In the last few years, several unconventional forms of money have become so popular that cash transactions have largely become a thing of the past. However, it can be argued that no other form of money has garnered as much attention in recent years as Bitcoin, the world’s first decentralized cryptocurrency. Interestingly, the origin of this virtual currency is shrouded in mystery.
It was launched in 2009 by a person or group whose only identity is the pseudonym ‘Satoshi Nakamoto’. Bitcoin has been designed in such a way as to circumvent existing financial systems in most countries, so its use poses several legal and policy questions. Before examining the legal validity of this virtual currency, let us first examine how Bitcoin works.
How does Bitcoin work?
Unlike conventional currencies like rupees and Euros, Bitcoin exists almost completely in the virtual world and is not issued by any central monetary authority.Instead, it is based on a peer-to-peer network which is similar to the networks that undergird services like Skype and Bit Torrent. Bitcoins are created by a complex number-crunching method commonly known as “Bitcoin mining”. Bitcoins can be purchased and sold for cash on several exchanges and websites.Examples of such exchanges include Mt. Gox in Japan, BitBox in the United States, Bitcurex in Poland, etc. BTCXIndia is India’s first Bitcoin exchange. BTCX claims to take special efforts to verify the authenticity of its customers in order to prevent the use of Bitcoins for illegal activities.
Any user who wants to enter into a transaction using Bitcoins needs to install a digital wallet on a PC or mobile phone.Generally speaking, such wallets are of three types: software wallets, mobile wallets or web wallets. These Bitcoin wallets are used to create Bitcoin addresses using which Bitcoin transactions can be undertaken.Once a user installs a digital wallet and creates a Bitcoin address, he/she can enter into a transaction with a company that accepts Bitcoins as a mode of payment for the services that they provide. In order to do this, a person needs to acquire the recipient’s Bitcoin address on which the Bitcoins are to be sent.
All Bitcoin transactions are recorded in a public transaction log known as a “block chain”. A transaction is then verified by Bitcoin miners in order to ensure that the person making the transaction really owns the Bitcoins and to prevent double-spending.The miner who is able to successfully verify the transaction first shares the result with the entire Bitcoin network. If his result is accepted by the network, the transaction is successfully completed and the miner gets 25 Bitcoins as a reward for his service.
Pros and cons of Bitcoins:
It is widely believed that the increasing use of the internet for facilitating a large array of transactions necessitates the use of a digital currency.As a result, many supporters of virtual currencies argue that, Bitcoin, as the most sophisticated virtual currency in the market, is uniquely positioned to fill that void. Second, as a decentralized currency, Bitcoin is free from unnecessary government control and interference that is the bane of most physical currencies.
Third, the system of Bitcoin mining has been designed in such a way that the maximum number of Bitcoins that can ever be created is 21 million. This reduces the threat of devaluation of the currency due to a sudden influx of new Bitcoins.
Finally, and most importantly, as the process of transferring Bitcoins is fairly straightforward, the transaction costs are much lower.
However, Bitcoin also has certain inherent disadvantages.
- First, as it remains unregulated, there is no effective framework for addressing customer complaints, resolving disputes, processing refunds, etc.
- Second, virtual currencies, by their very nature, are highly volatile as their value is a matter of heavy speculation.As a result, holders of Bitcoins have to grapple with the possibility of incurring heavy losses.
- Thirdly, and more fundamentally, as Bitcoins are not regulated by any agency, they can be used for funding illegal activities such as terrorism, gambling, etc relatively easily.As a matter of fact, several news reports indicate that Bitcoins have been extensively used in money laundering activities and in other illegal contexts.
- Finally, as a digital currency, Bitcoins are susceptible to hacking and other technology-related problems such as loss of password, malware attacks, etc.
Legal position of Bitcoins across the globe:
The use of Bitcoins remains a grey area from a legal perspective in most countries, but some countries have made their position on the use of Bitcoins abundantly clear.
In China, for example, the use of Bitcoins is restricted. On 5 December 2013, financial institutions in China were prohibited from handling transactions involving Bitcoins. The People’s Bank of China has prohibited financial institutions or payment companies from setting prices in the form of Bitcoins, buying or selling Bitcoins or insuring products related to Bitcoin. However, individuals are not prohibited from using Bitcoins in China.On the other hand, using Bitcoins is completely legal in Germany.
On 19 August 2013, the German Finance Ministry stated that Bitcoin is essentially a unit of account which can be used in multilateral clearing circles.It is treated as private money for tax and trading purposes.Similarly, in the United States, the Internal Revenue Service issued a statement in March 2014 stating that Bitcoins would be treated as property and not a currency which implies that every transaction in which Bitcoins are used would be subjected to capital gains tax. Bitcoin mining activities in the U.S. are subjected to income tax which is based on the fair market value as of the date of the specific activity.
Legality of Bitcoins in India:
In June 2013, the Reserve Bank of India acknowledged the use of virtual currencies and noted that such currencies pose regulatory, operational and other complex challenges.On December 24th, 2013, the RBI issued a press release stating that the use of virtual currencies like Bitcoin is not authorized by any monetary authority.Furthermore, the RBI cautioned users about the risks associated with the use of digital currencies and advised them to use such currencies in a circumspect manner.
In January 2014, a man named Venugopal Badaravada made a representation to the RBI through a lawyer, urging them to clarify their policy with regard to Bitcoins, but the RBI did not respond to his request. The RBI is closely monitoring the use of Bitcoins and is keeping an eye on how other central monetary authorities are reacting to the use of this currency.The definition of the term ‘currency’ under the Foreign Exchange Management Act, 1999, empowers the RBI to include any instrument within the ambit of the definition by way of an appropriate notification.
The RBI used this power in 2000 to include credit cards within the ambit of the definition, so it can certainly exercise this power for bringing Bitcoins within the auspices of the definition.Moreover, the Central Government is also empowered to include any new securities within the ambit of the definition of the term ‘security’, so Bitcoins can be legalized through this route as well.
Another interesting issue pertains to the legality of transactions involving Bitcoins under the Sale of Goods Act, 1930. Under that Act, price is an indispensable component for enforcing any transaction. However, if Bitcoins are treated as a form of property, then such a transaction would amount to a barter transaction and would not be enforceable under the Sale of Goods Act.
That being said, such a transaction would be enforceable under the Indian Contract Act, 1872 as it encompasses lawful consideration and is not opposed to public policy in any way.Similarly, transactions involving Bitcoins can also be brought within the ambit of the Income Tax Act if individuals earning Bitcoins convert their earnings into rupees and then pay income tax on the same.In the same way, sellers of Bitcoins can be made to pay taxes on capital gains.
Conclusion:
Bitcoin is increasingly gaining prominence in a number of contexts. Although Bitcoins have not yet been widely accepted in brick and mortar stores in India, news reports indicate that Castle Bloom, which is a salon in Chandigarh, is the first physical store to accept Bitcoins. Similarly, highkart.com is the first Indian website to accept payments exclusively in Bitcoins.
An online portal, Buysellbitco.in, was set up to facilitate the purchase and sale of Bitcoins, but it was shut down after a raid by the Enforcement Directorate found that it had violated foreign exchange laws. As is often the case with inventions that operate primarily in cyberspace, no single country can regulate the use of Bitcoins.
In an era of digital transactions, the use of digital currencies is inevitable, so countries have to work together to establish the necessary institutional framework to embrace and promote these developments, instead of imposing impediments that stultify their progress.