Virtual currency

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A virtual currency or virtual money has been defined in 2012 by the European Central Bank as "a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community". The US Department of Treasury in 2013 defined it more tersely as "a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency". The key attribute a virtual currency does not have according to these definitions, is the status as legal tender. Virtual currency that substitutes legal tender has been known as a scrip.

Definitions[edit]

In 2012, the European Central Bank defined it as "a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community".[1]:13

In 2013, the Financial Crimes Enforcement Network, a bureau of the US Treasury, defined it as "a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency".[2]

In 2014, the European Banking Authority defined it as "a digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically".[3]

History of the term[edit]

In his written testimony to the 2013 congressional hearing on virtual currencies Ben Bernanke stated "virtual currencies have been viewed as a form of “electronic money” or area of payment system technology that has been evolving over the past 20 years", in reference to a congressional hearing on the Future of Money before the Committee on Banking and Financial Services on 11 October 1995.[4] The Internet currency Flooz was created in 1999.[5] The term 'virtual currency' appears to have been coined around 2009, paralleling the development of digital currencies and social gaming.[6]

Although media have used the term 'digital currency', US government institutions have preferred and uniformly adopted the term 'virtual currency', first the US Treasury's FinCEN, then the FBI in 2012,[7] the General Accounting Office in its 2013 report[8] and other government agencies testifying at the November 2013 Senate Hearing about Bitcoin like the Department of Homeland Security, the U.S. Securities and Exchange Commission, the Office of the Attorney General.[9]

Limits on being currency[edit]

Attributes of a real currency, as defined in 2011 in the Code of Federal Regulations, such as real paper money and real coins are simply that they act as legal tender and circulate "customarily".[10]

The IRS decided in March 2014, to treat Bitcoin and other virtual currencies as property for tax purposes, not currency.[11][12] Some have suggested that this makes bitcoins not fungible - that is one bitcoin is not identical to another bitcoin, unlike one gallon of crude oil being identical to another gallon of crude oil - making bitcoin unworkable as a currency.[13] Others have stated that a measure like accounting on average cost basis would restore fungibility to the currency.[13]

Categorization by currency flow[edit]

Closed virtual currencies[edit]

Virtual currencies have been called "closed", when they have no connection to the real economy, like currencies "in-online -games-only" such as World of Warcraft (WoW). While there may be a black market for exchanging WoW Gold against real world assets, it is expressedly forbidden by the owner of WoW.

Virtual currencies with currency flow into one direction[edit]

This type of currency has been known for a long time in the form of customer incentive programs or loyalty programs. The first known coupon in history is probably from the US, attributed to Asa Candler, inventor of Coca-Cola and the free drink coupons in 1887, followed by C. W. Post's one-cent-off coupon in breakfast cereal boxes in 1895, both to drive sales. The business issuing the coupon functions as a central authority.[14] Coupons remained unchanged for 100 years until new technology enabling credit cards became more common in the 1980s, and credit card rewards were invented. The latest incarnation drives the increase of internet commerce, online services, development of online communities and games. Here virtual or game currency can be bought, but not exchanged back into real money. The virtual currency is akin to a coupon. Examples are frequent flyer programs by various airlines, Microsoft Points, Nintendo Points, Facebook Credits, Ven (currency)[dubious ] and Amazon Coin.

Convertible virtual currencies[edit]

A virtual currency that can be bought with and sold back for legal tender is called a convertible currency. It can be centralized as Linden Dollars, the online virtual currency of Second Life or decentralized, as for example Bitcoin.

Centralized versus decentralized virtual currencies[edit]

FinCEN defined centralized virtual currencies in 2013 as virtual currencies that have a "centralized repository", similar to a central bank, and a "central administrator".

A decentralized currency was defined by the US Department of Treasury as a "currency (1) that has no central repository and no single administrator, and (2) that persons may obtain by their own computing or manufacturing effort".[2] Rather than relying on confidence in a central authority, it depends instead on a distributed system of trust.[15]

Bitcoin, an example of a decentralized, convertible virtual currency[edit]

Bitcoin is the first truly decentralized global currency system, and at the same time the largest virtual currency as of 2014.[16] Trust in the currency is based on the "transaction ledger which is cryptographically verified, and jointly maintained by the currency’s users". The Bitcoin Foundation claims that Bitcoin was "designed to be fully decentralized with miners operating in all countries, and no individual having control over the network",[17] and that Bitcoin is "as virtual as the credit cards and online banking networks people use everyday".[18]

"Bitcoin mining has become increasingly centralized",[19] and cryptologic researchers have questioned, if Bitcoin is indeed a decentralized currency.[20] To improve Bitcoin's decentralization, they suggest to encourage fully decentralized mining pools, allow only 1 vote per Bitcoin client, and to increase transparency in decision making.[20]

The money matrix[edit]

Digital currency is a particular form of currency that is electronically transferred and stored, i.e., distinct from physical currency, such as coins or banknotes. According to the European Central Bank, virtual currencies are "generally digital", although their enduring precursor, the coupon for example, is physical.[1]

A cryptocurrency is a digital currency using cryptography to secure transactions and to control the creation of new currency units.[21] Since not all virtual currencies use cryptography, not all virtual currencies are cryptocurrencies. Cryptocurrencies are generally not legal tender, with a possible future (As of 2014) exception of a government run cryptocurrency to be created in Ecuador.[22]

The money matrix
adapted from[1]
Money format
Physical Digital
Not based on
cryptography
Cryptocurrency
Legal
status
Unregulated Virtual
Centralized Coupon Internet coupon
Mobile coupon
Local currencies Linden Dollar
Ven (currency)
Other centralized
virtual currencies
Decentralized N/A N/A Bitcoin
Other decentralized
cryptocurrencies
currency
Regulated Banknotes
and coins
E-money
Commercial bank
money (deposits)

Regulation[edit]

Virtual currencies pose challenges for central banks, financial regulators, departments or ministries of finance, as well as fiscal authorities and statistical authorities. Gareth Murphy, Central Bank of Ireland, described the regulatory challenges posed by virtual currencies as relating to:[23]

US Treasury guidance[edit]

On 20 March 2013, the Financial Crimes Enforcement Network issued a guidance to clarify how the US Bank Secrecy Act applied to persons creating, exchanging and transmitting virtual currencies.[2]

Securities and Exchange Commission guidance[edit]

In May 2014 the U.S. Securities and Exchange Commission (SEC) "warned about the hazards of Bitcoin and other virtual currencies".[24]

New York state regulation[edit]

In July 2014, the New York State Department of Financial Services proposed the most comprehensive regulation of virtual currencies to date.[25] Unlike the US federal regulators it has gathered input from Bitcoin supporters and the financial industry through public hearings and a comment period until October 21, 2014 to customize the rules. The proposal would curb anonymity of the consumer,[not in citation given] yet per NY DFS press release “... sought to strike an appropriate balance that helps protect consumers and root out illegal activity".[26] It has been criticized by smaller companies to favor established institutions, and Chinese bitcoin exchanges have complained that the rules are "overly broad in its application outside the United States".[27]

See also[edit]

References[edit]

