In recent years, virtual currencies like Bitcoin and Ripple have gained popularity and attracted controversy. With greater anonymity and lower transaction fees, as well as ease of use online, virtual currencies can seem like a desireable alternative to more traditional options. Nevertheless, virtual currencies carry some serious risks as well. Virtual currencies are largely unregulated, vulnerable to hacking and associated with crime. If you plan to invest in virtual currency or its derivatives, you should be fully informed of your compliance obligations, as well as the potential risks.
What is Virtual Currency?
When most people think of virtual currency, Bitcoin often is the first term that comes to mind. While Bitcoin could certainly be defined as virtual currency, its extent reaches much farther. The European Central Bank defines virtual currency 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.” This definition was issued in 2012, and since that time, other government entities in Europe and the United States have adopted similar definitions.
Essentially, virtual currency (VC) operates much like legal tender in that it can be used to purchase digital and physical goods, but it is not officially accepted in any jurisdiction. This “money” can be transferred, stored, or traded electronically and usually can be exchanged for real currency. Some VC, like Bitcoin, is widely used across the internet, while other virtual currencies are limited to a very specific online community or even within a single online game.
Digital Vs. Virtual Currency
People often use the terms "digital currency” and “virtual currency” interchangeably, but the reality is that virtual currency is a subset of digital currency. While any currency stored digitally can be called a digital currency, referring to virtual currency in most contexts only is meant to include digital currencies that are not tied on a one-to-one basis with a real currency. In other words, Bitcoin would be considered virtual currency, but PayPal Dollars would not.
Convertible Virtual Currencies
Most virtual currency can be converted into real currency. These convertible virtual currencies have exchange rates that fluctuate over time, just like real currency exchange markets. Some convertible currencies are rather standardized, like Linden Dollars, the online virtual currency used in Second Life, while others, like Bitcoin, fluctuate greatly on a daily basis. In fact, cryptocurrencies (VCs that use to cryptography both to secure transactions and control the creation of new units) such as Bitcoin, Ripple and Dash are particularly subject to wide fluctuations in exchange rates.
Closed Virtual Currencies
Some virtual currencies are not supposed to be possible to exchange for real currency or actually connected to the real economy. Instead, they are intended to function online within their games only. Virtual gold in World of Warcraft, for example is banned from real-world exchange by its creator.
How Is Virtual Currency Regulated?
CFTC and SEC Regulation
While not considered a security in itself, VC can sometimes fall under CFTC and SEC jurisdiction, because speculation on VC as a commodity has started to occur on exchanges. In particular, Exchange Traded Funds are starting to include virtual currency, and derivatives markets are making swaps and options with VC as an underlying asset available. Trading in securities and derivatives based on virtual currency requires the same compliance as trading on securities and derivatives based on any other underlying.
In 2013, the Financial Criminal Enforcement Network (FinCEN) declared that any entity enabling transactions using virtual currencies must register as a Money Services Business (MSB). FinCEN regulates all MSBs and requires strict reporting and record keeping. In addition, all administrators and exchangers of VC are now required to operate within FinCEN regulations, especially those related to preventing illegal activities.
Bank Secrecy Act
The Bank Secrecy Act of 1970, also known as the Currency and Foreign Transactions Reporting Act, requires financial institutions in the United States to assist U.S. government agencies in detecting and preventing money laundering. Since 2013, VC exchanges have been considered financial institutions for the purposes of the Bank Secrecy Act. This means that any suspicious activity on such exchanges should be reported to FinCEN. The extent to which all exchanges actually comply with such laws is unclear.
Illegal Use of VC
Cryptocurrencies and other VCs have long been associated with illegal activities on the internet. While obviously not all transactions using virtual currencies are illegal, law enforcement sometimes perceive it as an indicator of potentially shady activities. Virtual currency, for example, is the most commonly used currency on dark markets such as in the case of Silkroad. Beyond even these isolated illegal transactions, however, large-scale money-laundering and securities fraud (often through Ponzi schemes) is common. Because of these illegal transactions, any use of cryptocurrencies can fall under serious scrutiny.
Taxation of VC
For the purposes of the IRS, virtual currencies are considered property, not currency. Despite this, you still must pay taxes on the accrued value of virtual currency. Tax considerations related to Bitcoin can be quite complex, so if you have profited through VC, it may help to speak with a tax attorney experienced in virtual currencies.
Is using virtual currency like Bitcoin or Darkcoin on the Tor network legal?
It depends. Strictly speaking, it is not illegal to use virtual currencies like Bitcoin or Darkcoin on the Tor network or anywhere else of itself. On the other hand, purchasing illegal contraband, such as drugs or weapons, is always illegal. It really depends what you are doing on Tor.
Is virtual currency safe?
There are serious risks involved in trading in virtual currency. Since VC is largely unregulated, any transactions are not guaranteed or subject to consumer protections. In addition, VC exchanges have been found to be particularly vulnerable to hackers. The Consumer Financial Protection Bureau has declared virtual currencies to be highly volatile and an unproven new technology. If you plan to trade in virtual currency, you should be aware of the risks involved.