In the face of their increasing prevalence, virtual currencies have taken centre stage in debates about transparency and financial inclusion. Bitcoin, as the best-known example, has inspired the launch of many imitators. According to the European Banking Authority, there are more than two hundred of these currencies in circulation.

Touted as they are to increased payment efficiency and lower transaction costs, it is accurate to point to such currencies’ benefits. For instance, in countries where more citizens have mobile phones than bank accounts, access to a virtual currency opens the door to participation in commerce, and such financial inclusion can drive meaningful development.

Cryptocurrencies like bitcoin can often be purchased, sold, and exchanged with other types of electronic monies or standard currencies, but their use can entail real risk, especially in view of the current lack of regulation.

Potential risks of virtual currency

Relevant to the determination of virtual currencies’ legal status are the absence of trusted third-party intermediaries and the anonymity that characterises the transactions that rely on them. The currencies fall under the domain of no central government, and nor are they overseen by a public authority. Research published by the European Central Bank explains the obvious concern: ‘they can be used by criminals, fraudsters and money launderers to perform their illegal activities’.

A June 2014 report from the intergovernmental Financial Action Task Force outlined the risks posed by the unconventional structure of virtual currencies – money laundering and terrorism funding among them – and urged its member nations to gain a greater understanding of how they function.

Regulatory responses to virtual currency risks

Tax authorities have been among the first to respond to the new landscape. Given that the EU VAT Directive does not contain any provisions on cryptocurrencies, a central question is how these transactions should be treated for VAT purposes. In this respect, the European Court recently ruled that any exchange conducted with virtual currency should be exempt from value-added tax in the same way as traditional cash [Skatteverket v. David Hedqvist [2015]].

While most laws do not contemplate virtual currencies, governments are working to bring them within the scope of regulation. In its ‘Opinion on “virtual currencies”’, the European Banking Authority proposed the introduction of customer due diligence requirements, filling in the blanks of transactions with user identities and alerts on non-standard transactions.

The most prominent legislative response outside the EU has come from the New York State Department of Financial Services, which instituted regulations on virtual currencies last June. Virtual currency businesses with New York customers are now required to obtain the so-called BitLicense.

Conclusion

The lack of clarity around the proper application of regulation actually entails some opportunity, and it allows for rapid development, but it also poses a number of legal challenges. As governments review their response, careful legislators will necessarily strike the right balance between market integrity and consumer protection on the one hand and technological development and free enterprise on the other.