What is virtual currency bitcoin

What is bitcoin? An idiot’s guide to the virtual currency

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Once exclusively the domain of tech-savvy libertarians, virtual currency bitcoin has shot to prominence after a massive rise in value and the financial crisis in Cyprus. We explain what bitcoin is, how it works and whether it represents a glimpse into the future of the world economy.

What is bitcoin?

Bitcoin is a decentralised virtual currency, meaning neither does it exist in the physical world, nor does it have a central bank such as the Federal Reserve or the Bank of England. There are also a finite number of bitcoins in the world, with a limit of 21million bitcoins set to be reached by 2014.

Why all the fuss now?

Bitcoin was introduced in 2009 by a mysterious programmer known only as Satoshi Nakamoto, which is thought to be a pseudonym, and who has never given an interview. Previously the domain of technology-friendly libertarians, bitcoin has shot to mainstream financial attention after its value increased by up to 1,000 per cent since the start of the year.

The rise of bitcoin also coincided with the tipping point of the financial crisis in Cyprus, when it was announced individual savers faced a one-off levy in order for a eurozone bailout to go ahead. In light of governments raiding savings in this way, the prospect of a currency free from government regulation and interference suddenly becomes much more enticing. However, the US Treasury has recently made moves to apply laundering rules to virtual currencies such as bitcoin.

OK I’m interested, how does it work?

The first step is to visit bitcoin.org and download a ‘wallet’ on your computer or mobile. Bitcoin uses peer-to-peer networking and digital signatures where the money supply is automated and given to servers known as ‘bitcoin miners’. Bitcoins, in blocks of 25, are awarded to these miners when their computer generates a 64-digit number from a complex algorithm. It is helpful to think of bitcoin more as a commodity being mined rather than a traditional currency of which central banks can always create more of.

Can I buy bitcoins directly?

Yes, the most popular way is via online exchanges such at Mt GoX, or via bank transfer on websites including Coinbase. Sellers can also be found directly online or even by meeting them in person.

The most important question: What can I buy with bitcoins?

Technically anything, although virtually no mainstream retailers currently accept them. Blogging platform WordPress and WikiLeaks both accept bitcoin, while some sites offer gift vouchers for retailers such as Amazon. There are also websites selling electronic goods that exclusively accept bitcoin. The dark side to bitcoin is how it is accepted on sites such as anonymous marketplace Silk Road, where users can buy illegal drugs such as LSD.

It all sounds a bit too good to be true, what’s the catch?

The big question is whether bitcoin is truly a self-stabilising currency, with all the evidence so far pointing to no, with it having already shown massive fluctuations in price. Two months ago a single bitcoin was worth $20, but on April 10 its value crashed from $266 to $105 before returning to $160 within several hours. Many mainstream economists regard bitcoin as a bubble waiting to pop, with comparisons made with Dutch tulip mania in the 17th century. Exchanges can also be vulnerable to distributed denial of service attacks, which can lower prices.

For more information you can read the bitcoin community’s own guide to the currency.

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Virtual Currency

What Is Virtual Currency?

Virtual currency is a type of unregulated digital currency that is only available in electronic form. It is stored and transacted only through designated software, mobile or computer applications, or through dedicated digital wallets, and the transactions occur over the internet through secure, dedicated networks. Virtual currency is considered to be a subset of the digital currency group, which also includes cryptocurrencies, which exist within the blockchain network.

Key Takeaways

• Virtual currency is currency held within the blockchain network that is not controlled by a centralized banking authority.
• Virtual currency is different than digital currency since digital currency is simply currency issued by a bank in digital form.
• Virtual currency is unregulated and therefore experiences dramatic price movements since the only real force behind trading is consumer sentiment.

Understanding Virtual Currency

Virtual currency can be defined as an electronic representation of monetary value that may be issued, managed, and controlled by private issuers, developers, or the founding organization. Such virtual currencies are often represented in terms of tokens and may remain unregulated without a legal tender.

