Closed Virtual Currency

What Is a Closed Virtual Currency?

A closed virtual currency is an unregulated digital currency used as payment only within certain virtual communities. It has no connection to the real economy and cannot be converted to legal tender. Closed virtual currencies are also known as non-convertible virtual currencies, closed-loop currencies, closed-flow virtual currencies, or in-world money. These are in contrast to open or convertible virtual currencies that are directly exchangeable.

How Closed Virtual Currencies Work

Technology advancements all over the globe are driving disrupting changes in the traditional way of doing things, including the way goods and services are acquired and paid for. The rise of e-commerce and virtual community platforms has led to a demand for alternative means of conducting transactions.

One rapidly evolving payment technology that is making waves in the digital world is virtual currencies, for instance, in the case of bitcoin, a type of digital money used to purchase real-world goods or services online but is not recognized as legal tender in many countries — note that El Salvador (in June 2021) became the first country to recognize bitcoin as legal tender.

Types of closed virtual currencies include frequent flyer miles, loyalty points, and video arcade tokens.

Closed vs. Open Virtual Currencies

Virtual currency can be either open or closed in regards to its reach. An open virtual currency can be substituted for real money using online exchange systems or ATMs that are designed for virtual to real currency exchanges.

An example of an open virtual currency is bitcoin, the most popular decentralized cryptocurrency online. Because open currencies have a determinable value in real money and can be exchanged for real money, they are treated as properties or capital assets for tax purposes in the U.S.

Closed virtual currencies were created to operate in closed-loop environments and are limited to transactions in virtual goods within the closed environment. A closed platform allows for real currency to be exchanged for its virtual currency. In contrast, open virtual currencies can be redeemed for real goods and real currency.

Closed virtual currencies are centralized by design, compared with decentralized peer-to-peer currencies like bitcoin that are ungoverned by any central authority. With a closed virtual currency, there is a central system that issues the currency, establishes rules for its use, records transactions made by its users, and reserves the right to withdraw the currency from circulation.

Closed Virtual Currency Criticisms

There are some prevalent setbacks with closed currencies. The currency is usually illiquid and digitally scarce with no way to create more of it, unlike bitcoin mining, which creates more bitcoins for its users. A user can lose all of their earned coins in a matter of seconds through cyber thefts, software bugs, or account termination initiated by the virtual administrator or the user themself.

Real-World Example of a Closed Virtual Currency

Think of closed virtual currencies as closed-loop payment cards like the Nordstrom store credit card that can only be used in Nordstrom. Further, the currencies used in many online games are closed. Virtual assets acquired in-game can be traded for other in-game tools or currency and therefore, do not produce any taxable income.

Examples of closed-loop virtual gaming platforms and their specialty currencies include: