Convertible Virtual Currency

DEFINITION of 'Convertible Virtual Currency'

An unregulated digital currency that can be used as a substitute for real and legally recognized currency. Convertible Virtual Currency usually has a measurable value in real money, but what makes it convertible lies in its ability to be exchangeable. Not all virtual currency can be exchanged for legal tender though, therefore, not all virtual currency is convertible.

Also called an Open Virtual Currency.

BREAKING DOWN 'Convertible 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 cross-border and e-commerce platforms for shopping has led to a demand for alternative means of making payments. 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 and services, but has no legal tender status in some countries, meaning that it is not recognized as a medium of payment by legal systems such as the Federal Reserve.

The most popular form of virtual currency is known as Bitcoin. Bitcoin runs on a decentralized peer-to-peer currency network. It is decentralized because it bypasses the regulatory operations of central banks and central clearing houses which exist to monitor, verify, and approve transactions in legal tender. It is a peer-to-peer exchange tool because it is a currency created by the people for the people. Bitcoin is a convertible virtual currency because it can be exchanged for real money based on its determinable value in the market. The value of a Bitcoin in dollars has been exchanged from as low as $13 sometime in 2012 to as high as $1250 in 2013. As of 2016, the value of Bitcoin is determined to be fall between the range of $350 and $660.

Virtual currency can be converted for cash through online exchanges who act as brokers. Exchanges such as Coinbase and Bitstamp enable users to exchange their Bitcoins for their local currency. The Bitcoin holder makes a sell order like s/he would if making a trade with a securities broker. The sell order includes the number of Bitcoins and price per coin. The user’s account is credited in the local currency when his/her order is matched to a corresponding buy order.

Convertible virtual currencies can also be exchanged for real currency using Bitcoin ATMs which are only available in select countries. While the online exchanges may take a couple of days for the euro or dollar to be transferred to a user’s account, Bitcoin ATMs take only seconds to complete the transaction.

Convertible virtual currencies can also be centralized. Linden Money is a centralized virtual currency that is solely used in a virtual world called Second Life. Second Life is a social game with a virtual economy where players buy and sell goods using Linden Money. Players convert their real money, e.g. euros, into Linden dollars at the game’s official currency exchange site known as LindeX. Like a traditional exchange platform, market and limit buy and sell orders are conducted among the players. As of 2016, an average of 250 Linden dollars could fetch you $1 US dollar. FinCen, the U.S. Financial Crimes Enforcement Network, recognized Linden Money as a convertible centralized virtual currency in 2013.

The nature of convertible virtual currencies, makes them susceptible to use as vehicles for money laundering, tax evasion, and terrorist financing. This has led to some countries proposing regulatory measures on how the currencies will be observed and used for tax purposes. In the US, FinCen guidelines rule that virtual currency that can be exchanged for legally recognized money is property, not money, and will be treated as such. Tax principles that apply to property transactions therefore apply to these types of currencies. A taxpayer who receives Bitcoin or Linden dollars in exchange for goods and services has to record the fair value of the virtual currency in US dollars as of the date it was received. This value is included in computing the taxpayer’s annual gross income. In addition, virtual currency used for investing is regarded as a capital asset and is therefore subject to tax on its capital gains or losses.