ECB: Bitcoin And Virtual Currency Schemes

Virtual communities have proliferated in recent years – a phenomenon triggered by technological

developments and by the increased use of the internet. In some cases, these communities have 

created and circulated their own currency for exchanging the goods and services they offer,

and thereby provide a medium of exchange and a unit of account for that particular virtual


This paper aims to provide some clarity on virtual currencies and tries to address the issue in a 

structured approach. It is important to take into account that these currencies both resemble money 

and necessarily come with their own dedicated retail payment systems; these two aspects are 

covered by the term “virtual currency scheme”. Virtual currency schemes are relevant in several 

areas ofthe financialsystemand are therefore ofinterest to central banks. This, among otherthings,

explainsthe ECB’sinterest in carrying out an analysis, especially in view ofitsrole as a catalystfor

paymentsystems and its oversight role.

This report begins by defining and classifying virtual currency schemes based on observed

characteristics; these might change in future, which could affect the current definition. A virtual

currency can be defined as a type of unregulated, digital money, which is issued and usually

controlled by its developers, and used and accepted among the members of a specific virtual

community. Depending on their interaction with traditional, “real” money and the real economy,

virtual currency schemes can be classified into three types: Type 1, which is used to refer to closed

virtual currency schemes, basically used in an online game; Type 2 virtual currency schemes have

a unidirectional flow (usually an inflow), i.e. there is a conversion rate for purchasing the virtual

currency, which can subsequently be used to buy virtual goods and services, but exceptionally

also to buy real goods and services; and Type 3 virtual currency schemes have bidirectional flows,

i.e. the virtual currency in thisrespect actslike any other convertible currency, with two exchange

rates(buy and sell), which can subsequently be used to buy virtual goods and services, but also to

purchase real goods and services.

Virtual currency schemes differ from electronic money schemes insofar as the currency being

used as the unit of account has no physical counterpart with legal tender status. The absence of a

distinct legal framework leads to other important differences as well. Firstly, traditional financial

actors, including central banks, are not involved. The issuer of the currency and scheme owner

is usually a non-financial private company. This implies that typical financial sector regulation

and supervision arrangements are not applicable. Secondly, the link between virtual currency and

traditional currency (i.e. currency with a legal tender status) is not regulated by law, which might

be problematic or costly when redeeming funds, if this is even permitted. Lastly, the fact that the

currency is denominated differently (i.e. not euro, US dollar, etc.) means that complete control 

of the virtual currency is given to its issuer, who governs the scheme and manages the supply of

money at will. 

There are several business reasons behind the establishment of virtual currency schemes. They may 

provide a financial incentive for virtual community usersto continue to participate, or create lock-in

effects. Moreover,schemes are able to generate revenue fortheir owners,forinstance floatrevenue.

In addition, a virtual currency scheme, by allowing the virtual community owner to control its

basic elements (e.g. the creation of money and/or how to allocate funds), provides a high level of

flexibility regarding the business model and business strategy for the virtual community. Finally,

specifically for Type 3 schemes, a virtual currency scheme may also be implemented in order to

compete with traditional currencies, such as the euro or the US dollar. 

The first case study in this report relates to Bitcoin, a virtual currency scheme based on a peer-topeer network. It does not have a central authority in charge of money supply, nor a central clearing

house, nor are financial institutionsinvolved in the transactions,since users perform all these tasks

themselves.Bitcoins can be spent on both virtual and real goods and services.Its exchange rate with

respect to other currencies is determined by supply and demand and several exchange platforms

exist. The scheme has been surrounded by some controversy, not least because of its potential to 

become an alternative currency for drug dealing and money laundering as a result ofits high degree

of anonymity. 

The second case study in this report is Second Life’s virtual currency scheme, in which Linden 

Dollars are used. This scheme can only be used within this virtual community for the purchase 

of virtual goods and services. Linden Lab manages the scheme and acts as issuer and transaction

processor and ensures a stable exchange rate against the US dollar. However, the Second Life

scheme has been subject to debate, and it has been suggested that this currency is more than simply

money for online gaming.

Thereafter, a preliminary assessment is presented of the relevance of virtual currency schemes 

for central banks, paying attention mostly to schemes which are more open and linked to the real

economy (i.e.Type 3 schemes).The assessment coversthe stability of prices, ofthe financialsystem

and ofthe paymentsystem, looking also at the regulatory perspective.It also addressesreputational

risk concerns. It can be concluded that, in the current situation, virtual currency schemes:

− do not pose a risk to price stability, provided that money creation continues to stay at a low 


− tend to be inherently unstable, but cannot jeopardise financial stability, owing to their

limited connection with the real economy, their low volume traded and a lack of wide user 


− are currently not regulated and not closely supervised or overseen by any public authority,

even though participation in these schemes exposes users to credit, liquidity, operational and

legal risks;

− could represent a challenge for public authorities, given the legal uncertainty surrounding these

schemes, as they can be used by criminals, fraudsters and money launderers to perform their 

illegal activities;

− could have a negative impact on the reputation of central banks, assuming the use of such

systems grows considerably and in the event that an incident attracts press coverage,since the

public may perceive the incident as being caused, in part, by a central bank not doing its job


− do indeed fall within central banks’ responsibility as a result of characteristics shared with 

paymentsystems, which give rise to the need for at least an examination of developments and

the provision of an initial assessment.

This report is a first attempt to provide the basis for a discussion on virtual currency schemes.

Although these schemes can have positive aspectsin terms of financial innovation and the provision

of additional payment alternatives to consumers, it is clear that they also entail risks. Owing to

the small size of virtual currency schemes, these risks do not affect anyone other than users of 

the schemes. This assessment could change if usage increases significantly, for example if it were

boosted by innovations which are currently being developed or offered. As a consequence, it is

recommended that developments are regularly examined in order to reassessthe risks.

From the ECB's Virtual Currency Schemes, aka the "Bash Bitcoin Boondoggle"