How is In-App purchase of virtual currency banned but so widely used?

This is a great question. I think the virtual currency apps are like fart machines and flashlight apps: They were accepted into the store at first, but Apple eventually realized they didn't want that type of app on their store. So those apps that got accepted, they are still on the store, but from now on, no more.

As for your second and third questions, Apple isn't going to host any of the content of your game or app beyond what you can get into iCloud; they only record which things which people bought. So if someone bought 1000 coins 12 times, Apple will know that, but you have to keep track of how many coins the customer has left via iCloud or your own server.

Update: It looks like Apple will accept In-App purchase of virtual currency per the Apple Store Review Guidelines. Section 11.4 states:

Apps that use IAP to purchase credits or other currencies must consume those credits within the application

So as long as the currency is redeemable within your application, it's fine. However, right in the introduction, it does say:

We don't need any more Fart apps.

So fart apps are out, but virtual currency is OK!