Virtual Currency & Digital Currency Definition

Defining a new area is not an easy task. It took years before regulators and the industry could agree on defining the different types of crowdfunding, either for the sake of simply communicating or for regulatory purposes. A definition of a new area must be clear enough so that people understand the same thing, but it should also be broad enough to allow the creation of an “area”, able to cover a series of different elements that may differ in some features but still share some common characteristics.

Read more : What is Blockchain ?

The blockchain environment and its applications have given rise to different concepts, difficult to define and categorize. For example, terms like “cryptocurrencies”, “virtual currencies”, or “digital currencies” are used interchangeably as if they are identical terms, though this is not the case.

Something similar holds for “tokens”, which are interchangeably used with
the term “cryptocurrency”, while “tokens” offer a broader range of functions different from “cryptocurrencies”.

Figure 3.1 shows the interrelationship of these terms, as approached by the
International Monetary Fund (IMF). The graph shows that cryptocurrencies
are actually a subcategory of virtual currencies, which in turn are a subcategory of digital currencies. In the paragraphs that follow, an attempt is made to provide the definitions and taxonomy adopted by international organizations so that the features and functions of the elements contained in each category become clearer

Digital Currency Definition

According to the Financial Action Task Force (FATF) “digital currency can
mean a digital representation of either virtual currency (non-fiat) or e-money (fiat)”. This definition contains the term of “e-money”, which is the digital representation of a fiat currency. Since the definition of virtual currency does not include e-money, as will be explained in detail in the next section, digital currencies are, by definition, broader than virtual currencies.

On the other hand, World Bank3 defines digital currencies as “digital representations of value that are denominated in their own unit of account, distinct from e-money, which is simply a digital payment mechanism, representing and denominated in fiat money”, somehow differentiating digital currencies from e-money, although it allows the term digital payment mechanism to represent fiat money.

Last, according to the Bank for International Settlements (BIS), digital currencies are “assets represented in digital form” and there are three key aspects related to them. First, they typically have some monetary characteristics (such as being used as a means of payment), but are not typically issued in or connected to a sovereign currency, are not a liability of any entity and are not backed by any authority.

They have zero intrinsic value and, as a result, they derive value only from
the belief that they might be exchanged for other goods or services, or a certain amount of sovereign currency, at a later point in time.

A second key aspect refers to “the way in which these digital currencies are
transferred, typically via a built-in distributed ledger”. Third, they are issued by

a “variety of third-party institutions, almost exclusively non-banks, which have been active in developing and operating digital currency and distributed ledger mechanisms”. This last definition is much more descriptive than the first two, and there is an effort to provide certain features to the way they are defined.

Virtual currencies Definition

According to the IMF,4 virtual currencies are digital representations of value, issued by private developers and denominated in their own unit of account. Virtual currencies can be obtained, stored, accessed, and transacted electronically, and can be used for a variety of purposes, as long as the transacting parties agree to use them.

Virtual currencies can be either convertible that allow for the exchange of the virtual currency with fiat currency and for payments for goods and services in the real economy or nonconvertible that operate exclusively within a s elf-contained virtual environment.

According to the FATF, virtual currency is

a digital representation of value that can be digitally traded and functions as
(1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of
value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction.5
Since a virtual currency is not issued by any institution that can guarantee its value, its functions are fulfilled only within a virtual community.

Back in 2012, the European Central Bank (ECB) gave the following definition of virtual currencies: “a virtual currency is 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”. Three years later the Bank updated the virtual currency definition as “a digital representation of value, not issued by a central bank, credit institution or e-money institution, which in some circumstances can be used as an alternative to money”, broadening the scope of use of virtual currencies that could now be used also outside the virtual community. A year later, the ECB highlighted8 that they “do not qualify as currencies from a Union perspective [and] given that they are not in fact currencies, it would be more accurate to regard them as a means of exchange, rather

The ECB classifies virtual currencies into the following three categories :

  • Closed virtual currency schemes : These virtual currencies have no link to the real economy and can only be used in online games. Users earn them based on their online performance and the virtual currencies can only be spent within the specific virtual community and cannot be traded outside the virtual community.
  • Virtual currency schemes with unidirectional flow: Fiat currencies can be used to buy virtual currencies in this category, but they cannot be exchanged back to fiat currencies. Users can use this kind of virtual currency to purchase virtual goods or services within the community, and sometimes, if allowed, they can redeem them into real goods offered by the community.
  • Virtual currency schemes with bidirectional flow: These are virtual currencies that can be traded with fiat currency. They allow for the purchase of both virtual and real goods and services and are similar to any other convertible currency with regard to its interoperability with the real world. The definition of this category best fits with the case of cryptocurrencies

According to the European Banking Authority (EBA, 2014),10 a virtual currency is defined as “a digital representation of value that is neither issued by a central bank or public authority […], but is used by natural or legal persons as a means of exchange and can be transferred, stored or traded electronically”.

The EBA also notes that although some features of virtual currencies resemble the characteristics of electronic money, virtual currencies are not identical to electronic money since the latter is the digital form of the existing fiat currency, which virtual currencies are not.

Last, the US Treasury Department (FinCEN, 2013) defines11 the virtual currency as “a medium of exchange that operates like a currency in some environments but does not have all the attributes of real currency. In particular, virtual currency does not have legal tender status in any jurisdiction”.

Almost all definitions agree on two main things: (a) that virtual currencies are a subset of digital currencies, since they are digital representations of value or digital money, and (b) that they have no legal tender status in any jurisdiction, since they are not issued by a central bank, but by private developers. Some institutions go a bit further in providing specific features that virtual currencies have, such as that they can be obtained, stored, accessed, and transacted electronically, or that they function
as a medium of exchange and/or a unit of account and/or a store of value. Last, another common feature is that jurisdictions refer to the interrelation of virtual currencies with the real world, and how this dimension can categorize them into open or closed systems.

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