Electronic money, or e-money, is cash in electronic form. The monetary value is stored electronically and linked to a national currency. Electronic banking systems facilitate transactions with electronic money and allow easy, constant access to money.
Electronic money is more than just a convenient way to transact—has a tremendous impact on economies around the world.
At its core, electronic money is simply the electronic alternative to cash. It is the monetary value of cash stored electronically and backed by fiat money. It’s accepted as payment by parties other than the issuer.
If you paid for your morning coffee with a debit card, electronic money was transferred from your account to the merchant’s account. If you paid with a credit card, funds were transferred from the credit issuer to the merchant. When you get paid via direct deposit, you receive funds via an EFT.
How does Electronic Money work?
Electronic money can be held on cards, devices, or a server. E-money is not a separate currency and is overseen by the same central authority in charge of fiat currency. It is widely used in developed economies and is increasingly being adopted in developing economies.
A good way to understand how e-money works is to put it in the context of an electronic funds transfer (EFT). An EFT is a broad term for a payment processed electronically where e-money is digitally transferred from one account to another. The electronic funds transferred are backed by money in your account. You can make an EFT between two banks via an automated clearing house (ACH) network.
EFTs are a critical part of everyday banking and the vehicle through which government programs such as Social Security, Supplemental Security Income, and the Department of Veterans Affairs disburse money to individuals.
In a wider sense, electronic money can be used to empower citizens who do not have access to safe, secure, and affordable financial services. One way to do this is to pair e-money with mobile devices. The Groupe Speciale Mobile Association (GSMA) Mobile Money Program aims to accelerate the mobile e-money ecosystem to underserved populations—particularly the 2 billion unbanked people across the globe.1 In the program, mobile money users don’t need a bank account and can use peer-to-peer transactions as a substitute for cash.
Classifications of Electronic Money
Electronic money can be classified into two broad categories:
– Hard: hard electronic money is when e-money is used for irreversible transactions, ones that are highly securitized, and are more or less procedural in nature. They may include transactions that are drawn through a bank.
– Soft: soft electronic money is when e-money is used for reversible or flexible transactions. There is an increased level of flexibility offered, and users are allowed to manage their transactions even after payment is processed, like canceling a transaction or modifying the payment price, etc.
The changes can be made post-transaction within a defined period. They may include transactions that are passed through payment mechanisms like PayPal, PayTM, Interac, credit cards, and so on.
Features of Electronic Money
Just like physical paper currency, electronic money also includes the following four features:
Store of value: Just like physical currency, electronic money is also a store of value, the only difference being, that with electronic money, the value is stored electronically unless and until withdrawn physically.
Medium of exchange: Electronic money is a medium of exchange, i.e., it is used to pay for the purchase of a good or when acquiring a service.
Unit of account: Just like paper currency, electronic money provides a common measure of the value of the goods and/or services being transacted.
Standard of deferred payment: Electronic money is used as a means of deferred payment, i.e., used for the tools of providing credit for repayment at a future date.
Advantages of Electronic Money
Electronic money offers several advantages for the global economy, including:
Increased flexibility and convenience: The use of electronic money brings increased flexibility and convenience to the table. Transactions can be entered into from anywhere in the world, at any given time, with one click of a button. It removes the hassle and tediousness involved with the physical delivery of payments.
Historical record: The usage of electronic money is becoming increasingly popular because it stores a digital historical record of each and every transaction made. It makes tracing back payments easier and also helps with making detailed expenditure reports, budgeting, and so on.
Prevents fraudulent activities: Since electronic money makes available a detailed historical record of each and every transaction made, it is very easy to keep track of transactions and trace them back through the economy. It increases security and helps prevent fraudulent activities and malpractices.
Instantaneous: The use of electronic money brings with it a kind of instantaneousness that has not been experienced before in the economy. Transactions can be completed in split seconds with the click of a button from virtually anywhere in the world. It eliminates problems of physical delivery of payments, including long queues, wait times, etc.
Increased security: The use of e-money also brings with it an increased sense of security. To prevent loss of personal information while transacting online, advanced security measures are implemented like authentication and tokenization. Stringent verification measures are also employed to ensure the full authenticity of the transaction.
In a way, electronic money has been around for more than 100 years. In 1871, Western Union developed the business behind EFTs. Money could be wired over the telegraph from one place to another without the physical exchange of cash.
For a fee, a person in one location would deposit money with Western Union and the receiver could pick the money up in another Western Union location.
However, this isn’t the same technology used in electronic money transfers we know today. Another advancement in technology came in 1972 when the first automated clearinghouse (ACH) association was formed to handle electronic payments.
This technology came hand-in-hand with the magnetic stripe card, which computerized the process of individuals transacting with merchants. This information was transmitted through networks owned by merchants and banks. Consumers didn’t see it until the closing statement of their credit or bank card arrived in the mail.
The internet changed much about the process. Electronic money became more readily available for the individual to see, control, spend, bank, and more. Though money had been processed electronically for decades, the digital transformation brought faster and more efficient e-commerce transactions.
Electronic money vs. Cryptocurrencies
Electronic money is not a cryptocurrency, which has many characteristics that distinguish it. Both are in digital format, but for electronic money the user is clearly identified, while in cryptocurrency he can remain anonymous, up to a certain extent.
E-money is digitally issued against the fiat currency of a central authority, such as the dollar or the euro. Cryptocurrency, on the other hand, is created on the basis of a white paper. It is not considered fiat currency, although some coins (stablecoins) may be backed by reserves of fiat currency.
How it works and how it transitions are also different. For electronic money Transactions must be processed through a bank. These also go through a central processing bank called a clearinghouse. In the case of cryptocurrencies, as we know, transactions occur peer-to-peer and must be processed by computers on the network.
Typically, cryptocurrency transactions are verified through a calculation method agreed upon by the entire network and are recorded on a public ledger (the now familiar “blockchain”).
Another difference is that for e-money the supply is almost unlimited and is tied to fiat currency, which can be printed by the issuing authority. For cryptocurrency, on the other hand, the supply is limited in many cases.