How do I encrypt passwords with PostgreSQL?

digest(data text, type text) returns bytea; is not valid syntax.

I recommend using bcrypt instead. No additional function definitions are required:

INSERT into "login" (login, password, employee_id) 
     VALUES ('email',crypt('password', gen_salt('bf'));

Later...

UPDATE table SET password = crypt('password',gen_salt('bf'))

And checking the password:

SELECT ... FROM table 
    WHERE password is NOT NULL 
      AND password = crypt('password-to-test',password);

Bcrypt is recommended by Crafted Software and Jeff Atwood. The official pgcrypto docs may also be of interest.

I know this question is old but for those who having the same issue.

Step 1: first check whether prcrypto is installed or not

select e.extname, n.nspname from pg_catalog.pg_extension e left join pg_catalog.pg_namespace n on n.oid = e.extnamespace;

Step 2: If it is not installed then create extension

CREATE EXTENSION IF NOT EXISTS pgcrypto;

Step 3: Computes a binary hash of the given data.

    CREATE OR REPLACE FUNCTION sha1(bytea) returns text AS $$
      SELECT encode(digest($1, 'sha1'), 'hex')
    $$ LANGUAGE SQL STRICT IMMUTABLE;

Last Step:

Also use encode function If you want the digest as a hexadecimal string

SELECT encode(digest('blue', 'sha1'), 'hex');

directly sha('blue')

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