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Today in many countries the major problem is virtual currency and how to tackle on if we think it as a country economic growth. In a modern market economy, money is used to pay for goods and services, either in the form of cash, i.e. banknotes or coins that are transferred directly from the buyer to the seller, or alternatively in the form of a bank transfer through the payments infrastructure, typically after the buyer has initiated the payment using a payment instrument such as a card. The growth of the Internet has spawned a variety of networks, from online games to social networks, where Internet users meet and interact with one another according to a common set of rules. Some of these networks have introduced their own units of payment — or virtual currencies — for participants’ transactions. As long as these units are used only in the closed online environment, their economic significance is limited. Other, more interesting, types of virtual currencies are those with wider application — virtual currencies that can potentially be bought and sold in exchange for traditional currencies like kroner, euro or dollars. The best-known example is Bitcoin, which has recently attracted considerable attention from both the media and regulators. A number of similar, less widespread solutions with the same characteristics also exist. Bitcoins are created through a decentralised network of Internet users in a process called mining, which has often been compared to the mining of gold. Bitcoins can be bought and sold on various online exchanges and, unlike national currencies, they have no central issuer. Therefore, they do not represent a claim against a company in the same way as, for example, a bank deposit. Unlike bank deposits, bitcoins are not protected by any form of guarantee. Virtual currencies such as bitcoins are not regulated, either at the European level or in Denmark. Consequently, bitcoins are not subject to the normal protective measures for payments based on bank deposits, and consumers are not entitled to claim compensation for losses caused e.g. by hacker attacks. Recently, this has prompted several regulators to issue warnings about virtual currencies.1 In spite of the considerable focus on bitcoins, their use as a means of payment remains very limited, and few Danish retailers accept them as payment. Against that backdrop, the risks linked to the use of Bitcoin and other virtual currencies are currently assessed to be limited to the individual user and they are not deemed to pose a threat to financial stability in Denmark.

REGULATION OF VIRTUAL CURRENCIES

In Europe, the payments area is regulated by the Payment Services Directive and the E-Money Directive. The former provides rules for payment services, while the latter contains provisions on the issuance of electronic money, i.e. a prepaid monetary value stored on a medium such as a card or a server, which can be used for purchasing goods and services from others than the issuer. In Denmark, the two directives are transposed into Danish law in the Payment Services Act, which came into force in 2009. The former Danish act also regulated a number of electronic systems for the payment of goods and services that were not covered by the two directives, e.g. electronic vouchers that represent a claim for a number of services rather than a monetary amount. Since Denmark wanted to continue regulating these systems, the concept of payment substitutes was introduced, cf. Box 1. Virtual currencies as defined above are usually regulated by Danish law if they have an issuer. In that case, they are normally either electronic money or payment substitutes. Whether they belong in one category or the other generally depends on whether they can be used with others than the issuer. If this is the case, they are usually defined as electronic money. Conversely, bitcoins and similar solutions with no central issuer are covered neither by European legislation nor by the Danish Payment Services Act. When virtual currencies are characterised as unregulated, this is the type referred to. The absence of regulation reflects that there is no issuer against whom statutory claims can be made. Both at the national and the international level, several regulators, e.g. the European Banking Authority, EBA, are analysing the need for regulating this type of virtual currencies and the possibilities of doing so.

HOW DOES BITCOIN WORK?

Bitcoin was invented by Satoshi Nakamoto in 20095, but has undergone several changes since then. The bitcoin mining process and the rules and formats for transactions are described in the Bitcoin Protocol. The protocol is updated and amended regularly by developers in a peer-to-peer network, i.e. a computer network without a central server. Bitcoins are created through an online network, open to everyone, in a process called mining. Participants have downloaded a special program for the purpose and contribute their computer processing power to the mining process. Mining can be seen as a form of network maintenance for which the reward is new bitcoins. In practice, mining involves solving complex mathematical algorithms which requires much computing power. Participants compete to verify the most recent transactions by finding the solution for the algorithm. The first participant to offer the correct solution is rewarded with a number of new bitcoins. This method is designed to prevent double-spending of the same bitcoin. The reward received for solving the algorithm is defined in the protocol. The original reward was 50 bitcoins, but approximately every four years the reward is halved, and the current reward is 25 bitcoins. In practice, this means that the total number of bitcoins is finite, 21 million which will be reached in 2140, cf. Chart 1 (left). At the beginning of March, approximately 12.4 million bitcoins had been mined, equivalent to about kr. 40 billion. A bitcoin wallet, installed on a computer or smartphone, is needed to make and receive bitcoin payments. The wallet is a small program that provide access to a number of addresses, each with its own balance of bitcoins. Alternatively, a wallet can be stored online and be accessed through various providers. A bitcoin address is a string of numbers and letters, e.g. 1LmHSKLndRdrfkX12AuTsqA3aEpwuPU9Jg. If a user wishes to pay by bitcoin, he needs to know the payee’s address — just as it is necessary to know the payee’s registration and account numbers to make an ordinary online bank transfer. The transfer is done from the user’s wallet, which broadcasts it to the network for verification. Once verified by the network, the transaction is considered to be final.