# What Is Virtual Currency? Types, Pros & Cons Explained

## What Is a Virtual Currency?

A virtual currency is a digital representation of value. Instead of having a physical form, like paper notes, it is stored and exchanged through designated mobile or computer applications. They can take the form of gaming tokens, cryptocurrencies, or central bank-issued digital currencies.

Virtual currencies can be exchanged through secure, dedicated networks or the open internet. They are generally issued by private parties, central banks, or groups of developers. Due to the lack of regulation, investors should be careful about how they store and spend virtual currencies.

### Key Takeaways

*   Virtual currencies are digital representations of value that exist only electronically and are mainly unregulated.   
    
*   Virtual currencies can be open or closed, with open types like cryptocurrencies convertible to real-world money.   
    
*   Virtual currencies can offer advantages like eliminating intermediaries in transactions and increasing accessibility across geographies.   
    
*   They pose risks including vulnerability to hacking, involvement in scams, and volatile price swings.   
    
*   Virtual currencies differ from digital currencies like central bank digital currencies (CBDCs) and are a subset within the digital currency family.

## A Guide to Virtual Currencies

Virtual currencies are a form of [digital currency](https://www.investopedia.com/terms/d/digital-money.asp). They are issued by private parties, such as a group of developers or organizations, and do not have a physical form like paper money. They include cryptocurrencies and other tokens that hold value.

They differ from officially issued digital currencies called [central bank digital currency (CBDC)](https://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp).  

> **Important**
>
> Virtual currencies have been around for many years, but it's only since Bitcoin was introduced that it became important to define the different types of digital currencies. These definitions may change over time as regulators, academics, and interested parties learn more and become more familiar with them.

## Navigating the Regulatory Landscape of Virtual Currencies

Regulations for virtual currencies, tokens, and assets are still developing worldwide as of June 2024. For example, in 2023, The European Union published a broad definition in its Markets In Crypto Assets (MiCA) regulation. "Crypto-assets are digital representations of value or of rights that have the potential to bring significant benefits to market participants, including retail holders of crypto-assets." According to this rule, a virtual currency may not fall under MiCA jurisdiction in the EU, but it might if it meets this very vague definition.

In the U.S., the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) describes virtual currencies as digital values that are not U.S. dollars or foreign currencies and can be used like money. It also taxes trades involving certain virtual currency types, such as cryptocurrencies.  

The market watchdog, the [Securities and Exchange Commission (SEC)](https://www.investopedia.com/terms/s/sec.asp), has brought U.S.-based [cryptocurrency](https://www.investopedia.com/sec-chief-reiterates-call-for-cryptocurrency-regulation-5201311) exchanges under its supervision and continues to scrutinize all crypto-related products, services, and providers.

## Practical Applications of Virtual Currencies

Virtual currencies have many forms, so there are endless ways that they can be used. Cryptocurrency is most commonly purchased and sold by investors and traders on cryptocurrency exchanges to profit from price fluctuations and increases.

 In some countries, people use them when they lack other payment options or financial services. In its 2023 Geography of Cryptocurrency Report, blockchain and crypto-assets analysis firm Chainalysis reported that cryptocurrency adoption is down from previous years; however, lower-middle-income countries are adopting these currencies at a much higher rate than others.  

Many video games offer virtual currencies you can buy with real money and use to purchase items in-game. Most of these in-game currencies and tokens are not usable outside the game and cannot be transferred. However, there are blockchain-based games that use in-game currency which can be purchased with cryptocurrency. In this case, both currencies are virtual currencies because real-world value is being transferred.

## Exploring the Varieties of Virtual Currencies

Virtual currencies are classified as closed or open based on their network.  

### Closed Virtual Currency

A [closed virtual currency](https://www.investopedia.com/terms/c/closed-virtual-currency.asp) works only within a private system. It cannot be converted into another virtual currency or a real-world fiat currency. Examples of closed virtual currencies are currencies in gaming systems. Though such currencies can be used in their respective environments (in this case, games), they cannot generally be converted into real-world cash.

Airline miles, while not typically thought of as currency, are closed virtual currencies. They are issued by private parties, can only be used to redeem specific items, and cannot be converted into an associated monetary value.   

### Open Virtual Currency 

Open virtual currencies work in broad systems and can convert into different currencies. Examples of open virtual currencies are stablecoins and cryptocurrencies. Bitcoin and Ethereum, the two biggest cryptocurrencies by market capitalization, can be converted into other cryptocurrencies or certain [fiat currencies](https://www.investopedia.com/terms/f/fiatmoney.asp). This conversion process can trigger taxes, depending on how long you hold your cryptocurrency and its market value when you purchased and sold it.  

