What do the terms virtual currency, cryptocurrency, crypto asset, ICO and wallet service mean?
Virtual currency and cryptocurrency
A virtual currency is defined in the new Anti-Money Laundering Directive1). What virtual currencies have in common is that:
- they are not issued or guaranteed by a central bank or a public authority
- they are not necessarily attached to a legally established currency (legal tender)
- they do not possess the same legal status as currency or money
- they are accepted by natural or legal persons as a means of exchange
- they can be transferred, stored and traded electronically.
One of the best known virtual currencies is Bitcoin, which is a decentralised virtual currency that can be exchanged for legal tender, such as the euro. It was also the first cryptocurrency, i.e. a virtual currency based on encryption algorithms. A cryptocurrency is built on public and private keys by which value is transferred from one person to another and which are encrypted prior to every transfer.
Bitcoin and other virtual currencies can be considered as a form of asset, but only as long as they have a functioning market. Instead of virtual currencies and cryptocurrencies, the terms crypto or virtual asset are often used. For example, the Financial Action Task Force (FATF), an inter-governmental body working for the prevention of money laundering and terrorist financing which operates under the OECD, uses in its recommendations and guidance the terms virtual asset and virtual asset service provider (VASP). Bitcoin and other virtual currencies are, all things considered, a relatively small phenomenon and, at least for now, they have no impact on financial markets or financial stability.
ICO (Initial Coin Offering) and issuance of virtual currencies
Also associated with virtual currencies is the phenomenon ICO (Initial Coin Offering), which is one method of organising an issuance of a new virtual currency. An ICO is a way of raising risk funding for a business or product development project. It means the advance sale of a new virtual currency or token.
New virtual currencies issued via an ICO may vary greatly in nature, depending on how the ICO is organised. Virtual currencies can be roughly divided into three categories. In addition, hybrid models combining a number of different features have also been observed on the market.
- Payment instrument-like virtual currencies, originally planned as alternatives to traditional currencies and also intended to be used as payment instruments elsewhere than in their issuer’s services. The best known payment instrument-like virtual currency is Bitcoin.
- Virtual currencies used as payment for a certain commodity (utility coin), which can be used to pay for their issuer’s products or services. Generally, the products or services are only at an early stage of their development when the virtual currency usable to pay for them is issued.
- Financial instrument-like virtual currencies, where the virtual currency may have features in common with securities, such as voting and ownership rights or expected returns. These may, for example, be referred to as security tokens.
Stablecoins are cryptocurrencies with a value that is fixed to a predetermined underlying asset, such as a fiat currency, commodities, immovable property or financial instruments. This arrangement is commonly used to mitigate the sudden major fluctuations in value typical for many virtual currencies.
Wallet service providers
A wallet service provider means a natural person or entity that provides services to hold, store and transfer virtual currencies on behalf of its customers.
What are the risks associated with virtual currencies?
The security, integrity and balance of virtual currency systems are based on the mutual trust of their users. Value formation in virtual currency systems is not covered by the supervision of the Finnish Financial Supervisory Authority (FIN-FSA) nor any other authority.
Virtual currencies are primarily used as speculative investment objects, and their use for payment is secondary. No-one guarantees their value and as a result market prices fluctuate strongly. For these reasons, Bitcoin or other virtual currencies are not a real alternative to money, nor are they good payment instruments. There is also a money laundering and terrorist financing risk associated with virtual currencies, and they are widely used in criminal activity. The FIN-FSA has warned about the risks of virtual currencies.
What regulations must be taken into consideration when virtual currencies are used for trading or when they are accepted as payment instruments?
Parties involved with virtual currencies must take into consideration the regulation governing them and also stay aware of future regulatory projects. Investors who buy and sell virtual currencies must take into consideration the detailed guidance of the Finnish Tax Administration (in Finnish) on the taxation of income from virtual currencies. Similarly, parties who accept virtual currencies as payment instruments or parties who earn them from mining should be familiar with the Tax Administration guidance.
1) According to the definition, a virtual currency means a digital representation that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically.