Ninety-five per cent of music downloaded online is illegal, a report by the International Federation of the Phonographic Industry (IFPI) has said.
The global music trade body said this is its biggest challenge as artists and record companies miss out on payments.
There has, however, been a 25% rise since last year with downloads now accounting for a fifth of all recorded music sales.
The IFPI said worldwide music market revenues shrank by 7% last year.
This was blamed on falling CD sales, while the increase in digital sales failed to make up for this.
The IFPI, which represents 1,400 companies in 72 countries, estimated more than 40 billion music files were illegally shared in 2008.
There were 1.4 billion single tracks legally downloaded in 2008, with the top-selling digital single, Lil Wayne's Lollipop, selling 9.1 million copies.
There is a momentous debate going on about the environment on which our business, and all the people working in it, depends
John Kennedy, IFPI
BBC technology correspondent Rory Cellan-Jones said that despite the launch of many legal download services, customers still seemed to prefer to get their music free online.
The report revealed that the digital music business has grown steadily during the past six years.
In 2008, it grew by an estimated 25% and is now worth $3.7bn (£2.5bn)
Music fans in the UK downloaded 110 million single tracks in 2008 and bought 10.3 million digital albums - accounting for 7.7% of the market.
John Kennedy, chairman and chief executive of IFPI, said the industry had changed its approach to doing business.
He said: "There is a momentous debate going on about the environment on which our business, and all the people working in it, depends.
"Governments are beginning to accept that, in the debate over 'free content' and engaging ISPs in protecting intellectual property rights, doing nothing is not an option if there is to be a future for commercial digital content."
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