Virtual currencies are financial innovations that have grown in number and popularity in recent years. While there is no statutory definition for virtual currency, the term refers to a digital representation of value that is not government-issued legal tender. Unlike U.S. dollars and other government-issued currencies, virtual currencies do not necessarily have a physical coin or bill associated with their circulation. While virtual currencies can function as a unit of account, store of value, and medium of exchange, they are not widely used or accepted. Some virtual currencies can only be used within virtual economies (for example, within online role-playing games) and may not be readily exchanged for government-issued currencies such as U.S. dollars, euro, or yen. Other virtual currencies may be used to purchase goods and services in the real economy and can be converted into government-issued currencies through virtual currency exchanges. In previous work, we described the latter type of virtual currencies as “open flow.” Open-flow virtual currencies have received considerable attention from federal financial regulatory and law enforcement agencies, in part because these currencies interact with the real economy and because depository institutions (for example, banks and credit unions) may have business relationships with companies that exchange virtual currencies for government-issued currencies. Throughout the remainder of this report, we use the term virtual currencies to mean open-flow virtual currencies, unless otherwise stated. Virtual currency systems, which include protocols for conducting transactions in addition to digital representations of value, can either be centralized or decentralized. Centralized virtual currency systems have a single administering authority that issues the currency and has the authority to withdraw the currency from circulation. In addition, the administrating authority issues rules for use of the currency and maintains a central payment ledger. In contrast, decentralized virtual currency systems have no central administering authority. Validation and certification of transactions are performed by users of the system and therefore do not require a third party to perform intermediation activities. A prominent example of a decentralized virtual currency system is bitcoin. Bitcoin was developed in 2009 by an unidentified programmer or programmers using the name Satoshi Nakamoto. According to industry stakeholders, bitcoin is the most widely circulated decentralized virtual currency. The bitcoin computer protocol permits the storage of unique digital representations of value (bitcoins) and facilitates the assignment of bitcoins from one user to another through a peer-to-peer, Internet-based network. Each bitcoin is divisible to eight decimal places, enabling their use in any kind of transaction regardless of the value. Users’ bitcoin balances are associated with bitcoin addresses (long strings of numbers and letters) that use principles of cryptography to help safeguard against inappropriate tampering with bitcoin transactions and balances. When users transfer bitcoins, the recipient provides their bitcoin address to the sender, and the sender authorizes the transaction with their private key (essentially a secret code that proves the sender’s control over their bitcoin address). Bitcoin transactions are irrevocable and do not require the sender or receiver to disclose their identities to each other or a third party. However, each transaction is registered in a public ledger called the “blockchain,” which maintains the associated bitcoin addresses and transaction dates, times, and amounts. Users can define how much additional information they require of each other to conduct a transaction. According to industry observers, examples of technologies used to increase the privacy of participants in virtual currency transactions include (1) anonymizing networks, which use a distributed network of computers to conceal the real Internet address of users, such as The Onion Router (TOR); (2) “tumblers” such as BitcoinBath and BitLaundry that combine payments from multiple users to obstruct identification through the blockchain; and (3) alternative virtual currencies such as Zerocoin and Anoncoin that aim to make transactions fully anonymous. the identities of participants in bitcoin transactions. In addition, researchers have developed methods to determine identities of parties involved in some bitcoin transactions by analyzing clusters of transactions between specific addresses. By design, there will be a maximum of 21 million bitcoins in circulation once all bitcoins have been mined, which is projected to occur in the year 2140. Once all bitcoins have been mined, miners will be rewarded for solving the math problems that verify the validity of bitcoin transactions through fees rather than bitcoins. directly or use third-party payment processors that take payments in bitcoins from buyers and provide businesses the payments in the form of a traditional currency or a combination of bitcoins and traditional currency. Figure 1 shows various ways that individuals can obtain and spend bitcoins. http://blockchain.info. (Accessed on Mar. 31, 2014.) Due to data limitations, it is difficult to calculate the velocity, or the rate at which