19 March 2014

Significant risk attached to use of virtual currency

Central Bank of Iceland

Virtual currency can be described as a digital medium of exchange. Bitcoin is a known example of virtual currency. Another recent example is Auroracoin, which has been described as a “special virtual currency for Iceland.” 

Neither Auroracoin nor Bitcoin is a recognised currency or form of legal tender in the sense of Icelandic law. It should be noted that, according to Article 5, Paragraph 1 of the Act on the Central Bank of Iceland, no. 36/2001, the Central Bank of Iceland is the only entity in Iceland that is authorised to issue banknotes, coin, and other currency that could be exchanged by people instead of banknotes and legal coin. Virtual currency is not electronic money in the sense of the Act on the Issuance and Handling of Electronic Money, no. 17/2013, as it does not represent a claim on the issuer. 

The use of virtual currency also falls outside the scope of the Act on Payment Services, no. 120/2011. To the best of the Bank’s knowledge, the issuer of Auroracoin is not a licensed operator subject to supervision by a financial supervisory entity, nor are the issuers of Bitcoin and other comparable virtual currencies. 

The use of Auroracoin for payment is based on an agreement between the payer and the recipient, and the settlement risk rests entirely with the holder of the virtual currency. In other words, users of Auroracoin (including consumers) enjoy none of the protection that, by law, extends to customers of payment service providers. Users of Auroracoin are not protected by the substantive rules of Acts no. 120/2011 and 17/2013, which include provisions on redemption requirements and responsibility of the parties in cases involving unauthorised payments, nor are they protected by deposit insurance, as deposits in financial institutions are. The value of virtual currency is based solely on supply and demand, and it should be noted in particular that the Icelandic authorities are not responsible or liable for the value or stability of Auroracoin. 

Governmental and legislative authorities around the world are faced with the demanding task of eliminating the legal vacuum surrounding virtual currency. The European Union is working towards a solution that will probably entail amendments to pan-European regulatory instruments. 

The Central Bank of Iceland has kept abreast of developments in electronic payment intermediation on the basis of Article 4 of Act no. 36/2001, including developments in virtual currency, and regularly assesses the potential impact on payment systems and the financial system as a whole. Until now, virtual currency has been used very little in payment intermediation in Iceland. The Central Bank is of the opinion that financial stability is not affected by use of and/or transactions with virtual currency. 

It should also be noted that the purchase and sale of virtual currency has been examined within the Central Bank in connection with enforcement of the Foreign Exchange Act, no. 87/1992. The Bank is of the opinion that there is no authorisation to purchase foreign currency from financial institutions in Iceland or to transfer foreign currency across borders on the basis of transactions with virtual currency. For this reason alone, transactions with virtual currency are subject to restrictions in Iceland. 

Finally, the Bank wishes to reiterate that use of virtual currency can be extremely risky, as recent experience shows that the value of virtual currency in terms of recognised currencies can fluctuate widely.

Further information can be obtained from Már Guðmundsson, Governor of the Central Bank of Iceland, at tel: +354 569 9600.

No. 9/2014
March 19 2014