Bitcoin and other virtual currencies could increase the risk of fraud and damage Britain's economy if they are widely adopted, the Bank of England says.
The finite supply of Bitcoins – which are traded between users outside the banking system – meant that an economy where they formed the main currency would be at risk of deflation, the UK’s central bank said.
Most currencies have their supply partly controlled by central banks to keep the amount of currency in circulation in line with the value of goods and services produced in the economy, but Bitcoin is designed to have an upper limit of 21 million coins and more than 13 million are already in circulation.
"The inability of the money supply to vary in response to demand would likely cause greater volatility in prices and real activity," the BoE said.
The currency was introduced in 2009 and has more than 1 million users worldwide with the value currently at roughly £291, but its value has ranged from £224 to £566 so far this year.
Some supporters of Bitcoin view the fixed supply as an advantage, because it stops governments or central banks from altering the currency supply to achieve political or economic goals. The BoE created £375bn of currency between 2009 and 2012 to buy government bonds and support the economy.
And it can also offer far more anonymity than standard banking systems, making it a popular choice for making illicit deals on the Internet.
The central bank did see promise in some of the technology underlying Bitcoin's decentralised payments system, which could be more robust than electronic systems that rely on a handful of banks verifying transactions.
However, this hinged on digital currencies finding a way to retain enough users, known as "miners", to independently verify transactions while keeping transaction costs low enough to compete with banks.
"A significant risk to digital currencies' sustained use (is) that they will not be able to compete on cost without degenerating ... to a monopoly miner, thereby ... exposing them to risk of system-wide fraud," the BoE said.
The bank said Bitcoin did not pose a threat to British financial stability at present.
It estimated no more than 20,000 people in Britain had significant Bitcoin holdings, with fewer than 300 transactions a day nationwide and predicted that unpredictable exchange rates and the prospect of rising transaction costs might limit the widespread adoption of virtual currencies
Roughly 60 per cent of Bitcoin trading is against the Chinese yuan, 32 per cent is against the dollar and 3 per cent against the euro, the BoE said.