reduced. This is especially the case with the high costs associated with the cross-border movement of money.

Physical money has security issues. Risk of theft, forgery, and the need for physical storage at a bank can be reduced or eliminated with digital currency.

Some digital currencies (such as cryptocurrencies) aim to decentralize monetary policy and can include people in the distribution of currency previously handled by a central bank's financial institution partners.

Digital currency technology automates accounting and other recordkeeping, saving time and expenses for issuers, merchants, and everyday users.

Cons of digital currencies

Since it is a computing technology, digital currency is not immune to hacking and other cybercrimes. If an economy adopted digital currency, financial stability and national security could become a cybersecurity risk.

Cash is anonymous, but digital transactions can be tracked. While most digital currencies seek to anonymize user identity, transactions leave a trail.

Digital currency reduces traditional transaction costs, but it carries its own unique set of expenses. Cybersecurity costs are one. Many cryptocurrency users, for example, choose to store their digital assets in a crypto wallet, a piece of hardware that can be disconnected from the internet (known as cold storage). Blockchain-based payments also have to pay fees associated with the computing transactions.

Digital currency presents new challenges for regulators and policymakers trying to ensure financial stability.

Future of digital currency

Digital currencies are still in the early days of development. Cryptocurrency values have skyrocketed in recent years as various companies have expressed interest in building new services and products with them, and investors have increasingly viewed cryptos as an investment asset class. Central banks that create and back fiat currency may also alter the landscape if they begin issuing their own digital currencies.

What makes a digital currency

Money in digital form (such as dollars sitting in your bank account) is a type of digital currency, but it isn't the same as cryptocurrency. The reason is that money in digital form can be converted into physical cash (for example, via an ATM) when making a withdrawal. Traditional money in its digital form can be used to facilitate electronic payments by card at physical merchants and online, but there are some differences between it and money built as an actual digital currency.

Money in its current form -- including digital forms of cash on deposit at the bank -- is created and distributed by a central bank Think of the U.S. dollar, which is printed by the U.S. Treasury and distributed by the Federal Reserve. In a centralized process, a system of serial numbers is usually used to make sure each note is unique. Bank partners are used to distribute cash into the economy.

A digital currency such as cryptocurrencies, however, makes use of an electronic ledger system to create a network of computing nodes to process transactions. Cryptography is often used to make user identities and transaction details anonymous. A digital currency can also bypass bank and financial institution intermediaries and be provided directly to users.

The IRS defines digital currency as a "virtual currency" if it "functions as a medium of exchange, a unit of account, and/or a store of value." The IRS defines Bitcoin as a type of "convertible virtual currency" since it can be easily exchanged for U.S. dollars. In this context, virtual currency purchases and sales will trigger taxable events, per the IRS.

What Is a Digital Currency?

Key Points

Investing in Cryptocurrency in 2025

How Is Cryptocurrency Taxed? (2025 IRS Rules)

Is Cryptocurrency a Good Investment?

What Is the Next Cryptocurrency to Explode in 2025?

About the Author

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Advantages and disadvantages of digital currency

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Cons of digital currencies

Future of digital currency

What is a digital currency?

What makes a digital currency

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