Unlike regular money, virtual currency relies on a system of trust and may not be issued by a central bank or other banking regulatory authority. They derive their value based on the underlying mechanism, like mining in cases of cryptocurrencies, or the backing by the underlying asset. Anyone who watches cryptocurrency prices will see the seesaw effect of psychological trading.

The term came into existence around 2012, when the European Central Bank (ECB) defined virtual currency to classify types of “digital money in an unregulated environment, issued and controlled by its developers and used as a payment method among members of a specific virtual community,” according to Bitcoin News.

Along with use by the common public, a virtual currency can have restricted usage, and it may be in circulation only among the members of a specific online community or a virtual group of users who transact online on dedicated networks. Virtual currencies are mostly used for peer-to-peer payments and are finding increasing use for the purchase of goods and services.

Due to the lack of a centralized regulatory authority, virtual currencies are prone to wide swings in their valuations.

Difference between Digital, Virtual, and Crypto Currencies

Digital currency is the overall superset that includes virtual currency, which in turn includes cryptocurrencies. Compared to virtual currency, a digital currency covers a larger group that represents monetary assets in digital form.

Digital currency can be regulated or unregulated. In the former case, it can be denominated to a sovereign currency—that is, a country’s central bank can issue a digital form of its fiat currency notes. On the other hand, a virtual currency often remains unregulated and hence constitutes a type of digital currency.

Cryptocurrencies like bitcoin and ethereum are considered to be a part of the virtual currency group. A cryptocurrency uses cryptography technology that keeps the transactions secure and authentic, and also helps to manage and control the creation of new currency units. Such cryptocurrencies exist and are transacted over dedicated blockchain-based networks that are open to the common public. Anyone can join and start transacting in cryptocurrencies.

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Is Bitcoin A Digital Currency or a Virtual Currency?

Bitcoin has been labeled as many things in mainstream media over the past six years. First reports called Bitcoin nothing more than “magic internet money”, which later changed to “virtual money” and eventually the term “cryptocurrency”. However, there is still a lot of confusion about whether Bitcoin is a digital currency or virtual currency.

Virtual Currency – Unregulated Digital Money Without Legal Tender

In order to explain what virtual currency truly is, we have to go back in time to 2012, during which the term was first created. The European Central Bank coined the term virtual currency to classify types of “digital money in an unregulated environment, issued and controlled by its developers and used as a payment method among members of a specific virtual community”.

When we translate this into Bitcoin terms, virtual currency seems to sum it up quite nicely. Bitcoin started out as digital money – even though that moniker has changed – and is, according to many people, unregulated. Additionally, Bitcoin has a limited number of use cases, most of which are transactions between community members.

But this is where the first misconceptions started to pop up. Bitcoin is not regulated, but it is certainly not unregulated either. Everyone involved in the Bitcoin ecosystem has to adhere to a certain set of rules, ranging from taxation purposes to record keeping and accounting. From a specific legal perspective, Bitcoin remains without oversight in most countries in the world, a status that most likely will never change due to to its decentralized nature and community members all over the world, living in different jurisdictions.

Furthermore, Bitcoin used to be a payment method accepted only by community members in its early stages of development. But In recent years, both online and brick-and-mortar stores have started accepting Bitcoin payments, allowing the cryptocurrency to operate outside of its “community borders”. In a sense, Bitcoin has become money, as it can be used to pay for goods and services.

The term virtual currency has undergone quite some changes in 2013 and 2014. Financial Crimes Enforcement Network classified virtual currency as “a medium of exchange operating like a currency in some environments but without having all of the true attributes of a currency.” Bitcoin fits this description as well, because it lacks fungibility, one of the main aspects of a true currency.

One year later, the European Banking Authority defined virtual currency as a “digital representation of value that is neither issued by a central bank or a public authority, nor necessarily attached to a fiat currency.” Once again, Bitcoin fits the bill, as it can be used as payment form in its natural state, rather than being tied to fiat currency values. However, this is hardly ever the case, as most merchants take the fiat currency price and charge the corresponding amount in BTC.

A List of Recent Virtual Currencies

In recent years, there have been quite a few types of virtual currency trying to create an ecosystem of

their own. Closed virtual currencies, which have no ties to the real economy, are most commonly found in video games. World of Warcraft gold is one such an example, despite there being a [quite large] black market for buying and selling in-game gold in exchange for fiat currency.

Frequent flyer programs by major airlines, Facebook Credits and Nintendo Points are virtual currencies in their own right. This type is known as “virtual currencies with currency flow in one direction”, as you can buy these types of currency with fiat currency. However, a consumer is – officially speaking – not allowed to resell these codes in a physical or digital format in exchange fiat currency.

Last but not last, there are the convertible virtual currencies, of which Bitcoin and Linden Dollars are two perfect examples. Both of these virtual currencies can be bought and sold in exchange for legal tender, such as EUR, USD or CNY. However, there is also the option of converting convertible virtual currencies intermittently, such as the exchange from Bitcoin to Linden Dollars.

Digital Currency – An internet-based Instantaneous Medium of Exchange

To make matters slightly more confusing, cryptocurrencies – such as Bitcoin – and virtual currencies – such as Linden Dollars – are both digital currencies. The reason for that is simple: both types of currency allow for the purchase of goods and services, yet they can also be used in closed-down environments such as online gaming or a social network.

At its core, a digital currency is an Internet-based form of currency or medium of exchange that allows for instantaneous transactions and borderless transfer-of-ownership. Additionally, a digital currency exhibits various properties similar to a physical currency.

The main reason why bitcoin is both a digital and virtual currency is because it does not exist in the “real physical world”, yet it also facilitates the payment of goods and services in the real world. Especially this latter part is interesting, because virtual currencies are not intended to be used in “real life transactions”. Bitcoin has transcended that border, and managed to gain a foothold in the real world as an alternative payment method.

If someone wants to label Bitcoin in its truest form, they would have to call it a “digital cryptocurrency”. Because of Bitcoin’s hybrid nature between digital and virtual currency, a new type of currency term had to be created. Despite lacking the fungibility of a traditional currency, Bitcoin is maturing into a global payment method.

What type of terminology do you use to refer to Bitcoin? Let us know in the comments below!

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Is Bitcoin a Digital Currency or a Virtual One?

Danny Bradbury

Is Bitcoin a Digital Currency or a Virtual One?

Is bitcoin a virtual currency, a digital currency, or both? And why does it matter?

In press reports, it’s often referred to as both. The Bangkok Post today refers to “virtual currencies including the bitcoin”, while the Toronto Star describes the collapse of a bitcoin exchange after hackers stole its “digital currency”. But digital and virtual currencies are two different things, with different behaviours.

It’s more than a semantic distinction: it’s a discussion of how a form of money functions.

If we replace the word ‘currency’ with ‘economy’, then the distinction may be clearer. When we hear ‘digital economy’, then we generally think of money whizzing its way electronically around the world, and being used in real life interactions. If we say ‘virtual economy’, then the first thing that many of us will think of is Second Life, EVE Online, or World of Warcraft.

Perhaps that’s why Peter Earle divides it into cryptocurrencies vs. ‘simulated’ or ‘game’ currencies. Earle is the chief economist at Humint, a marketing agency that is planning to launch altcoin services for brands, and also handles economies for multiplayer online games.

“The main difference is that the latter are typically limited to use within a bounded, specified economic system,” he says.

Virtual currencies may have value against real-world currency, but that doesn’t necessarily make them easily exchangeable.

“They tend to be subject to one-way flows: real-world money is converted into simulated/game currencies, but not back out,” says Earle. “This is because game/simulated currencies are essentially goods, and not an actual medium of exchange.”

Gold in World of Warcraft is generally exchanged mostly within the game.That isn’t to say that it doesn’t get traded with other currencies through third-party exchanges, but that isn’t its purpose. Instead, it oils the wheels for everything else that happens in the game, and that is its sole purpose. The same goes for Eve Online, which uses the ISK as its unit of exchange, or Second Life, which uses the Linden.

