Virtual currency trading value and volume is soaring globally, but regulating virtual currencies and those who provide virtual currency exchange services (Exchangers) is challenging.
Exchangers operate at the interface between the physical and the virtual value chains, exchanging virtual money, such as Bitcoin, into tangible, so-called "fiat" money, or vice versa.
Now, the Proceeds of Crime (Miscellaneous Amendments) (Jersey) Regulations 2016 (the Regulations), which came into effect on 26 September 2016, have brought Exchangers within the ambit of Jersey's anti-money laundering legislation. Like other financial services businesses, Exchangers must comply with the island's laws, regulations, policies and procedures aimed at preventing and detecting money laundering and terrorist financing.
The Regulations 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 (JFSC).
But in a nod to the island's burgeoning Fintech sector, an innovative regulatory sandbox has been created, allowing Exchangers with turnover of less than £150,000 per calendar year to test virtual currency exchange delivery mechanisms in a live environment without the normal registration requirements and associated costs.
As such, the Regulations offer a measured approach to risk, create further opportunities for the Fintech community and place Jersey at the forefront of regulatory development in this sector.
Background to virtual currencies
Fiat currency is paper based currency that a government, State or collection of countries (such as the European Union) has declared to be legal tender, but which is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that the money is made of. Most modern paper/plastic currencies are fiat currencies; they have no intrinsic value and are used solely as a means of payment.
Virtual currencies, on the other hand, 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 technologies that form the basis of a digital money ecosystem. Each unit of virtual currency (such as Bitcoin, Ether or Ripple, for example) is used to store and transmit value among participants in a particular blockchain.
Virtual currencies use cryptography for security, making them incredibly difficult to counterfeit or hack. Importantly, virtual currencies are not issued by any central authority, 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 2016. 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 challenges to regulatory systems. Regulation is needed to ensure virtual currencies are not used to facilitate money laundering and terrorism activities and to give regulators associated monitoring, investigatory and preventative powers.
But regulating virtual currencies is difficult. How does a centralised government system regulate an application that exists on a decentralised, deliberately anonymous technology platform (blockchain) which has no obvious rules that govern it?
The starting point for addressing the question of regulation is determining the nature of the "application" in this context. Should virtual currency properly be regarded as a currency or a commodity?
Globally, it seems we are yet to reach a consensus on the answer to this fundamental question. In the US, for example, the United States Treasury has historically taken the view that Bitcoin is a form of currency, whilst a Florida Circuit Court Judge recently held 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; however, in 2015 the European Union’s Court of Justice ruled that for tax purposes, Bitcoin must be treated like a currency and not a commodity, an approach also followed by the UK.
With this lack of consensus on the nature of virtual currencies, it is perhaps no surprise that a consistent approach to their regulation has yet to emerge. Two main possibilities persist: to categorise virtual currencies in a way that folds them into existing statutory regimes; or to introduce new regulations focussing specifically on virtual currency.
Jersey's regulatory approach
Consistent with the European and UK approach, the Regulations adopted in Jersey amend the Proceeds of Crime (Jersey) Law 1999 (the 1999 Law) to provide for virtual currency to be categorised as a form of currency. Specifically, the Regulations define virtual currency widely as any currency which (whilst not itself being issued by, or legal tender in, any jurisdiction) 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.
By treating virtual currency as a currency rather than as a commodity, Jersey's approach has been to regulate virtual currency within its current statutory regime. Exchangers will be subject to the existing Money Laundering (Jersey) Order 2008 and the AML/CFT handbook and will be required to adopt normal policies and procedures to prevent and detect money laundering and terrorist financing. Similarly, businesses trading in goods worth at least €15,000 per transaction who receive payment in virtual currency have been brought within the same legislative regime applicable to so-called "high value dealers" under the 1999 Law.
Regulatory sandbox for Exempt Exchangers
However, in one important aspect, Jersey has combined the different regulatory approaches mentioned above by introducing a bespoke carve-out to the existing statutory regime for Exchangers with a turnover of less than £150,000 per calendar year (Exempt Exchangers). Although the general rule is that Exchangers are required to register with, and pay annual fees to, the JFSC, Exempt Exchangers will simply need to notify the JFSC that they are carrying on the business of virtual currency exchange.
As such, whilst the JFSC will still maintain overall supervisory and investigative powers in relation to such Exempt Exchangers, Jersey has effectively created a safe harbour in which they can test innovative products, services, business models and delivery mechanisms in a live environment without immediately being subject to the usual costs associated with obtaining registered status. This is expected greatly to reduce the initial burden associated with developing a virtual currency exchange platform through the testing and start-up implementation phases.
The application of a ‘regulatory sandbox’ in this specific and evolving area of regulation is innovative. The establishment of a £150,000 economic threshold for Exchangers creates a fair balance between giving innovators the chance to explore the opportunities created by virtual currencies, while applying a measured regulatory approach.
A clear trend is emerging - virtual currency use is on the rise and is heading into the mainstream. Jersey is an optimum jurisdiction from which to make that leap.
 Holden, W. 16 September 2016 "The Future of Blockchain Deep Dive Data & Forecasting 2016-2021" Published by Juniper Research.
 "Florida v. Espinoza". 22 July 2016 F14-2923, Circuit Court of the Eleventh Judicial Circuit in and for Miami-Dade County, Florida. Circuit Court Judge T. Pooler
 Opinion of Advocate General Kokott.16 July 2015 Digital reports (Court Reports - general). ECLI identifier: ECLI:EU:C:2015:498 "Sktteverket v David Hedqvist"