The QQ All-in-One Card is issued by Tencent and China Merchants Bank in Hangzhou, Zhejiang Province, on November 8, 2005.

The virtual world seems to be making inroads into reality, though there are signs that the government is fighting back.

In the latest wrinkle in the fabric separating reality from virtual reality, virtual money is being exchanged for real yuan on a booming scale. The practice is so widespread that it has raised concerns that virtual money could challenge the renminbi's status as the only legitimate currency in China.

Last month, the country's top financial and Internet regulatory officials made repeated public statements about how they were weighing different proposals to manage the virtual economy.

Tencent, China's largest instant messaging service provider and the issuer of the virtual Q Coin, took the message to heart and filed a lawsuit against a website that exchanges the money in a bid to clamp down on the cross-over economy.

The company, which is listed on the Hong Kong Stock Exchange (SEHK 700), has not been affected by the situation, and its stock price remains steady.

Still, analysts said the involvement of top financial regulators would only spur the development of virtual money.

The possibility of regulatory action was first raised by Li Chao, spokesman for the People's Bank of China (PBOC), on November 3. He said at a working conference in Southwest China's Chongqing Municipality that virtual money had become a cause for concern and that the PBOC would draft a regulation covering virtual transactions next year.

A week later, Xie Zhong, deputy director of the PBOC's Payment System Department, said the central bank was drawing up regulations, but did not reveal details.

Su Ning, vice-president of the PBOC, told a working conference on December 14 that imposing regulations on virtual money would ease the risk posed by the virtual currency trade. "The risks could be large," he said. "When money is saved in virtual accounts on websites, it can be used for investments or simply grabbed."

Any potential regulations would cover virtual accounts, transactions and also money, he added.

Besides financial regulators, Internet regulators also have their eyes on the virtual economy.

"Virtual money has been a source of great concern for the government because it reflects a kind of Internet addiction," Tuo Zuhai, deputy director of the Ministry of Culture's market department, which monitors the Internet, was quoted as saying by the Nanfang Daily on December 8.

"It is becoming the focus of our work to look into websites involved in exchanging virtual money into real yuan, in buying and selling virtual items and in hacking into other people's accounts to plunder their reserves," he said in the report.

These remarks were part of the growing debate over the legitimacy of the virtual money.

The issue came to light last month when Yang Tao, a public prosecutor in East China's Jiangxi Province, published an article in the Chinese-language magazine Law and News asking whether virtual Q coins were a threat to the yuan.

More than 22.4 million people use Tencent's QQ messaging service, and the Q coin is widely regarded as a more convenient currency for paying for online services than the RMB.

Q coin holders have their own accounts at Q banks. They can buy the virtual coins from Tencent's official website for 1 yuan (13 US cents) per coin, or from online vendors at about half the price.

They mainly use Q coins to buy virtual goods, like weapons in online games, and sometimes real-world items such as CDs and cosmetics.

However, in the online black market, these coins are also being converted back into cash. Evidence of the prevalence of these cyber space exchanges has even show up in court, where the number of cases involving online property has grown in the past two years.

In one extreme case last year, an online gamer in Shanghai killed another player who had taken his cyber-weapon, called a Dragon Sabre in the popular online game Legend of Mir III, and sold it for 7,200 yuan (US$871).

The gamer almost forfeited his real-world life for doing so when he was handed a death sentence with a two-year reprieve.

Still, Tencent spokeswoman Catherine Chan said in a written statement that the company's virtual money did not pose a threat to the real-world economy.

Q coins were created to work as tokens for the consumption of the company's online services, and the Q coin "is definitely not a currency," she said.

"We do not have a mechanism to facilitate these operations (Q coins being exchanged into RMB) and we are also against the transaction of Q coins solicited via dubious operations," she added.

But what would happen if Tencent went bankrupt? That would be a terrible day for netizens, said Liang Chunxiao, chief analyst at Chinalabs, a Chinese information technology counselling firm.

The PBOC's biggest concern about virtual money should be how to insure the solvency of the organizations that issue it, he said.

"If Tencent one day went bankrupt, the Q coin would completely lose its value," said the analyst.

He added that althoug bankruptcy was unlikely, there was still a risk of its happening in the future.

One possible action the PBOC could consider taking would be to ask outfits that circulate virtual money to set up a reserve account at a designated bank to guarantee their solvency on behalf of the public, he said.

Earlier this year, Alibaba set up such a system with the Industrial and Commercial Bank of China (ICBC) to cover its online payment platform, Alipay. The ICBC has been releasing monthly reports on Alipay's solvency since last May.

"The co-operation between Alipay and ICBC has helped Alipay win the trust of its customers," said Liang. "I think organizations that circulate virtual money would be pleased to set up similar systems."

Liang said the PBOC's Administrative Measures on Payment and Settlement Organizations, which are meant to regulate online payment companies in China would serve as a template for regulating virtual money. The measures are expected to be issued as early as this month.

"Under these measures, all online payment companies in China have to get a license from the PBOC in order to continue their business," he said. "I think the regulation on virtual money will follow a similar pattern."

However, Ala Musi, deputy director of the Legal Committee under the China Electronic Commerce Association, said that instead of bringing virtual money under the control of the real currency system, the PBOC would be more likely to expand the current currency system into the virtual world.

He said virtual money had emerged in recent years as a convenient payment tool for the consumption of online value-added services because e-commerce facilities and legislation process are lagging behind demand in China.

"I think the PBOC may release the regulation together with the Ministry of Information Industry and the Ministry of Commerce," he added.

Rather than waiting passively for the regulation, Tencent is striving to form an alliance between the Q coin and the currency system in the real world.

Last month, the company announced that it would co-operate with the Industrial Bank to launch China's first virtual credit card, called the QQ Show Card, which will be attached to a real card and can be used to prepay for online value-added services after being connected with a user's QQ number.

Last year, the company also launched a debit card called the QQ All-in-One Card in co-operation with China Merchants Bank. To date there are more than 1 million QQ All-in-One Cards in circulation.

Experts said Tencent's efforts to combine the virtual money payment system with real financial institutions would help the company ease the public anxieties and reduce its operational risk.

"We are in communication with some financial regulators in China, and we are preparing for a potential licensing offer from them," Martin Lau, Tencent's president, reportedly said at a third-quarter earnings conference call on November 22, according to a record provided by Thomson StreetEvents.

Meanwhile, Tencent sued Taobao.com, one of China's largest consumer-to-consumer marketplaces, in Shanghai on December 21. It said the latter had become one of the most popular websites for netizens to buy and sell Q coins, and therefore undermined its control over the virtual money.

However, Liang said that Tencent did not have to worry too much.

"I don't think the PBOC's regulations will harm these companies' ability to offer online value-added services," he said.

"On the contrary, I think the involvement of China's top financial regulator will help clarify the appropriate uses of virtual money and boost its development by solving the existing problems through regulation," he added.

Moreover, although it appears that efforts to regulate virtual money are on the way, experts estimated that draft versions of the new rules would not be available for several years.

"I don't think the PBOC will be able to work out a draft in the next one or two years," said Liang. "I think the rise of virtual money is quite a new issue that should be subject of long-term research."

"In the long term, the country's financial watchdogs will surely take the virtual money under supervision," said Ala Musi, noting that the PBOC was unlikely to risk smothering a potentially promising industry by drafting regulations in haste.

"No matter when it comes out, the regulation will surely help the development of virtual money, which will benefit companies like Tencent," he added.