  1. ^ a b c European Central Bank (October 2012). "1" (PDF). Virtual Currency Schemes. Frankfurt am Main: European Central Bank. p. 5. ISBN 978-92-899-0862-7. Archived from the original on 2012-11-06. 
  2. ^ a b c "FIN-2013-G001: Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies". Financial Crimes Enforcement Network. 18 March 2013. p. 6. Archived from the original on 2013-03-19. 
  3. ^ "EBA Opinion on ‘virtual currencies" (pdf). European Banking Authority. 4 July 2014. p. 46. Retrieved 8 July 2014. 
  4. ^ SUBCOMMITTEE ON DOMESTIC AND INTERNATIONAL MONETARY POLICY. "The Future of Money". Congressional Hearing. Internet Archive. Retrieved 27 May 2014. 
  5. ^ Samuelson, Kristin (13 November 2011). "The ins and outs of Bitcoin. Does the latest digital currency have staying power?". Chicago Tribune. Archived from the original on 2012-01-27. 
  6. ^ Sutter, John D. (19 May 2009). "Virtual currencies power social networks, online games". CNN. 
  7. ^ "Bitcoins Virtual Currency: Unique Features Present Challenges for Deterring Illicit Activity" (PDF). Cyber Intelligence Section and Criminal Intelligence Section. FBI. 24 April 2012. Archived from the original on 2013-03-09. 
  8. ^ US Government Accountability Office (May 2013). "Virtual Economies and currencies: Additional IRS guidance could reduce tax compliance risks". GAO Report GAO-13-516. Report to the Committee on Finance, U.S. Senate. Archived from the original on 2013-06-21. 
  9. ^ Raskind, Max (18 November 2013). "U.S. Agencies to Say Bitcoins Offer Legitimate Benefits". Bloomberg. Archived from the original on 2013-11-19. 
  10. ^ "31 CFR § 1010.100(m)". Code of Federal Regulations. Archived from the original on 2014-03-24. 
  11. ^ "Notice 2014-21". Fact sheet. IRS. March 2014. Retrieved 25 April 2014. 
  12. ^ Levitin, Adam (March 26, 2014). "Bitcoin Tax Ruling". Blog. Retrieved 25 April 2014. 
  13. ^ a b "Bitcoin is legally property, says US IRS. Does that kill it as a currency?". The Guardian. 31 March 2014. Retrieved 30 May 2014. "Adam Levitin is a law professor at Georgetown University, and he believes that the ruling means that bitcoin can never be treated as "fungible"" 
  14. ^ Kanner, Bernice (7 September 1992). New York Magazine. Retrieved 19 April 2014. 
  15. ^ "Bitcoin: Bitcoin under pressure". The Economist. 30 November 2013. Archived from the original on 2013-11-30. 
  16. ^ Decker, C.; Wattenhofer, R. (11 September 2013). "Information propagation in the Bitcoin network" (PDF). IEEE Thirteenth International Conference on Peer-to-Peer Computing (P2P). Archived from the original on 2014-03-24. 
  17. ^ "What is Bitcoin mining?". FAQ. Bitcoin Foundation. Archived from the original on 2014-03-15. 
  18. ^ "Is Bitcoin fully virtual and immaterial?". FAQ. Bitcoin Foundation. Archived from the original on 2014-03-15. 
  19. ^ Lee, Timothy (4 July 2013). "Four Reasons Bitcoin Is Worth Studying". Forbes. Retrieved 6 October 2014. 
  20. ^ a b Gervais, A; Karame, G; Capkun, S; Capkun, V (2013). "Is Bitcoin a Decentralized Currency?". 829/2013. International Association for Cryptologic Research. Archived from the original on 2014-01-31. 
  21. ^ Andy Greenberg (20 April 2011). "Crypto Currency". Forbes.com. Retrieved 8 August 2014. 
  22. ^ Jerin Mathew (25 July 2014). "Ecuador to Create Government-Run Digital Currency as It Bans Bitcoin". International Business Times. 
  23. ^ Murphy, Gareth (3 July 2014). "The Regulatory Challenges of Virtual Currencies". Central Bank of Ireland. Retrieved 6 July 2014. 
  24. ^ Bobelian, Michael (9 May 2014). "SEC Warns Investors To Beware Of Bitcoin". Forbes. Retrieved 2 October 2014. 
  25. ^ Bobelian, Michael (25 July 2014). "New York's Financial Regulator, Benjamin Lawsky, Maintains Lead On Bitcoin Regulation". Forbes. Retrieved 3 October 2014. 
  26. ^ "NY DFS RELEASES PROPOSED BITLICENSE REGULATORY FRAMEWORK FOR VIRTUAL CURRENCY FIRMS". New York State Department of Financial Services. 17 July 2014. Retrieved 8 October 2014. 
  27. ^ SydneyEmber (21 August 2014). "More Comments Invited for Proposed Bitcoin Rule". DealBook (NY Times). Retrieved 3 October 2014.