Digital Currency vs Virtual Currency

Digital currency is largely backed and regulated by a Central Bank, often referred to as electronic money. In contrast, virtual currency operates in an unregulated and decentralized manner. According to the Financial Crimes Enforcement Network's ruling on "Application of FinCen’s regulations to virtual currency mining operations," virtual currency functions like currency in some environments, but it does not have all the attributes of a real currency, and it lacks legal tender status anywhere.

The European Central Bank also shares a similar perspective in their publication "Virtual Currency Schemes," identifying Bitcoin as a virtual currency. These digital assets are decentralized, unregulated, and exhibit only a few characteristics of actual currencies.

Bitcoin as Virtual Currency

Bitcoins, which are categorized by the European Central Bank as virtual currency, are decentralized and lack regulation. They are based on cryptographic systems that use both public and private keys. Transactions are recorded on a distributed ledger. As a result, Bitcoin falls under the category of cryptocurrency, with digital currency being a general term that can encompass many types of currency. Bitcoin is an example of a decentralized, unregulated virtual currency with limited attributes of a real currency.

Centralized vs Decentralized Currency

Currency is often classified into centralized and decentralized categories. Centralized currency is governed by a central repository or a designated entity, ensuring trust in transactions. On the other hand, decentralized currencies, like Bitcoin, operate in a peer-to-peer (P2P) system where entities operate independently. Transactions happen directly between users, without a centralized entity, meaning that all parties carry the risk.

IRS Guidance on Virtual Currency

The Internal Revenue Service (IRS) defines virtual currency as property for U.S. federal tax purposes. This means that virtual currency is not treated as actual currency but is treated as an asset subject to capital gains tax. In a notice dated March 25, 2014, the IRS made it clear that virtual currencies like Bitcoin are considered property, and taxes are applied accordingly.

Bitcoin as Convertible Virtual Currency

According to the IRS and the European Union, Bitcoin qualifies as a "convertible" virtual currency because it can be converted into fiat currency or legal tender. It is considered fungible because it has an equivalent value in real currency. While Bitcoin does not have legal tender status, it is widely accepted as a medium of exchange for goods and services.

Digital Goods vs Virtual Goods

Digital goods are products that exist in electronic formats, such as e-books, e-tickets, and downloadable software. In comparison, virtual goods refer to digital assets that exist within a virtual space, such as items in online games. Bitcoin itself is not classified as a digital good, but it serves as a medium to buy digital goods like software or online services. This distinction is crucial as Bitcoin is used for purchasing digital products rather than being classified as one itself.

Bitcoin and Software

Bitcoin operates on a decentralized system, powered by software written in code. This software is often referred to as a "computer program" as per the Indian Copyright Act, 1957. This code defines how Bitcoin transactions are validated, how security is maintained, and how the blockchain operates.