The second categorization of virtual currencies is whether the virtual currency has a centralized administrating authority or not. A virtual currency with a central administrating authority is called a “centralized” virtual currency. A virtual currency with no central administrating authority is called a “decentralized” virtual currency.

All non-convertible virtual currencies are centralized. By definition, they are issued by a central authority that establishes rules making them non-convertible. Convertible virtual currencies may be either centralized or decentralized.

Centralized Virtual Currencies have a single administrating authority (administrator) – i.e., a third party that controls the system. An administrator issue the currency establishes the rules for its use, maintains a central payment ledger and has the authority to redeem the currency (withdraw it from circulation). The exchange rate for a convertible currency may either be floating – i.e., determined by market supply and demand for the virtual currency – or pegged – i.e., fixed by the administrator at a set value measured in fiat currency or another real-world store of value, such as gold or a basket of currencies. Currently, the vast majority of virtual currency payment transactions involve centralized virtual currencies. Examples: E-gold (defunct); Liberty Reserve dollars/euros (defunct); Second Life “Linden dollars”; PerfectMoney; WebMoney “WM units”; and World of Warcraft gold.”

A third party in the context of this categorization is an individual or entity that is involved in a transaction but is not one of the principals and is not affiliated with the other two participants in the transaction – i.e., a third-party function as a neutral entity between the principals in a business or financial transaction.

Decentralized Virtual Currencies (a.k.a. crypto-currencies) are distributed, open-source, math-based peer-to-peer virtual currencies that have no central administrating authority and no central monitoring or oversight. Examples: Bitcoin; Ethereum; LiteCoin; and Ripple.”

The most typical example of a decentralized virtual currency is Bitcoin, although there are others. Decentralized virtual currencies typically operate based on a peer-to-peer network through which transactions are managed. Information about transfers of ownership propagates through the network. After a short period of time, when the transactions are confirmed, the security and integrity of the value transfer are assured.


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