Though most open virtual currencies have a decentralized setup, some cryptocurrencies might be centralized in design, meaning a central agency is responsible for their production and distribution.

> **Fast Fact**
>
> The in-game currency used in blockchain-based games might be considered an open virtual currency if it can be sold back to the game or to another user.

## Benefits of Using Virtual Currencies

The advantages of virtual currencies are as follows:   

*   Virtual currency technology can remove geographical limits.
*   Decentralized virtual currencies cut out middlemen to connect directly between buyer and seller.
*   Some virtual currencies can be programmed to complete automated transactions. For example, [smart contracts](https://www.investopedia.com/terms/s/smart-contracts.asp) on Ethereum's [blockchain](https://www.investopedia.com/terms/b/blockchain.asp) can hold and release money in escrow accounts without human intervention.
*   Virtual currencies are digital repositories of value and can assign value to disparate sets of objects, from gaming tokens to artwork.  
    

## Challenges and Risks of Virtual Currencies

The disadvantages of virtual currencies are as follows:

*   Hackers often target virtual currencies.
*   Virtual currencies can be used in scams. Several initial coin offerings (ICOs), which became popular after a runup in cryptocurrency prices, were [scams](https://www.investopedia.com/news/ico-scams-are-far-dead/) in which private developers sold worthless tokens for hypothetical networks.
*   Unregulated virtual currencies offer no legal protections because private entities issue them and lack regulation.
*   Virtual currencies with market value can be subject to highly volatile price swings.

## Comparing Digital, Virtual, and Cryptocurrencies

Even though they sound alike and function in a similar manner, digital, virtual, and cryptocurrencies are, in fact, different. Listed below are the main points of difference between the three types of currencies:  

*   Digital currency is the group of currencies all virtual currencies, stablecoins, and CBDCs belong to.
*   Virtual currencies generally encompass cryptocurrency, gaming tokens, or other types of tokens.
*   Cryptocurrencies are virtual currencies that use cryptographic techniques.

## Is Virtual Money Real Money?

If something is generally accepted as a means of exchange, a store of value, or a unit of account, it is considered by most to be money. Virtual money can meet this definition, but not always. For example, virtual money earned in a video game used to purchase in-game items is likely not real money. But if it transitions somehow to being exchanged for money that meets this definition, it could become real money.

## Is Virtual Currency the Same As Cryptocurrency?

Definitions are constantly changing, but by the most currently used ones, cryptocurrency is a form of virtual currency.  

## What Is the Most Valuable Virtual Currency?

Bitcoin is by far the most valuable and popular virtual currency. It took the market by storm in the mid-2010s and has held the top spot for price and market cap ever since.  

## The Bottom Line 

Virtual currencies are digital representations of value that can exist only electronically. They can be exchanged through open networks, such as a public blockchain, or through closed, private networks. While largely unregulated, they have attracted increasing scrutiny from law enforcement.

Advocates say that the advantage of virtual currencies is removing intermediaries and friction to facilitate transactions. However, their volatility and susceptibility to hacks and scams should caution the average retail investor.

 _The comments, opinions, and analyses expressed on Investopedia are for informational purposes only. Read our [](https://www.google.com/url?q=https://www.investopedia.com/legal-4768893%23toc-warranty-and-liability-disclaimer&sa=D&source=editors&ust=1701187225102462&usg=AOvVaw2vAK7IwDAxG_nzGLk-uNEj)[warranty and liability disclaimer](https://www.google.com/url?q=https://www.investopedia.com/legal-4768893%23toc-warranty-and-liability-disclaimer&sa=D&source=editors&ust=1701187225102700&usg=AOvVaw0btcTMmk2NK1hAotP5MOpq) for more info._

> **Article Sources**
>
> 1.  Eur-Lex. "[Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on Markets in Crypto-Assets, and Amending Regulations (EU) No 1093/2010 and (EU) No 1095/2010 and Directives 2013/36/EU and (EU) 2019/1937 (Text With EEA Relevance)](https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32023R1114&pk_campaign=todays_OJ&pk_source=EURLEX&pk_medium=TW&pk_keyword=Crypto%20assets&pk_content=Regulation&pk_cid=EURLEX_todaysOJ)."
>     
> 2.  Internal Revenue Service. "[FAQs About Virtual Currencies](https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions#:~:text=Virtual%20currency%20is%20a%20digital,and%20a%20medium%20of%20exchange.)."
>     
> 3.  Chainalysis. "[The 2023 Geography of Cryptocurrency Report](https://go.chainalysis.com/geography-of-cryptocurrency-2023.html)," Page 7. Requires entering an email account and downloading a file.