In this article, we'll explain the different types of cryptocurrency, including examples and how each type is used.
By the end of this article, you should have a better understanding of the four main types of cryptocurrency.
There are four main types of cryptocurrencies: payment cryptocurrencies, utility tokens, central bank digital currencies, and stablecoins.
Below, we'll go through each in more detail.
A payment cryptocurrency serves as a means of payment as well as a peer-to-peer electronic cash to facilitate transactions, as the name suggests.
Generally speaking, this form of cryptocurrency has a specialized blockchain that exclusively supports that purpose because it is intended to be a general-purpose currency.
This means that these blockchains cannot support the operation of smart contracts or decentralized applications (Dapps).
Additionally, these payment cryptocurrencies frequently include a cap on the total quantity of digital coins that may ever be produced, which naturally deflates them.
The value of the digital currency is anticipated to increase as the amount of these digital currencies that can be mined decreases.
Cryptocurrencies that are used as payment methods include Bitcoin, Litecoin, Monero, Dogecoin, and Bitcoin Cash.
Tokens, like Ether on the Ethereum network, are not subject to caps, which is a significant distinction between them and payment cryptocurrencies.
Because more and more of these tokens are produced, the value of this digital asset should be expected to decline, just like the value of a fiat currency in a nation that is perpetually running its money printing press.
As a result, these cryptocurrencies are inflationary.
A use case, often known as a specific purpose or function on the blockchain, is served by a utility token.
To write something to the Ethereum blockchain, for instance, transaction fees must be paid.
Ether can also be used to create and buy Dapps on the network.
Since central banks are the ones that issue this digital money, they retain complete control and regulation over the CBDC.
For many countries, the adoption of a CBDC into the financial system and monetary policy is still in its early stages; however, it might spread over time.
Many central banks throughout the world are currently developing their use of CBDCs, but many of them are built on the same ideas and technologies as cryptocurrencies like Bitcoin.
The currency is similar to other well-known cryptocurrencies in that it is issued in token form or with electronic records to show ownership.
The advantages of decentralization, pseudonymity, and absence of censorship are forfeited by CBDC holders, however, as these cryptocurrencies are effectively controlled, monitored, and regulated by the government that issues them.
The "paper trail" of transactions that CBDCs keep for the government allows it to levy taxes and other forms of economic rent.
On the plus side, it can be fairly anticipated that CBDCs will hold their value over time or, at the very least, mirror the pegged physical currency in a stable political and inflationary context.
To ensure the value of the cryptocurrency, the business that oversees the peg is obliged to have reserves.
Investors may utilize stablecoins as a means of savings or as a medium of exchange that enables regular value transfers free from price fluctuations are drawn in by this stability.
The most well-known stablecoin is Tether's USDT, which ranks behind Bitcoin and Ether as the third-largest cryptocurrency by market capitalization.
Since the USDT is linked to the US dollar, its value should remain constant at one USD.
This is accomplished by backing each USDT with reserve assets in the form of cash or cash equivalents equal to one USD.
Holders can exchange their fiat currency for USDT or directly redeem their USDT with Tether Limited for $1, less any fees Tether levies.
Tether also makes money by lending money to businesses.
However, there is no control or regulation of stablecoins by the government.
Another well-known stablecoin, TerraUSD, and its twin coin, Luna, both fell apart in May 2022. Only 11 cents remained of TerraUSD's $1 value.
The issue with TerraUSD was that it was backed by its own currency, Luna, as opposed to investing reserves in cash or other safe assets.
Luna's value dropped from over $80 to a tiny fraction of a cent during its meltdown in May.
TerraUSD's peg to the dollar was broken as holders of stablecoins rushed to redeem them.
Once again, the lesson is to exercise caution before purchasing any stablecoins by reading the whitepaper and becoming familiar with how the stablecoin manages its reserves.