Currency usage matters

There’s another key difference between in-game virtual currency, and a digital currency used extensively outside the boundaries of a virtual world: their usage. In online game worlds, the issuers of the currency are created for a specific purpose.

Charles Hoskinson, cryptographer and co-founder of the Ethereum cryptocurrency framework, describes virtual currencies like these as “tokens”.

“A central entity issues the tokens and then they’re used for specific contexts. They can appreciate real-world value though. So WoW and Eve Online ISK do have a market price,” he says. “This is why people in China spend days earning them.”

They do this via a process known as gold farming, where banks of player-workers manually play games to accrue gold or other in-game currencies. This can then be exchanged for fiat currency: if people don’t want to spend time in the game earning their fortune, then they can buy their way in. But that’s a long way from making the currency properly and systematicallly exchangeable.

However, these behaviours extend beyond mere in-game currencies, argues Wences Caseres, who founded mobile payments network Lemon, and who just launched a mobile wallet called Xapo. There is another type of asset with those characteristics, that is used in the real world: loyalty points. Like in-game currencies, these are issued by a central body.

“Virtual currencies are owned and controlled by a counterparty (Facebook credits, American Airlines miles, American Express Points, etc) and you have to trust that counterparty since it is up to them to set the value and redemption rules. Digital currencies on the other hand are designed in a way in which, just like with gold, you do not need to trust anyone.”

What we’ve been describing here are what Hoskinson refers to as three core characteristics of money. The first, exchangeability, involves the ability to switch something for a different currency. The second is the ability to act as a store of value, meaning that an asset will more or less hold its value over time without suffering from massive fluctuations. The third is to be a unit of account (usable widely, rather than to buy virtually-drafted broadswords and breastplates).

Virtual currencies, as used in games, exhibit few of these characteristics, except maybe the ability to hold value. But what about bitcoin?

What should we call bitcoin?

Bitcoin is exchangeable, and it isn’t used just to keep a game or a loyalty points system running. So does that make it a digital currency, rather than a virtual one? CoinDesk generally describes it as such, but Hoskinson doesn’t agree. In fact, he doesn’t think it’s a currency at all.

It is also working its way towards becoming a unit of account, in which it is used to price goods and services, and doesn’t need to be referenced against anything else for its value.

This is the holy grail for a currency: if you can live your life using it, without worrying about having to transfer it to any other form of exchange, then you know it’s arrived. “Bitcoin is getting there, with about 15,000 products and services available, maybe more,” Hoskinson says.

It also needs to be a store of value. so that value can be deposited in it, and then retrieved at a later date, while still having held that value, or at least decayed in value at a predictable rate. Bitcoin’s suitability here is open for debate.

Although many advocates talk up its long-term value, bitcoin has jumped and plunged in value at various points over the last year. You wouldn’t want to store your life savings in it today, and even unit trust and ETF managers are saying that it isn’t yet a vehicle for retail investment.

“We want it to be predictable, because that gives you the ability to issue credit. Which is one of the most important things in an economy,” says Hoskinson. “It behaves much more like a digital commodity, or a tech stock.”

That’s certainly how some are classifying it. Finland recently decided that it was a commodity, and the Bank of England thinks that it looks rather similar to one, too. And Goldman Sachs doesn’t think it’s a currency either.

This makes the case (at least for the time being) for cryptocurrencies to be in a class of their own – neither digital currencies, nor virtual. Once they strongly satisfy those three underlying standards for money, they could be technically considered currencies. The ‘crypto’ would simply be a subcategory.

So, technically speaking, bitcoin could be described as a cryptocurrency. Or a digital currency in waiting. But for now, we’ll use ‘cryptocurrency’ and ‘digital currency’ interchangeably at CoinDesk. That’s easier to type than ‘crypto-proto-digital currency/commodity’.

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