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Virtual Currencies: Explaining Both Sides of the Coin

In this digital age, virtual currencies continue to attract more and more attention, particularly the most recognised, the Bitcoin. But what exactly are virtual currencies and how do they work?

Whilst different virtual currencies have various characteristics, the general acceptance is that they are “digital representations of value”. In other words they exist purely within our computer systems. They are not issued or guaranteed by any government, nor are they administered by any central bank and they are not legal tender in any country.

Virtual currencies can be used in many of the same ways as tangible money, acting as a “medium of exchange” to buy goods or services, or to exchange into conventional currencies. Despite their name however, they are not regarded as currencies or money in a standard legal sense. Put simply, virtual currencies are only valuable to those who agree to treat them as such. But in this way, they may not be so different from assets such as gold or silver, which in reality, are merely attractive metals that people perceive as of being of value.

The most well-known virtual currency is Bitcoin. Bitcoins come into existence by a process known as “mining”. Some specialist computer users run advanced software, in order to solve complex mathematical questions. Therefore, the issue of bitcoins is rather like getting a gold star for doing difficult sums. Once mined, they can be exchanged and used by others. An infrastructure of service providers has thus formed, including bitcoin exchanges, suppliers of digital bitcoin wallets and even ATMs.

There is a single ledger, the “blockchain”, recording the issue of bitcoins and all transactions. Access to this virtual currency, depends on two cryptographic keys, one public and one private. The supply of bitcoins is intended to be finite and only 21 million of them should ever be mined.

What is their official status?

Virtual currencies still have an uncertain status, in many parts of the world. In the UK, it is unlikely that most will be regarded as money or currency, though this can depend on exactly how they are constituted. Therefore, transactions using bitcoins will not be regulated in the same way as currency payments and electronic money services.

There are some grey areas however. Transactions may be regarded as “property” so bitcoin funds or derivatives transactions based on bitcoins may well be regulated under UK law. Other virtual currencies have different structures, so legal treatment can vary. The position remains unclear however and those setting up virtual currency businesses should always consider getting specific advice on their plans.

Both the Treasury and the FCA are currently looking at virtual currencies with a view to extending or clarifying the rules. These are part of a positive agenda intended to encourage innovation and choice, so is likely to be welcomed by participants. Other countries are also following suit and some (notably Germany) already give a significant degree of recognition to virtual currencies.

The pros and cons

Bitcoin has high profile fans including Richard Branson and Al Gore who have publicly sung its praises. Generally, its supporters point to features such as transaction speed – which can be minutes rather than days, in some cases. The low cost of transactions is also a talking point as they could become a particular advantage for micropayments, for which conventional money transfer might be too expensive.

The European Banking Association (EBA), on the other hand, has issued warnings to consumers as well as an official opinion on virtual currencies. Their view highlights no less than 70 risks including:

The Financial Action Task Force (“FATF”) also recently made some similar, points regarding use of virtual currencies and money laundering.

Both effectively argue for consideration of further and clearer regulation – but this is something which many participants would also welcome.

But spare a thought for Mr James Howells of Newport…

Mr Howells’ computer held a number of bitcoins. After spilling a drink on it, he threw everything bar the hard drive away, which subsequently sat in a desk for quite some time before also being binned.

He then learnt that the bitcoins had increased in value to £7.5m. Despairingly, he went to his local landfill site only to be told that the hard drive was now buried under several feet of rubbish and there was no realistic chance of retrieving it!


This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.

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