2. Digital currency vs virtual currency vs cryptocurrency: understanding the differences
You'll hear all these three terms applied to Bitcoin, and it can get very confusing. It might seem like they are all the same thing – but they are not. Here's the difference:
1) Digital currency is any kind of currency that exists only in digital (electronic) form. This means it doesn't come in the form of bank notes or coins.
Anyone can issue a digital currency: a central bank, a group of developers, a credit institution, admins of an online game, and so on. So if China launches a digital yuan, it will be a digital currency. Chinese government can make it legal tender and give it equal status with cash RMB. On the other hand, in-game gold coins in the World of Warcraft are also a digital currency. But we'll probably never see the gold of Azeroth accepted in real-world markets.
Clearly, Bitcoin and all other cryptocurrencies are digital currencies.
2) Virtual currency. This is any currency that is not issued by a central bank or official financial institution. The key feature of virtual currencies is that they are not regulated by the government. Thus, they are not legal tender on the state level. But they are accepted as currencies within a certain community.
Bitcoin was created by a pseudonymous developer and it's not regulated by any state or bank. So it's a virtual currency. But in-game currencies like shards in DOTA 2 are also a virtual currency. It was created by the game's developers and you can buy game objects with it.
Here's an important point: virtual currency doesn't have to be digital. For example, you can design a board game where you print little fake dollars on colored paper and use them as money in the game. They will be physical (made of paper), not digital. But it will still be a virtual currency.
One the other hand, you can have a currency that is digital but not virtual. If a government issues its own cryptocurrency (say, a digital Chinese yuan) and makes it legal tender, it will be regulated and accepted as legal tender. It won't be virtual.
3) Cryptocurrency. A cryptocurrency is a type of digital currency that is secured using cryptography. Cryptographic protection helps prevent fraud – for example, users can't create new Bitcoins willy-nilly or spend the same Bitcoin twice. This is important when you don't have a central bank that monitors transactions.