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5.8 Community (Complementary) Currency Systems 5.8.1 Types of System The most common type of complementary currency system at present is the Liberty Dollar with 62 systems registered, followed by the Mutual Credit System with 17, Local Exchange Trading System (LETS) with 16 registrations , Voucher Currency System 11, Barter System and REGIO System with 7 registrations each. However, LETS system had the most members with 102,940, followed by Time Banks with 20,000 members and Mutual Credit Systems with 17,530 members. Figure 11: Complementary Currency Systems Prevalence

5.8.2 Type of Organization Although some types of organizations prefer to be non-formal and non-registered, the vast majority of complementary currency systems are formally registered as a private enterprise or non-government organization, with only 28 out of 150 organizations not formally registered. Figure 12: Complementary Currensy System Organization Type

5.8.3 Medium of Exchange Regarding the Medium of Exchange used, Direct Barter is listed as the most common, followed Paper Notes, Accounts and Electronic Transactions. Figure 13: Complementray Currency System Medium of Exchange

5.8.4 Complementary system and virtual currency schemes Social inclusion, community development and other social and community goals has been the main reasons for implementing systems, the rapid development of systems outside of the G8 countries is shifting the purpose for starting systems towards socio-economic development, promoting micro, small and medium enterprise development and activating the local marketplace. In connection with the high penetration of the internet, there has also been a proliferation of virtual communities in recent years. A virtual community is to be understood as a place within cyberspace where individuals interact and follow mutual interests or goals. In some cases, these virtual communities have created and circulated their own digital currency for exchanging the goods and services they offer, thereby creating a new form of digital money. The existence of competing currencies is not new, as local, unregulated currency communities existed long before the digital age. These schemes can have positive aspects if they contribute to financial innovation and provide additional payment alternatives to consumers. However, they can also pose risks for their users, especially in view of the current lack of regulation. Definition of virtual currency: “a virtual currency is 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”. The definition of virtual currency schemes excludes an entity like PayPal, the internet-based payment system because it is supervised by the Commission de Surveillance du Secteur Financier of Luxembourg and the electronic money scheme is overseen by the Banque centrale du Luxembourg. Table 23: Electronic money schemes/Virtual currency schemes

Money format Digital Unit of account Traditional currency (euro, US dollars, pounds, etc.) with legal tender status Invented currency (Linden Dollars, Bitcoins, etc.) without legal tender status Acceptance By undertakings other than the issuer Usually within a specific virtual community Legal status Regulated Unregulated Issuer Legally established electronic money institution Non-financial private company Supply of money Fixed Not fixed (depends on issuer’s decisions) Possibility of redeeming funds Guaranteed (and at par value) Not guaranteed Supervision Yes No Type(s) of risk Mainly operational Legal, credit, liquidity and operational Virtual currency schemes can be considered to be a specific type of electronic money, basically used for transactions in the online world. However, a clear distinction should be made between virtual currency schemes and electronic money. According to the Electronic Money Directive (2009/110/EC), “electronic money” is monetary value as represented by a claim on the issuer which is: stored electronically; issued on receipt of funds of an amount not less in value than the monetary value issued; and accepted as a means of payment by undertakings other than the issuer. Although some of these criteria are also met by virtual currencies, there is one important difference. In electronic money schemes the link between the electronic money and the traditional money format is preserved and has a legal foundation, as the stored funds are expressed in the same unit of account (e.g. US dollars, euro, etc.). In virtual currency schemes the unit of account is changed into a virtual one (e.g. Linden Dollars, Bitcoins). Electronic money schemes are regulated and electronic money institutions that issue means of payment in the form of electronic money are subject to prudential supervisory requirements. This is not the case for virtual currency schemes. 5.8.5 Examples of virtual currency models The Bitcoin scheme Designed and implemented by the Japanese programmer Satoshi Nakamoto in 2009, the scheme is based on a peer-to-peer network similar to BitTorrent, the famous protocol for sharing files, such as films, games and music, over the internet. It operates at a global level and can be used as a currency for all kinds of transactions (for both virtual and real goods and services), thereby competing with official currencies like the euro or US dollar. The scheme maintains a database that lists product and service providers which currently accept Bitcoins. These products and services range from internet services and online products to material goods (e.g. clothing and accessories, electronics, books, etc.) and professional or travel/tourism services. Bitcoins are not pegged to any real-world currency. The exchange rate is determined by supply and demand in the market. There are several exchange platforms for buying Bitcoins that operate in real time. Mt.Gox is the most widely used currency exchange platform and allows users to trade US dollars for Bitcoins and vice versa. Bitcoin is based on a decentralized, peer-to- peer (P2P) network, i.e. it does not have a central clearing house, nor are there any financial or other institutions involved in the transactions. Bitcoin users perform these tasks themselves. In the same vein, there is no central authority in charge of the money supply. In order to start using Bitcoins, users need to download the free and open-source software. Purchased Bitcoins are thereafter stored in a digital wallet on the user’s computer. Consequently, users face the risk of losing their money if they don’t implement adequate antivirus and back-up measures. Users have several incentives to use Bitcoins. Firstly, transactions are anonymous, as accounts are not registered and Bitcoins are sent directly from one computer to another. Also, users have the possibility of generating multiple Bitcoin addresses to differentiate or isolate transactions. Secondly, transactions are carried out faster and more cheaply than with traditional means of payment. How Bitcoin transaction works (technical description) According to the founder, Nakamoto (2009), an electronic coin can be defined as a chain of digital signatures. Each owner of the currency (Pi) has a pair of keys, one public and one private. These keys are saved locally in a file and, consequently, a loss or deletion of the file would mean that all Bitcoins associated with it are lost as well. Every single Bitcoin carries the entire history of the transactions it has undergone, and any transfer from one owner to another becomes part of the code. The Bitcoin is stored in such a way that the new owner is the only person allowed to spend it. All signed transactions are then sent to the network, which means that all transactions are public transactions, although no information is given regarding the involved parties. The key issue to be addressed by the system is the avoidance of double spending, i.e. how to prevent a coin being copied or forged, especially considering there is no intermediary validating the transactions. The solution implemented is based on the concept of a “time stamp”, which is an online mechanism used to ensure that a series of data have existed and have not been altered since a specific point in time, in order to get into the hash. Each time stamp includes the previous time stamp in its hash, forming a chain of ownership. By broadcasting the new transactions, the network can verify them. The systems that validate the transactions are called “miners” – essentially these are extremely fast computers in the Bitcoin network which are able to perform complex mathematical calculations that aim to verify the validity of transactions. The people who use their systems to undertake this mining activity do soon a voluntary basis, but they are rewarded with 50 newly created Bitcoins every time their system finds a solution.“Mining” is therefore the process of validating transactions by using computing power to find valid blocks (i.e. to solve complicated mathematical problems) and is the only way to create new money in the Bitcoin scheme. The Bitcoin scheme is designed as a decentralized system where no central monetary authority is involved. Bitcoins can be bought on different platforms. However, new money is created and introduced into the system only via the above-mentioned mining activity, i.e. by rewarding the “miners” who perform the crucial role of validating all transactions made, with new Bitcoins. Therefore, the supply of money does not depend on the monetary policy of any virtual central bank, but rather evolves based on interested users performing a specific activity. From time to time, Bitcoin is surrounded by controversy. Sometimes it is linked to its potential for becoming a suitable monetary alternative for drug dealing and money laundering, as a result of the high degree of anonymity. On other occasions, users have claimed to have suffered a substantial theft of Bitcoins through a Trojan that gained access to their computer. The Electronic Frontier Foundation, which is an organization that seeks to defend freedom in the digital world, decided not to accept donations in Bitcoins anymore. Among the reasons given, they considered that “Bitcoin raises untested legal concerns related to securities law, the Stamp Payment Act, tax evasion, consumer protection and money laundering, among others”. Bitcoin has also featured in the news, in particular following a cyberattack perpetrated