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Virtual currencies – a growing need to regulate?

Virtual currencies ("VCs") are non-physical stores of value that can be exchanged for goods and services at places that accept them. There is no central bank that issues them; instead, they are operated under VC schemes, either maintained by a centralised VC operator, or by a community of VC users. Typically traded electronically, VCs may be used to purchase products and services and may be transferred from one user to another. They are not denominated in fiat currency, such as the US dollar, but can be purchased using such currencies.  Examples of VCs include WebMoney and Perfect Money (centralised VC schemes) and Bitcoin, Litecoin and Namecoin (decentralised VC schemes).

Probably the most widely-recognised example of VC is the bitcoin. The bitcoins came into existence around 2009 but it was not until 2013 that public interest in them grew stronger.  The central banks of countries such as China and Thailand have made recent headlines with their cautious stance against the bitcoin.

In December 2013, the People's Bank of China prohibited Chinese financial institutions from handling transactions involving bitcoins, stating that the bitcoin had no legal status and should not be used as a currency. BTC China, the then-largest bitcoin exchange in terms of trading volume, was adversely affected by this prohibition, temporarily ceasing to accept trades denominated in yuan.  Since then, BTC China has resumed trading, and the Chinese bitcoin market showed signs of revival when another major bitcoin exchange, Japan-based Mt Gox, closed down in February 2014.

The bitcoins also had a similar wary reception in Thailand.  When Bitcoin Co. Ltd attempted to apply for a licence to operate a bitcoin exchange in Thailand, the Bank of Thailand stated that due to a lack of existing applicable laws, capital controls and the fact that the bitcoin "straddles multiple financial facets", bitcoin activities are considered illegal in Thailand.

The Internal Revenue Service ("IRS") of the United States recently issued a notice which provides that virtual currency is treated as property (not currency) for US federal tax purposes.  Hence, general tax principles that apply to property transactions would apply to transactions using virtual currency. The Internal Revenue Authority of Singapore ("IRAS") has an advisory on tax treatment of VCs on its website, and also appears to treat VCs as property for income tax purpose.

Investors and purchasers of VCs should be aware of the associated risks. With VCs being a nascent technological development and many competitors entering the market, it is not uncommon for VC operators to suddenly close down due to financial difficulties, or government intervention or prohibition. When this happens, as in the case of Liberty Reserve or more recently, Mt Gox, users of that VC exchange may suffer losses to the value of their currency or be entirely unable to recover the value of the monies altogether. Also, in decentralised VC schemes like Bitcoin, the price of the currency is not fixed and can fluctuate unpredictably within a short period of time. In addition to consumer risks, money laundering and terrorist financing risks are also associated with this new currency, because of the ease of converting real currency into virtual and back again without the need for know-your-customer checks.

It is because of these inherent risks that financial regulators have started to look into how to regulate VCs.  In New York, the Department of Financial Services announced that it plans to impose capital requirements, a regulatory framework for consumer investment in VCs, and even a "BitLicence" requirement. In Singapore, the Monetary Authority of Singapore ("MAS") has moved from merely cautioning consumers on using bitcoin to "consider[ing] additional measures to address the risks posed by virtual currencies and their intermediaries". On 13 March 2014, MAS announced that it will be introducing rules to regulate VC intermediaries, making Singapore one of the first countries in the world to do so.

VCs are developing rapidly and their popularity is also increasing. It is only a matter of time before government regulators step in with regulations.  However, due to the fact that it is a completely new invention with characteristics which have not been encountered before in traditional currencies, it will be challenging for the regulators to adapt the current financial regulatory measures to apply to it, and will be interesting to see how they will do so.

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