INTRODUCTION
We have made huge advancements from barter system of exchange to paper currency and from paper currency to plastic money. But in today’s world of ever growing complexities of economies and increasing instabilities in markets, virtual currency is the new reality. In less than a decade after its introduction cryptocurrency has attracted the attention of businesses, consumers, central banks and governments. Cryptocurrency aims at replacing the conventional money and its issuing authority such as central banks and to provide people with a more decentralised electronic system of payment based on the blockchain technology. Cryptocurrency promises a better and more logical system not based on trust but on mathematical calculation carried out by a computer programme.
The conventional fiat money has now and then proved to be inefficient to keep up with the highly dynamic nature of markets and central economic institutions has lost the trust of people to maintain stability in the economy. The 2008 financial crisis is a glaring example. Our money supply is created by private financial institutions on a for-profit basis. This money system is designed to benefit those who provide it, not those who use it. It is created when either it is backed by value or through lending it for interest to be generated. However the problem is that the money required to pay off the interest is never created and thus it remains in constant shortage. This shortage keeps it in constant demand. Cryptocurrency provides us with an opportunity to reinvent financial services for new era.
However cryptocurrency has raised a number of issues with regards to its efficiency, credibility and especially its legality. The essay discusses the legal issue regarding cryptocurrency, its use and the technology behind it.
CONCEPT OF CONVENTIONAL MONEY AND BANKS
Money serves an important function of economic exchange. Earlier good were exchanged for goods. But then societies grew larger and economic activity expanded which lead to the introduction of money and the institutions issuing it came into existence. Money serves three important functions: (a) measure of value: value of goods are measured in terms of money and a price is fixed, (b) exchange: it is a means of payment for goods and services in terms of money and (c) store of value: it is stored as a value for carrying out exchange in future. To fulfil these functions, money needs to have a stable value over time. The expansion of economic activity required more convenient system of money that could respond to increasing demand, be efficiently used in trade and have a stable value. However, maintaining trust in the institutional arrangements through which money is supplied has been the biggest challenge. From ancient times, the stamp of a sovereign certified a coin’s value in transactions. Later, bills of exchange intermediated by banks developed as a substitute of large amount of coins. Today, central banks bears the authority to issue money and maintain trust in it. The cheques issued by the central bank are backed by the amount of value equal to face value of the cheques in form of assets held by the bank. Supply of money is controlled in the market through public-private venture between banks. Banks plays the important function of maintaining the record of transactions i.e. a ledger. Banks charge a fee for this tedious work. Thus playing an intermediary role in transfer of value from one person to another. Cryptocurrency aims at substituting this intermediary role of banks with the revolutionary blockchain technology.
CRYPTOCURRENCY: A VALUE REVOLUTION
World Bank defines crypto currencies as digital currencies that rely on cryptographic techniques to achieve consensus.[1] European Securities and Market Authority (ESMA) defines cryptocurrency as digital representations of value that is neither issued nor guaranteed by a central bank or public authority and do not have the legal status of currency or money.[2] The key feature of cryptocurrency is that it uses technique called cryptography. Cryptography is the technique of protecting information by transforming it (i.e. encrypting it) into an unreadable format that can only be deciphered (or decrypted) by someone who possesses a secret key.[3]
More comprehensively it can be defined as:
a digital representation of value that –
- is intended to constitute a peer-to-peer (“P2P”) alternative to government-issued legal tender
- is used as a general-purpose medium of exchange (independent of any central bank),
- is secured by a mechanism known as cryptography and,
- can be converted into legal tender and vice versa.[4]
There are around 2000 Cryptocurrencies in the world, major ones being Bitcoin, Ethereum, Litecoin, Tether, Tron and Stellar. However, digital peer-to-peer exchange is faced with the problem of “double-spending”. Any digital form of money is easily replicable and can thus be fraudulently spent more than once. In our conventional money system “double-spending” is checked by banks which maintains the record of all transactions taking place. Crypto currencies overcome the double-spending problem via decentralised record-keeping through Blockchain technology.
BLOCKCHAIN: THE BACKBONE OF CRYPTOCURRENCY
Blockchain was first conceptualised in a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” published under the alias of Satoshi Nakamato in the year 2008.[5] Blockchain is a particular type or subset of so-called distributed ledger technology (“DLT”). DLT is a way of recording and sharing data across multiple data stores (also known as ledgers), which each have the exact same data records and are collectively maintained and controlled by a distributed network of computer servers, which are called nodes.[6]
Blockchain is a mechanism that employs an encryption method known as cryptography (technique of protecting information by encrypting it into an unreadable format that can only be decrypted by someone who possesses a secret key.[7]) and uses a set of specific mathematical algorithms to create and verify a continuously growing data structure, to which data can only be added and from which existing data cannot be removed and that takes the form of a chain of “transaction blocks”[8], which functions as a distributed ledger.[9]
Blockchain is simply a distributed database. Additions to this database are initiated by one of the members (i.e. the network nodes), who creates a new “block” of data, which can contain all sorts of information. This new block is then broadcasted to every party in the network in an encrypted form (utilising cryptography) so that the transaction details are not made public.[10] Those in the network (i.e. the other network nodes) collectively determine the block’s validity in accordance with a pre-defined algorithmic validation method, commonly referred to as a “consensus mechanism”.[11] Once validated, the new “block” is added to the blockchain, which essentially results in updating of the transaction ledger that is distributed across the network.[12]
Blockchain-based crypto currencies have two groups of participants: “miners” and “users”. A cryptocurrency user is a natural person or legal entity who obtains coins to use them to purchase real or virtual goods or services, to make P2P payments, or to hold them for investment purposes (i.e. in a speculative manner).[13] Miner participates in validating transactions on the blockchain by solving a “cryptographic puzzle”. A miner supports the network by harnessing computing power to validate transactions and is rewarded with newly mined coins (i.e. through an automatic decentralized new issuance).[14]
Crypto assets derive market value from their potential to be exchanged for other currencies, to be used for payments, and to be used as a store of value. Unlike the value of fiat currencies, which is anchored by monetary policy and their status as legal tender, the value of crypto assets rests solely on the expectation that others will also value and use them.
CRYPTOCURRENCY: COUNTOURS UNDER INDIAN LAW
Legality of cryptocurrency can be examined on two broad basis:
1.
The legal position of cryptocurrency under Indian law
2. The legality of Cryptocurrency vis-à-vis blockchain and cryptography.
1. The legal position of cryptocurrency under Indian law.
Currency in an economy is a legal tender. Legal tender refers to bills and coins approved in a country for payment of debts, the purchase of goods, and other exchange for value.[15] The Constitution provides exclusive power to issue and regulate currency to the Union government.[16] To constitute a currency as a valid legal tender under Indian law, the issue of the currency should be in accordance with a valid legislation or ordinance enacted by the parliament, such as the Coinage Act, 1906 or the Reserve Bank of India Act, 1934, or the Union government should recognise it as a currency or as valid legal tender through an official order. These are issued by the Reserve Bank of India (RBI) in India. Since crypto-currencies are not issued by a centralised government authority such as the central bank therefore they are not legal tenders.
This was made clear in the Union Budget 2018, when Finance Minister Arun Jaitley reiterated that the crypto currencies are not recognised as legal tender. During his budget speech, the Finance Minister said, “The Government does not consider crypto-currencies legal tender or coin and will take all measures to eliminate use of these crypto-assets in financing illegitimate activities or as part of the payment system.” However, Jaitley also added that the government would try and explore the blockchain technology, which drives crypto-currencies.[17]
As per on of the RBI notification it prohibited banks, lenders and other regulated financial institutions from “dealing with virtual currencies,” which stipulated that “in view of the associated risks, it has been decided that, with immediate effect, entities regulated by the Reserve Bank shall not deal in VCs or provide services for facilitating any person or entity in dealing with or settling VCs. Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer / receipt of money in accounts relating to purchase/ sale of VCs.”[18]
Recently, the Inter-Ministerial Committee headed by headed by Economic Affairs Secretary Subhas Chandra Garg which was setup to study the virtual currency ecosystem in India came up with its report[19]. The Committee accepted the fact that use of Distributive Ledger Technology may have a number of benefits if deployed in financial sector but it is associated with risks. The Committee suggested the introduction of an official crypto currency ‘Digital Rupee’ to replace private crypto currency. The Committee suggests to penalise all those who mine, generate, hold, sell, deal in, transfer, dispose of or issue crypto currency with imprisonment of up to 10 years along with a fine that may range from 1 lakh for non-commercial dealings to 25 lakh for commercial dealings.
Presently the crypto currencies are not legal tenders but an attempt can be made to traced their legal position in property, goods and commodities as under:
As movable property: The General Clauses Act, 1897 provides that the movable property shall mean the property of every description, except immovable property. The definition is wide enough to include in its ambit the intangible virtual currencies though having no physical presence in real world.
As goods: Sale of Goods Act, 1930 states that goods means every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale. Moreover, the Supreme Court has observed in the case of Tata Consultancy Services v. State of Andhra Pradesh[20] that goods may be a tangible property or an intangible one and law does not make any distinction between tangible and intangible property. Being a movable property cryptocurrency comes under the ambit of goods under Sales of Goods Act.
As commodity – The term ‘commodity’ is understood to include every movable thing that is bought and sold (except animals), an article of trade, movable article of value or something that affords convenience or advantage especially in commerce.[21] Thus, crypto-currencies can also be classified as an intangible movable asset falling under ‘commodity’ under the Indian legal framework.
As assets – It is interesting to note that despite being unregulated, the tax authorities in India[22] have served notice to approximately one lakh traders and investors dealing in cryptocurrency to levy taxes on the gains made out of such trade, treating cryptocurrency as assets. Reference can also be made to United States and Canada where cryptocurrency has been held an asset. The United States Internal Revenue Services in 2014 issued a formal ruling expressly stating that for the purposes of federal taxation the virtual currency will be treated as property and that general taxation principles applicable to property transactions will apply to virtual currency as well.[23] The Canada Revenue Agency (CRA) has characterized cryptocurrency as a commodity and not a government-issued currency. The use of cryptocurrency to pay for goods or services is treated as a barter transaction.[24]
2. The legality of Cryptocurrency vis-à-vis blockchain and cryptography.
Cryptocurrency makes use of blockchain and cryptography, the essential feature of which is that, it keeps out the centralised institutions from regulating and controlling the innumerable transactions taking place. The question is can there exist a currency out of the domain of banks and the government. Moreover, its anonymous nature makes it prone to be used for nefarious activities. Thus there is a need to delve into its legality.
Currency with no banks: In modern economies money is provided through joint public-private venture, with central banks as the issuing authority. Central Banks not regulate and control flow of money but also decide its value. They act as intermediaries in the payment system and their role includes ensuring that the payment system operates smoothly and balance is maintained between demand and supply for money. However cryptocurrency has no such regulator and its supply is limited through a computer programme. A number of countries such as USA and Canada have made its use legal.
Anonymity
and pseudonimity: Cryptocurrencytransactions
are all stored in a public ledger that is accessible to everyone. These
transactions provide privacy through pseudonymity. Each transaction is associated
with the public address of the sender and receiver, the real-life names of the
owners of these addresses are not known on the network. To increase privacy,
each person could create as many public addresses as they like, making it
difficult to link transactions to the same person. It is one of the key
issues surrounding cryptocurrency. The anonymity prevents cryptocurrency
transactions from being adequately monitored, allowing shady transactions to
occur outside of the regulatory perimeter, allowing criminal organisations to
use Cryptocurrencies to obtain easy access to “clean cash”.[25] Anonymity is also the major
issue when it comes to tax evasion. Entering into taxable cryptocurrency
transactions without paying taxes is tax evasion. But, when a tax authority
does not know who enters into the taxable transaction, because of the anonymity
involved, it cannot detect nor sanction this tax evasion. This makes cryptocurrencies
a very attractive means for tax evaders.[26] Cryptocurrency has even
been described as the “tomorrow’s tax havens”.[27] Moreover, other financing
regulations such as freezing and confiscation of property have no application
to crypto currencies because to be able to freeze and confiscate
cryptocurrencies it is necessary to know that a criminal has them, and this is
what the anonymity surrounding cryptocurrencies prevents.[28]
Universal in nature: Cryptocurrency has no boundaries and thus not restricted by law of any one country. Problems arises when it is located where there are no money laundering and terror financing laws in place.[29] Cryptocurrencies do not fit easily into existing frameworks. In particular, they lack a legal entity or person that can be brought into the regulatory perimeter. Cryptocurrencies live in their own digital, nationless realm and can largely function in isolation from existing institutional environments or other infrastructure. Their legal domicile, is impossible to establish clearly. Thus arises need for regulation and global cooperation.
SUGGESSIONS AND CONCLUSION
Rise of cryptocurrency is a new technological “value revolution”. This is an opportunity for Governments and the Central Banks to reinvent financial services for the future generations. Our present money system is lagging behind in this fast paced world. We need something fast, efficient, reliable and which can uphold the trust of the people and provide them economic freedom in absolute sense. Though there are certain legal issues as discussed and therefore the government and the central banks should step in to regulate and establish cryptocurrency and harness its immense possibilities through regulation and legislations. Following are a few suggestions:
- Central Banks can make use of this the technology and issue Central Bank Digital Currency. Such currency can easily circulate between banks businesses and consumers using distributed ledgers without requiring the central bank to keep track of transactions and adjust balances. It would be based on a permissioned distributed ledger, with the central bank determining who acts as a trusted node.
- Governments should strive to effect regulations and policies to bring cryptocurrency under the legal framework and promote paperless transaction and a digital economy.
- Banks should continue to strive to make fiat currencies better and more stable units of account. As IMF Managing Director Christine Lagarde noted in a speech at the Bank of England last year, “The best response by central banks is to continue running effective monetary policy, while being open to fresh ideas and new demands, as economies evolve.”
- Financial and Investment Regulators should step in to provide rules and regulations for cryptocurrency related assets and make them accountable to exchequer.
- Transaction in crypto assets is a taxable event and thus an opportunity for Tax Regulators to earn revenue from the gains of investments in crypto assets.
- Government should regulate and implement policies to prevent the use of cryptocurrency for nefarious activities such as money laundering and the financing of terrorism. Anti-Money Laundering and Terror Financing law should be strengthened at national as well as international level.
- Cryptocurrency exchange (persons or entities offering exchange services for selling and buying of cryptocurrency for fiat money) should be effectively regulated. Other services such as Crypto Wallets and Trading platforms should be regulated for effective control over use and flow of cryptocurrency.
Cryptocurrency has captured the imagination of
individual and society, longing for economic freedom. Cryptocurrency is a revolution
and has the potential to provide economic freedom to the society in real sense.
There has been several speculations to its legality especially because it
provide a substitute for authoritative and centralised controls of government
over money. However the need of the hour is regulation and formalisation of
cryptocurrency by the government and banks to establish a decentralised
monetary system without actually interfering in its working, which can instil
the trust of public in financial institutions.
[1] H. NATARAJAN, S. KRAUSE, & H. GRADSTEIN, “Distributed Ledger Technology (DLT) and Blockchain”, World Bank Group, IV (2017), Click here
[2] ESMA, EBA & EIOPA, “Warning on the risks of Virtual Currencies”, (2017), Click here
[3] J. Faulkner, Getting started with Cryptography in .NET, (2016)
[4] European Parliament, “Cryptocurrencies and Blockchain”
[5] Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash”, (2009), https://bitcoin.org/bitcoin.pdf
[6] id. at 1
[7] Id. at 3
[8] Hence the name “Blockchain”
[9] id. at 1
[10] Id.
[11] Id.
[12] CPMI, “Digital currencies”, (2015), https://www.bis.org/cpmi/publ/d137.pdf.
[13] ECB, “Virtual Currency Schemes – a further analysis”, 2015, https://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemesen.pdf.
[14] ECB, “Virtual Currency Schemes – a further analysis”, February 2015, https://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemesen.pdf,
[15] Black’s Law Dictionary, Eighth Edition, (2004).
[16] Ind. Const. Art. 246 read with Seventh Schd., Entry 36.
[17] Budget 2018: Bitcoins, crypto-currencies illegal, but govt. to explore Blockchain. (Jan. 27, 2019, 3:31 PM). Click here for more
[18] Press Release, Reserve Bank of India, Prohibition on Dealing in Virtual Currencies (VCs) (Jan. 30, 2019, 12:35 AM) https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11243&Mode=0
[19]Inter-ministeral committee suggests banning crypto currency, (Aug 25, 6:46 pm) Click here for more
[20] (2001) 4 SCC 629
[21] Dr. H. K. Saharay & P. M. Bakshi, “Judicial Dictionary of Words and Phrases”, Thomson Reuters, 2nd Edition Volume I (2016)
[22] Income Tax Department to exact taxes from Bitcoin Investors, (Aug 23, 2019, 3:00 PM) https://www.businesstoday.in/current/economy-politics/cbdt-chairman-income-tax-department-to-exact-taxes-from-few-lakh-bitcoin-investors/story/269592.html.
[23] I.R.S. Notice 2014-21, 2014-16 I.R.B. 938 (14 April 2014) § 4, A-1
[24] Mariam Al-Shikarchy et al., Gowling WLG, Canadian Taxation of Cryptocurrency . . . So Far, Lexology (Nov. 14, 2017), Click here
[25] FATF, “Report on emerging terrorist financing risks”, (Oct. 2015), Click here
[26] IMF Staff Discussion Note, “Virtual Currencies and Beyond: Initial Considerations”, January 2016, https://www.imf.org/external/pubs/ft/sdn/2016/sdn1603.pdf, 27; OECD, “Tax Challenges Arising from Digitalisation – Interim Report”, 2018, 206, No. 501; R.M. BRATSPIES, “Cryptocurrencies and the Myth of the Trust less Transaction”, March 2018, 43 (electronically available via https://ssrn.com/abstract=3141605).
[27] T. Mandjee, “Bitcoin, its Legal Classification and its Regulatory Framework”, (2016), https://digitalcommons.law.msu.edu/jbsl/vol15/iss2/, 188 and the references there.
[28] Id.
[29] ECB, “Virtual Currency Schemes – a further analysis”, (Feb. 2015), https://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemesen.pdf
Image: compareremit.com
This article is written by Mayank Sharma.
Disclaimer: This article is an original submission of the Author. Lex Insight does not hold any liability arising out of this article. Kindly refer to our Terms of use or write to us in case of any concerns. This article is a part of the 1st National Essay Competition, 2019.
