DEFINITION of 'Closed Virtual Currency'

An unregulated digital currency that is used as payment only within certain virtual communities. A Closed Virtual Currency has no connection to the real economy and cannot be converted to legal tender. Think of closed virtual currency as closed loop payment cards like the Nordstrom store credit card that can only be used in Nordstrom.

Also called Non-Convertible Virtual Currency, Closed Loop Currency, Closed-Flow Virtual Currency and In-World Money.

BREAKING DOWN 'Closed Virtual Currency'

Technology advancements all over the globe are driving disrupting changes in the traditional way of doing things including the way goods and services are acquired and paid for. The rise of e-commerce and virtual community platforms has led to a demand for alternative means of conducting transactions. One rapidly evolving payments technology that is making waves in the digital world is virtual currency. Virtual currency is a type of digital money that is used to purchase real-world goods or services online, but has no legal tender status in some countries. From an economic and legal standpoint, virtual currency is not recognized as a full form of money.

Virtual currency can be either open or close in regards to its reach. An open virtual currency is one that can be substituted for real money using online exchange systems or ATMs that are designed for virtual to real currency exchanges. An example of an open virtual currency is Bitcoin, the most popular decentralized cryptocurrency online. Because open currencies have a determinable value in real money and can be exchanged for real money, they are treated as properties or capital assets for tax purposes in the US.

Closed virtual currencies were created to operate in closed-loop environments, and are limited to transactions in virtual goods within the closed environment. A closed platform allows for real currency to be exchanged for its virtual currency. In contrast, open virtual currencies can be redeemed for real goods and real currency. The currencies used in many online games are closed. Virtual assets acquired in-game can be traded for other in-game tools or currency and therefore, do not produce any taxable income. Examples of closed-loop virtual gaming platforms and their specialty currencies include: World of Warcraft’s Gold; Entropia Universe’s Project Entropia Dollar; and Ultima Online’s Gold Coins. Other forms of closed virtual currencies include frequent flyer miles, loyalty points, and video arcade tokens.

Closed virtual currencies are centralized by design, compared to decentralized peer-to-peer currencies like Bitcoin that are ungoverned by any central authority. With a closed virtual currency, there is a central system that issues the currency, establishes rules for its use, records transactions made by its users, and reserves the right withdraw the currency from circulation.

There are some prevalent setbacks with closed currencies. The currency is usually illiquid and digitally scarce with no way to create more of it unlike Bitcoin mining which creates more Bitcoins for its users. A user can lose all of his earned coins in a matter of seconds through cyber thefts, software bugs, or account termination initiated by the virtual administrator or the user himself.

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