on 20 June 2011, which managed to knock the value of the currency down from USD 17.50 to USD 0.01 within minutes. Apparently, around 400,000 Bitcoins (worth almost USD 9 million) were involved. According to currency exchange Mt.Gox, one account with a lot of Bitcoins was compromised and whoever stole it (using a Hong Kong based IP to login) first sold all the Bitcoins in there, only to buy them back again immediately afterwards, with the intention of withdrawing the coins. The USD 1,000/day withdrawal limit was active for this account and the hacker was only able to exchange USD 1,000 worth of Bitcoins. Apart from this, no other accounts were compromised, and nothing was lost. Second Life is a virtual community Second life virtual community created by Linden Lab (Linden Research, Inc.), a privately held company based in San Francisco. The main idea behind Second Life is to create an opportunity for people to change all the things about their life that they dislike. This virtual world mirrors the real world, and its users – called residents – interact with each other and perform their daily tasks and activities just as they do in real life (e.g. meeting friends, playing, writing or organizing a party). They can also engage in a business project or buy a house, a car or a yacht. In this virtual world, users do not have to face any kind of restriction. Users need to install software on their computers and open a free Second Life account to make use of the virtual world. A premium membership option (USD 9.95 per month, USD 22.50 quarterly, or USD 72 per year), which extends access to an increased level of technical support, is also available. The number of users registered on 28 November 2011 was more than 26 million. Once they have subscribed, users become residents and they can start using this online world by creating avatars – the residents’ digital representation – which may take any form they choose (human, animal, vegetable, mineral, or a combination thereof) or even their own image in real life. A resident account can only have one avatar at a time. Nevertheless, residents are free to change the form of their avatars at any time. Residents can earn money in different ways. They can sell whatever they are able to create; they can also profit from their previous investments (e.g. buying a house and then selling it at a higher price), but they can also win prizes in events. In the Second Life economy, people create items, such as clothes, games or spacecraft, and then sell them within the community. Most of the money earned comes from the virtual equivalent of land speculation, as people lease islands or erect buildings and then rent them out to others at a premium. The economy within Second Life works in a similar way to any other economy in the world, but exhibits some specific features. 1. It is a self-sufficient economy, i.e. a closed economy where no activity is conducted with the outside; secondly, it is only focused on virtual goods and services; and thirdly, it is generated and takes place entirely within Linden Lab’s infrastructure. Everything else is quite similar to a normal economy. 2. Second Life has its own economic agents (buyers, sellers and even an online-community regulator) interacting in its economic system and conducting commerce; the factors of production are the same as in a real economy (labor, capital and land); and the price system is the mechanism in charge of resource allocation. 3. Second Life is focused on the virtual world, but this does not mean that everything is virtual in this community. There are real economic transactions behind Second Life and there are also real issues and problems that arise. 4. Within Second Life, Linden Lab is the only authority and regulator. To some extent they also oversee the system, but without the involvement of any public authority. 5. It is not even clear if any authority even needs to be involved. In fact, in the current situation, any potential issue within this virtual marketplace can perhaps be regarded in the context of consumer 6. Second Life goes beyond a regular online game. From an economic and financial point of view, 7. Second Life exhibits specific features that link this virtual world with the real world. Firstly, as stressed above, some companies are starting to use the online world for merchandising their products. Also, virtual businesses have been set up and obtain real profits in Second Life. Secondly, it seems that some residents have been able to earn significant amounts of real money with their financial transactions, but in the process have assumed high levels of risk. Special attention also needs to be paid to counterparty risk and fraud risk. Users are not protected against either, but both are real risks that exist in this virtual environment. Users generally do not know the reliability of the counterparty with which they are doing business. In this context, the lack of regulation and information required to open an account might create the adequate conditions for criminals, terrorists, fraudsters and money launderers. The extent to which any money flows can be traced back to a particular user is unknown. 5.8.6 Virtual currency schemes and P4All

