Understanding Virtual Currency

Understanding Virtual Currency

• Virtual currency is a digital value acting as a unit of account, store of value, or medium of exchange.
• Lacks legal tender status in most countries, with El Salvador being an exception; value is driven by market supply and demand.
• Highly volatile compared to traditional currencies, enabling global value transfers without central bank oversight.
• Bitcoin, launched in 2009, utilizes a blockchain network for peer-to-peer transactions and operates on predetermined protocols.
• Other popular cryptocurrencies include Ethereum, Dogecoin, and Litecoin; new cryptocurrencies continue to emerge.
• A coin in the virtual currency space represents an exchange unit, with value derived from market demand; Bitcoin’s supply is fixed through a mining process.

Virtual Currency Categories

Centralized Virtual Currency

• Governed by a central authority, an issuer can be a government or private entity, resembling the role of a central bank.
• Examples: Bahamian Sand Dollar (government-issued), XRP (privately-issued).

Decentralized Virtual Currency

• Operates without central oversight, leveraging blockchain technology and a distributed trust system.
• Offers resistance to government intervention and is less susceptible to censorship or tampering.

Convertible Virtual Currency (CVC)

• Can be exchanged for real currency, used for purchases, and functions without a physical form, tracked on decentralized networks.
• Not typically government-issued.

Non-convertible Virtual Currency

• Restricted to specific communities, mainly utilized in virtual gaming for in-game transactions and enhancements.
• Centralized by game developers, not exchangeable for legal tender.

Virtual Currency Market Participants

• User: Individuals or entities using virtual currency for goods, services, or investment.
• Exchanger: Businesses facilitating trades between digital currencies or between digital and fiat currencies, similar to stock exchanges.
• Administrator: Entities issuing or redeeming virtual currencies and establishing network regulations.

Regulating the Virtual Currency Market

• Virtual currency anonymity poses risks for financial crimes; public ledgers like blockchain provide tracking, but personal identification remains challenging.
• Monero and similar coins enhance user anonymity, complicating fund tracing.
• FinCEN classifies Administrators and Exchangers as Money Services Businesses, imposing registration and recordkeeping regulations.
• FATF recommends regulating Virtual Asset Service Providers (VASPs) for anti-money laundering and counter-terrorism financing.
• VASPs involve activities related to virtual assets for clients, such as exchanging currencies and managing digital assets.

Key Regulatory Aspects

• Regulation requires a risk-based approach, international cooperation, and adherence to the "travel rule" for transactions of $3,000 or more, collecting identifying information.
• FATF noted progress but emphasizes further technological investment for compliance with the travel rule.
• Identified indicators for suspicious activities: inconsistent exchange patterns, multiple transfers to one user, rapid purchases following third-party funds, and similar red flags.
• Updated FATF guidelines discourage blanket de-risking of virtual currency, providing risk indicators for peer-to-peer exchanges and clarifying standards for stablecoins and decentralized finance products.