What it means
Official currency is backed by law: a government declares it legal tender and demands tax payments in it. A private currency has no such backing, so its value rests on trust and on what the issuer promises to give in return.
Issuing one creates a liability for the issuer. If a retailer hands out points that can later be spent in its stores, it owes future goods or discounts and must record that obligation in its accounts.
Some private currencies are tied to an official currency, with each unit redeemable for a fixed amount, such as one token for one dollar. Others float, so their price moves with demand, and some are valued only inside a network of participating businesses.
A key figure for issuers is breakage, the share of issued units that are never redeemed. Breakage reduces the expected cost to the issuer, but it is an estimate, and accounting rules require it to be supported by evidence from past behaviour.
Regulators watch private currencies closely when they are widely used, because they can look like deposits or payments services. Risks include the issuer failing, the token losing value, and customers being unable to redeem it.
For a finance team the practical tasks are to record the liability, review the breakage estimate each period, and check that any cash set aside matches the units in circulation. Where the currency is redeemable for official money, the reserve should be held in safe assets that can be turned into cash quickly, such as bank deposits.
In practice
Real-world examples.
Example
An airline issues miles to frequent flyers that can be exchanged for flights and upgrades. The miles are sold in bulk to credit card partners, so they form a meaningful revenue stream. Finance defers part of that revenue until the miles are redeemed, and reviews its estimate of unused miles every year.
Example
A small town launches a local currency accepted by 80 shops, with each token worth one dollar and redeemable at a community fund. Residents spend it locally, which keeps money circulating among neighbours. The fund holds dollars equal to the tokens in circulation, and publishes its balance each month so that shopkeepers can see the tokens are fully covered.
Example
An online game sells virtual coins that players spend on in-game items. The company records the cash received as deferred revenue until the coins are used. It also tracks how many coins remain unspent for years, because that history supports the estimate of coins that will never be used.
Formula
Calculation
Expected liability = units outstanding x redemption value per unit x (1 - breakage rate)
Suppose a coffee chain has 2,000,000 loyalty points outstanding. Each point can be redeemed for goods worth $0.01, and the company expects 20% of points never to be redeemed.
Liability before breakage = 2,000,000 x 0.01 = $20,000.
Expected liability = 20,000 x (1 - 0.20) = 20,000 x 0.80 = $16,000.
If breakage turns out to be only 10%, the true cost would be 20,000 x 0.90 = $18,000, which is $2,000 more than provided for.Case study
Seen in the real world.
Harbour Market Co-op is an illustrative, fictional community group that issued paper vouchers worth $5 each to encourage shoppers to buy from local traders. Over a year it sold 40,000 vouchers for $200,000 in cash.
The treasurer kept the cash in a separate account because every voucher was a promise to a trader. By the year end, 34,000 vouchers had been redeemed, leaving 6,000 outstanding with a face value of $30,000.
She recorded $30,000 as a liability and noted that, based on the first year, about 5% of vouchers would probably never be redeemed. In this illustrative story the lesson is that a private currency is only as good as the reserve behind it, and that estimates of unused units need to be reviewed regularly.
Watch out
Common mistakes.
- Counting the cash from selling private currency as revenue straight away, when the issuer still owes goods or services in return.
- Assuming breakage will always stay at the same level, when behaviour changes with expiry rules, promotions and customer mix.
- Treating a private currency as equal to official money, when it may not be accepted everywhere and has no legal backing.
Questions
People also ask.
Is a private currency legal?
In most places it is, provided it does not pretend to be legal tender and respects financial regulation such as the rules on deposits, payments and consumer protection, but the details differ by country and by how the token is used.
Are loyalty points a private currency?
They are a limited form, because they can only be spent with the issuer or its partners, but they still create a liability that must be recorded.
Is a stablecoin a private currency?
Yes, it is issued by a private party and aims to track an official currency, so its safety depends on the quality of the reserves behind it.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related