bitcoins are spent, and the number of transactions between unique users in a given time period. https://blockchain.info. (Accessed on Apr. 1, 2014.) million commercial Automated Clearing House (a traditional payment processor) transactions per day in 2013. While bitcoin is the most widely used virtual currency, numerous others have been created. For example, dozens of decentralized virtual currencies are based on the bitcoin protocol such as Litecoin, Auroracoin, Peercoin, and Dogecoin. Similar to the bitcoin market, the size of the market for these virtual currencies is unclear. However, as of March 31, 2014, the total reported value of each of these currencies was less than $400 million (ranging from about $33 million for Dogecoin to about $346 million for Litecoin). Other virtual currencies that have been created are not based on the bitcoin protocol. One of the more prominent examples is XRP, which is used within a decentralized payment system called Ripple. Ripple allows users to make peer-to-peer transfers in any currency. A key function of XRP is to facilitate the conversion from one currency to another. For example, if a direct conversion between Mexican pesos and Thai baht is not available, the pesos can be exchanged for XRP, and then the XRP for baht. As of March 31, 2014, the total value of XRP was $878 million. Virtual currencies have drawn attention from federal agencies with responsibilities for protecting the U.S. financial system and its participants and investigating financial crimes. These include, but are not limited to, CFPB, CFTC, DHS, DOJ, SEC, Treasury, and the prudential banking regulators. The prudential banking regulators are the FDIC, Federal Reserve, NCUA, and OCC. Within Treasury, FinCEN has a particular interest in the emergence of virtual currencies because of concerns about the use of these currencies for money laundering and FinCEN’s role in Additionally, because virtual currencies (like combating such activity. government-issued currencies) can play a role in a range of financial and other crimes, including cross-border criminal activity, key components of DOJ and DHS have an interest in how virtual currencies are used. Relevant DOJ components include the Criminal Division (which oversees the Computer Crime and Intellectual Property Section and the Asset Forfeiture and Money Laundering Section), the FBI, and the Offices of the U.S. Attorneys (U.S. Attorneys). Relevant DHS components include the Secret Service and ICE-HSI. Money laundering is the process of disguising or concealing the source of funds acquired illicitly to make the acquisition appear legitimate. While federal agencies’ responsibilities with respect to virtual currency are still being clarified, some virtual currency activities and products have implications for the responsibilities of federal financial regulatory and law enforcement agencies. Virtual currencies have presented these agencies with emerging challenges as they carry out their different responsibilities. These challenges stem partly from certain characteristics of virtual currency systems, such as the higher degree of anonymity they provide compared with traditional payment systems and the ease with which they can be accessed globally to make payments and transfer funds across borders. Although virtual currencies are not government-issued and do not currently pass through U.S. banks, some activities and products that involve virtual currencies have implications for the responsibilities of federal financial regulatory and law enforcement agencies. These activities and products encompass both legitimate and illegitimate uses of virtual currencies. Examples of legitimate uses include buying virtual currencies and registered virtual-currency-denominated investment products. Examples of illegitimate uses include money laundering and purchasing illegal goods and services using virtual currencies. The goal of FinCEN administers BSA and its implementing regulations.BSA is to prevent financial institutions from being used as intermediaries for the transfer or deposit of money derived from criminal activity and to provide a paper trail to assist law enforcement agencies in their money laundering investigations. To the extent that entities engaged in money transmission conduct virtual currency transactions with U.S. customers or become customers of a U.S. financial institution, FinCEN has responsibilities for helping ensure that these entities comply with BSA and anti-money-laundering regulations. Under 31 C.F.R. § 1010.100(ff)(1)-(7), money services businesses are generally defined as any of the following: (1) currency dealer or exchanger, (2) check casher, (3) issuer or seller of traveler’s checks or money orders, (4) provider or seller of prepaid access, (5) money transmitter, and (6) the U.S. Postal Service. FinCEN’s regulations define a money transmitter as a person that provides money transmission services, or any other person engaged in the transfer of funds. 31 C.F.R. § 1010.100(ff)(5)(i).The term money transmission services means the “acceptance of currency, funds, or other value that substitutes for currency to another location or person by any means.” Id. services businesses are also required to monitor transactions and file reports on large currency transactions and suspicious activities.