Although in practical terms virtual currency schemes are only an evolution, from a conceptual point of view they do present substantial changes when compared to real currencies and payment systems. Conventional actors like financial institutions, clearing houses and central banks are absent from these schemes. They, however, proliferate against the background of the huge growth in access to and use of the internet and as a result of the technical innovations behind these schemes. Moreover, they are not often bound to a specific country or currency area, which complicates law making, regulating and law enforcing. Although these schemes can have positive aspects in terms of financial innovation and the provision of additional payment alternatives for 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 the users of the schemes. However, it can reasonably be expected that the growth of virtual currencies will most likely continue, triggered by several factors: • the growing access to and use of the internet and the growing number of virtual community users • the increase of electronic commerce and in particular digital goods, which is the ideal platform for virtual currency schemes • the higher degree of anonymity compared to other electronic payment instruments that can be achieved by paying with virtual currencies • the lower transaction costs, compared with traditional payment systems; and • the more direct and faster clearing and settlement of transactions, which is needed and desired in virtual communities By implementing a virtual currency scheme focused on the online world (basically for virtual goods and services) an enterprise or organization a supplier can generate additional revenue. The use of virtual currencies can help motivate users by simplifying transactions and by preventing them from having to enter their personal payment details every time they want to make a purchase. It can also help lock users in if, for instance, it is possible to earn virtual money by logging in periodically. Virtual currencies can also be used as an important tool for application developers and advertisers when designing a strategy to reap the benefits of the virtual goods market. It is however important that the use of virtual schemes in an inclusive ecosystem have to prevent the following consequences: • Pose a risk to price stability, provided that money creation continues to stay at a low level • Jeopardize financial stability owing to their limited connection with the real economy, their low volume traded and a lack of wide user acceptance • Not regulated and are not closely supervised or overseen by any public authority, even though participation in these schemes exposes users to credit, liquidity, operational and legal risks • Do not 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 • Do not 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 properly Challenges in using virtual currency schemes, in an inclusive ecosystem: 1. the preservation of the unit of account 2. the risks to the effectiveness of monetary policy and its implementation 3. the possible distortions to the information content of monetary aggregates Further, conceptually, virtual currency schemes could have an impact on price stability and monetary policy if they affect the demand for the central bank’s liabilities and interfere in the control of the supply of money through open market operations. Overall, these schemes could affect price stability if: 1. they substantially modify the quantity of money 2. they have an impact on the velocity of money, the use of cash, and/or influence the measurement of monetary aggregates 3. there is an interaction between the virtual currencies and the real economy However, the impact on the quantity of money is difficult to assess, because the lack of reliable information at this level. The impact on the velocity of money, the use of cash, and/or influence the measurement of monetary aggregates is a measure of how a unit of currency is spent to purchase goods and services produced in the economy. It is however, not clear how the technological innovations presented by virtual currency schemes might affect the velocity of money in an inclusive ecosystem. In an extreme case, virtual currencies could have a substitution effect on central bank money if they become widely accepted by all the stakeholders. The increase in the use of virtual money might lead to a decrease in the use of “real” money, thereby also reducing the cash needed to conduct the transactions generated by nominal income. The third aspect, the interaction between the virtual currencies and the real economy has impacts globally. In some countries, like in China, virtual currency scheme (Q-coin) can be bought with a credit card or by using balance on pre-paid cards i.e. phone pre-paid cards. Risks associated with this alternative can be the growing of black market or illegal money. The big difference from real money is, however, that there is no country or currency area behind the virtual currency scheme and therefore the exchange rate is not affected as seriously by the strength of the (virtual) economy, its trade imbalances or its productivity.

