Virtual currency trading value and volume is soaring all over the world, but the task of regulating virtual currencies and those who provide virtual currency exchange services is far from easy. Jersey believes that it has struck the right balance.

‘Exchangers,’ as they are sometimes known, operate at the interface between the physical and the virtual value chains, exchanging virtual money such as Bitcoin for government-issued fiat money, or vice versa.

Now, the Proceeds of Crime (Miscellaneous Amendments) (Jersey) Regulations 2016, which came into effect on 26 September, have subjected exchangers to Jersey's anti-money laundering laws. They also make virtual currency exchange a supervised business and require exchangers to register with, and fall under the supervision of, the Jersey Financial Services Commission.

To help the island's burgeoning ‘fintech’ sector, the Government is allowing exchangers with turnover of less than £150,000 per calendar year to test virtual currency exchange mechanisms in a live environment without the normal registration requirements and associated costs. It refers to this policy as “setting up a regulatory sandbox.” In doing so it is following in the footsteps of the United Kingdom, whose Financial Conduct Authority rolled out its own scheme in the summer.

Virtual currencies explained in brief

Fiat currency is currency – a small proportion of it in the form of paper or plastic – that a state or collection of states (such as the European Union or East Caribbean Currency Union) has declared to be legal tender, but which is not backed by any physical commodity. The value of fiat money is derived from the law.

Virtual currencies, like most pounds, dollars or other units of fiat currency, have no physical presence. They are, as the name implies, virtual and exist only on a digital distributed decentralised network called a blockchain.

In essence, each virtual currency is a collection of concepts and bits of technology that form the basis of a digital money ecosystem. Each unit of virtual currency (such as Bitcoin, Ether or Ripple) is used to store and transmit value among participants in its own blockchain.

Virtual currencies use cryptography for security, making them incredibly difficult to counterfeit or hack. Importantly, virtual currencies are not issued by any governmental agency, although this is likely to change in the future.

Interest in virtual currency continues to grow and virtual currency trading value and volume has rocketed in recent years. A recent study from Juniper Research, for example, speculated that transaction values in Bitcoin may triple to $92 billion in the last three months of this year. Meanwhile, Japan's leading Bitcoin exchanger has announced that it has surpassed 200,000 customers a month, rising tenfold in 12 months. Putting this in context, roughly 430 billion yen ($4.25 billion) in Bitcoin was traded in Japan in the first half of 2016, up approximately 50 times from the previous year.

Currency or commodity?

The nature of virtual currencies is complex and presents regulators with a problem. They think that regulation can ensure that virtual currencies are not used to facilitate money laundering and terrorist activity. They also want to have monitoring, investigatory and preventative powers over it. The regulation of virtual currencies, however, is difficult.

One question that presents itself is whether people should regard virtual currency as a currency or as a commodity. The Earth’s governments have yet to reach a consensus on the answer to this fundamental question. In the United States, for example, the Treasury has historically taken the view that Bitcoin is a form of currency, but Florida Circuit Court Judge T Pooler recently held in Florida v Espinoza that Bitcoin is not ‘real money.’ In Europe, tax authorities in countries such as Sweden have previously argued that Bitcoin should be treated like a commodity and thus subject to sales tax on transfer, but in 2015 its overlords in the European Union’s Court of Justice ruled that Bitcoin must be treated like a currency for tax purposes and not a commodity, an approach that the UK has also taken.

Two main regulatory possibilities persist: to categorise virtual currencies in a way that subjects them to existing statutory regimes; or to introduce new regulations that focus on it exclusively.

Jersey's regulatory approach

The Jersey regulations define ‘virtual currency’ as any currency which digitally represents value, is a unit of account, functions as a medium of exchange and is capable of being digitally exchanged for money in any form.

Jersey regulates virtual currency as part of its existing statutory regime by treating virtual currency as a currency rather than as a commodity. Exchangers are subject to the existing Money Laundering (Jersey) Order 2008 and the “AML/CFT handbook” and have to pursue normal policies and procedures to prevent and detect money laundering and terrorist finance. Similarly, businesses that trade in goods worth at least €15,000 per transaction in virtual currency are now subject to the Proceeds of Crime (Jersey) Law 1999 as it applies to so-called ‘high-value dealers.’

A ‘safe harbour’ for exempt exchangers

Although the general rule is that exchangers are required to register with, and pay annual fees to, the Jersey Financial Services Commission, ‘exempt exchangers’ (i.e. those under the £150,000 limit) need only notify the JFSC that they are carrying out the business of virtual currency exchanges. The ‘safe harbour’ that Jersey has created for them is expected to reduce the initial burden associated with developing a virtual currency exchange platform through the testing and start-up phases to a significant degree.