A frequently asked question is whether cryptocurrency can be defined as ‘money’. The short answer is that cryptocurrency is not a form of money. To understand why, we can ask whether the characteristics of cryptocurrencies match the key characteristics of money:

• Widely accepted means of payment – can cryptocurrencies be utilized for buying and selling? Typically, money exists in the form of a country's currency and is broadly recognized as a method of payment. Although cryptocurrencies can facilitate purchases and sales, they are not widely embraced as a payment method, and research indicates that only a small percentage of cryptocurrency owners use them consistently for transactions.
• Store of value – can cryptocurrencies sustain their purchasing power (the ability to buy a similar set of goods and services) over time? Significant price volatility in many cryptocurrencies implies that their purchasing power is not preserved over time, which diminishes their role as a reliable store of value.
• Unit of account – are cryptocurrencies a standard means of assessing the value of goods and services? In Australia, the pricing of goods and services is expressed in Australian dollars. While a few businesses might accept cryptocurrencies for payment, they are not typically employed to gauge and compare prices.

So, while cryptocurrencies can be used to make payments, currently their use as a means of payment is limited and they do not display the key characteristics of money.

However, there is one type of digital currency that could be considered money – digital currency issued by a central bank.

A Central Bank Digital Currency (CBDC) can be best described as a digital version of cash. It is issued by the central bank, available to the public, and utilized for transactions between businesses and households. The national currency serves as the unit of account, and it can be exchanged at parity (i.e., one for one) with other monetary forms, including physical cash or electronic deposits held at well-regulated financial institutions.

What distinguishes cryptocurrencies from CBDCs? In other words, what qualifies a CBDC as money? A central bank can guarantee that a digital currency it issues possesses the three essential characteristics of money – meaning a CBDC could act as a widely accepted payment method, a store of value, and a unit of account.

Since it is issued by a central bank, a CBDC would hold legal tender status, ensuring its acceptance as a payment method. Additionally, a CBDC would serve as an equivalent store of value to other monetary forms, as it could be exchanged for an equal amount of physical cash or electronic deposits. Ultimately, the unit of account for a CBDC issued by the Reserve Bank would be the Australian dollar, allowing it to be used for measuring the value of goods and services. These and other significant features are summarized in the table below.

Surveys conducted by the Bank for International Settlements indicate that CBDCs are an active area of research for nearly all central banks. Despite this, only a few central banks have actually issued digital currencies – to date no high income country has issued a CBDC. The Reserve Bank remains cautious about whether issuing a CBDC would be in the public interest. Primarily, this is because many of the benefits of CBDCs have largely already been realised by existing technologies. In a 2021 speech, the Head of Payment’s said:

Some of the technology behind cryptocurrencies brings forth several considerations for public policymakers. Due to the anonymity offered by cryptocurrency systems and their global reach, there are concerns regarding how to restrict the use of digital currencies in criminal activities. Moreover, the current intrigue surrounding cryptocurrencies may have contributed to the speculative nature of these markets, raising issues related to consumer protection. Should cryptocurrencies gain wider acceptance, they could also pose challenges for the banking sector's role and heighten financial stability concerns during a crisis. Additionally, the significant amounts of electricity consumed in cryptocurrency mining raise questions about resource allocation and the environmental impact of these payment systems.

For further details on the risks associated with cryptocurrencies, refer to ASIC’s MoneySmart website.

Conversely, a Central Bank Digital Currency (CBDC) could potentially fulfill various public policy goals, such as maintaining public trust in money and enhancing efficiency, safety, resilience, and innovation within the payment system. The Reserve Bank is actively reviewing the case for a CBDC and collaborating with other central banks on this matter. The Reserve Bank is assessing the pertinent technical aspects, along with the wider policy implications.

Although the Reserve Bank has not yet reached a conclusion regarding the issuance of a CBDC, the Governor mentioned in his 2021 speech ‘Payments: The Future?’ that:

For further details on the Reserve Bank’s research, refer to: Central Bank Digital Currency.

The most recognized cryptocurrency is Bitcoin.

Bitcoin was introduced in 2009, following the release of a report detailing the Bitcoin system under the pseudonym Satoshi Nakamoto. The system was crafted to electronically replicate the characteristics of a cash transaction. It was intended to facilitate peer-to-peer (or person-to-person) transactions, eliminating the necessity to know or trust the other party involved, and to function without a central authority (like a bank).

In contrast to traditional national currencies such as the Australian dollar, which derive part of their value from being designated as legal tender, Bitcoin and other cryptocurrencies lack any legislated or inherent value. Instead, Bitcoin's worth is dictated by what individuals are prepared to pay for it in the marketplace (and theoretically, its value could plummet to zero at any moment).

A notable aspect of the Bitcoin system is that the supply of Bitcoins grows at a predetermined rate and is limited to approximately 21 million (with each bitcoin capable of being divided into 100 million satoshis or 0.00000001 bitcoins). Consequently, the supply of Bitcoins is often likened to that of a limited resource, such as gold.

The Bitcoin system enables transactions to take place directly between individuals without the need for a central authority (like a bank) to authenticate or document the transactions. This contrasts with most traditional payment methods, such as electronic bank transfers, which depend on a central entity to maintain and update transaction records. For instance, commercial banks keep a record of their clients' account balances, deposits, and withdrawals.

Instead, the Bitcoin network utilizes ‘blockchain’ technology to document transactions and the ownership of bitcoins. This technology essentially links groups of transactions (‘blocks’) together over time (forming a ‘chain’). Each time a transaction takes place, it becomes part of a new block that is appended to the chain. Consequently, the blockchain serves as a record (or database) of every bitcoin transaction that has ever taken place, accessible for anyone to view and update on a public network (commonly known as a ‘distributed ledger’). The security of the Bitcoin system is upheld by ‘cryptography’, a technique for verifying and safeguarding data through intricate mathematical algorithms (or codes). This renders the system extremely resistant to corruption.

Bitcoin transactions are validated by other users within the network, and the process of assembling, verifying, and confirming transactions is frequently termed ‘mining’. Specifically, intricate codes must be solved to validate transactions and ensure the system remains uncorrupted. The Bitcoin system escalates the complexity of these codes as additional computing power is employed to resolve them. A new block of transactions is generated approximately every ten minutes. ‘Miners’ are motivated to solve these codes and process transactions because they receive rewards in the form of new bitcoins (currently 6.25 new Bitcoins per block).

The rising competition among miners for new Bitcoins has led to significant increases in the amount of computing power and electricity needed (often utilized for air conditioning to cool computer systems). Although precise calculations are challenging, some estimates indicate that the annual energy consumption of the Bitcoin system is roughly equivalent to that of the country of Thailand.

This explainer aims to enhance your understanding of cryptocurrencies. It should not be interpreted as advice or a recommendation to purchase, trade, or invest in Bitcoin or any other cryptocurrency. Should you choose to trade or utilize cryptocurrencies, be aware that you may be assuming risks for which there is no remedy.