The price of the virtual currency and its volatility in an ecosystem depends consequently on five main factors: 1. The supply of money and other issuer actions, such as the decision to intervene in the market in order to maintain a fixed or semi-fixed exchange rate. Typically, the exchange rate is set in a bid/ask spread, although, for instance, Linden Lab also implements its own type of “monetary policy” measures to stabilize it. 2. The dimension of the network. Virtual currency schemes exhibit network externalities, i.e. the value of the currency will also depend on how many users and merchants use and accept it. Therefore, it can be expected that, as the size of the network (consumers and merchants) grows, the currency’s value will increase accordingly. Moreover, virtual currency schemes with low trading volumes are expected to suffer more volatility in their exchange rates, as the exchange transaction of only a few users could alter the value of the currency. 3. Institutional conditions governing the virtual community. The virtual communities that have clear and transparent policies and state-of-the-art security measures are more likely to generate confidence and have stronger currencies. 4. The virtual currency issuer’s reputation for meeting its commitments. Since virtual currency payments are not settled in central bank money or commercial bank money, nor is there any lender of last resort, a crucial element affecting the virtual exchange rate is the trust gained by the virtual currency issuer. 5. Speculations regarding the future value of the currency and history of cyberattacks suffered in the virtual community. The true impact of virtual currency schemes in an inclusive ecosystem will consequently largely depend on the number of active users, as well as the number of merchants willing to accept the virtual currency for real transactions. In addition, the fact that these currencies have only exchange value and no use value may also pose a problem. Users of the system actually exchange real currency for computing bits. There is normally no asset with intrinsic value underlying the virtual currency, nor is there any central bank backing the currency and acting as lender of last resort. At the same time, these markets are illiquid and rely on others wanting to join the scheme. As a consequence, users face a substantial liquidity risk and could end up owning bits that no one wants to buy. At the moment, these schemes do not allow borrowing or lending. But this may change in the future. Another important issue is the lack of regulation. The legal basis of a payment system consists of framework legislation, as well as specific laws, regulations, and agreements governing both payments and the operation of the system. Virtual currency schemes visibly lack a proper legal framework, as well as a clear definition of rights and obligations for the different parties. Key payment system concepts such as the finality of the settlement do not seem to be clearly specified. Furthermore, the global scope that most of these virtual communities enjoy not only hinders the identification of the jurisdiction under which the system’s rules and procedures should eventually be interpreted, it also means the location of the participants and the scheme owner are hard to establish. As a consequence, governments and central banks would face serious difficulties if they tried to control or ban any virtual currency scheme, and it is not even clear to what extent they are. In the EU, there are some who suggest that Bitcoin could fall under the Electronic Money Directive (2009/110/EC). This Directive uses three criteria to define electronic money: (i) it should be stored electronically; (ii) issued on receipt of funds of an amount not less in value than the monetary value issued; and (iii) accepted as a means of payment by undertakings other than the issuer. Another European law that might have some relevance to virtual currency schemes like Bitcoin is the Payment Services Directive (2007/64/EC). This Directive lays down rules on the execution of payment transactions where the funds are electronic money, yet it does not regulate the issuance of electronic money, nor does it amend the prudential regulation of electronic money institutions as provided for in the Electronic Money Directive. Therefore, the new category of payment service provider it introduces – payment institutions – should not be allowed to issue electronic money. As a consequence, Bitcoin clearly falls outside the scope of the Payment Services Directive. 5.8.7 Consequences for the design of an inclusive ecosystem • The system should have a well-founded legal basis under all relevant jurisdictions. • The system’s rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the financial risks they incur through participation in it. • The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks • The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day • A system in which multilateral netting takes place should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single settlement obligation. • Assets used for settlement should preferably be a claim on the central bank; where other assets are used, they should carry little or no credit risk. • The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily processing. • The system should provide a means of making payments which is practical for its users and efficient for the economy. • The system should have objective and publicly disclosed criteria for participation, which permit fair and open access • The system’s governance arrangements should be effective, accountable and transparent.