This is the first of a two-part blog, which seeks to address various issues pertaining to the creation, use and regulation of cryptocurrency in India.
In 2008, the internet was bombarded with a phenomenon that challenged hitherto accepted notions of currency, governance, code and the principle of trust.
Accessed from here
Satoshi Nakamoto (who might be an individual, a group of individuals or a robot, for nobody knows) posted a white paper outlining the need for a new kind of payment system. Why? – for easier internet-based transactions and to cut out intermediaries. This white paper was met with a deafening but highly polarized response. In 2009, Nakamoto then created the first cryptocurrency, the Bitcoin. A domino effect then followed, beginning with more businesses centered on the trade of Bitcoins, and leading to the creation of over 900 different types of cryptocurrencies.
But first, what are Bitcoins?
An in-depth analysis of all cryptocurrencies is a task that the author is (unfortunately) not equipped to do, but the basic principle is similar to that of the Bitcoin.
The easiest way to understand how Bitcoins work is to contrast them against fiat currency. The most importance feature of fiat currency is that it is centralized. Printing/minting, circulation and valuation of a fiat currency is decided by a central regulatory body, such as the RBI in India. Bitcoins, on the other hand, are decentralized. There is no regulatory body, either real or virtual, controlling the creation and the value of Bitcoins. Instead, the Bitcoin is a virtual currency created using a body of technology known as cryptography, and the code that created Bitcoins is an open-source code, meaning that anyone can view the said code.
Satoshi Nakamoto used the “blockchain technology” as the foundation of the Bitcoin. The blockchain is referred to as a “public ledger” of Bitcoins, i.e. it is the blockchain that both creates Bitcoins and keeps a record of transactions using Bitcoins; and all of this can be viewed by anyone.
Think of the blockchain as the Snake from that highly addictive game bearing the same name on Nokia phones. The game starts with only one dot representing the snake. This dot is the genesis block created by Nakamoto. In the game, the snake needed to eat more dots to expand. Similarly, for new blocks to be added to the blockchain and consequently, for more Bitcoins to be created, the blockchain needs to be ‘mined’. The persons engaging in such mining, known as miners are like the players controlling the movement of the snake.
Mining involves two processes – one, processing, verifying and aggregating transactions that have been recorded on the blockchain and two, solving a complex mathematical problem that requires miners to find a unique number known as the ‘nonce value’. So miners are the ones that maintain the blockchain through their act of verification, and are also the ones that expand the blockchain, through their mathematical and coding capabilities. When the genesis block was created, many presumed that the block was mined by Nakamoto themselves, and the first Bitcoins came to be created. After the creation of the genesis block, more people start studying the base code and Bitcoin supporters became miners. The incentive for these miners is two-fold – they receive transaction fees for processing transactions recorded on the blockchain and they receive the new Bitcoins that are created by virtue of a new block being added to the blockchain. As miners acquire Bitcoins, they trade them for fiat currency, and this trade continues ad infinitum.
Other points of distinction
The second point of distinction between fiat currency and Bitcoins is the manner of keeping record. With fiat currency, any bank keeps two kinds of accounts – the amount of money you have in your account, and a paper or electronic trail of transactions from and to your account. With Bitcoins, there is only one ledger, which is the blockchain itself. Every transaction involving Bitcoins is recorded on the blockchain itself, and the miners assist in such record-keeping using computers and code. Further, unlike bank records, the blockchain is a public record-book.
This then leads to the third point of distinction between fiat currency and Bitcoins. Bank records are kept private to protect the identity of their customers. The public ledger system of Bitcoins seems to deviate entirely from these basic principles of privacy. But this is not true. Every person wishing to trade in Bitcoins and/or mine Bitcoins is required to register on the network, and create a Bitcoin wallet. While doing so, the said person is given two electronic signatures of sorts – a public key and a private key. The blockchain records any transaction involving this person’s Bitcoin wallet using the person’s public key and not her name or any other known identity. And to ensure security for each transaction, the said person is required to authenticate each transaction of hers using her private key. Her private key is not visible or known to anyone, similar to how passwords are known only to the user whom the password belongs to.
Finally, any transaction using fiat currency, even on the internet, requires approval from a financial institution or an authorized third party. In Nakamoto’s white paper (referred above), Nakamoto refers to such a set-up as a “trust-based model” of transacting, and criticizes it for not being cost-effective. Bitcoins allow for direct transactions between sellers and buyers, which is both cost-effective and less time-consuming.
It’s interesting to note that the Bitcoin is the only cryptocurrency whose creators are not identified. While Satoshi Nakamoto had an active online presence between 2009 and 2011, he/she/they is now nowhere to be found.
The continued use of Bitcoins and maintenance of the blockchain, in the face of such anonymity is the best of kind of proof that trust-based models of transacting are obsolete. People are using a currency that no one knows who created, and are quite satisfied with the same. In fact, there were calls for nomination of Satoshi Nakamoto for an Nobel Prize in economics, but was rejected by the (traditionalist) Nobel Committee which states that the prizes can’t be awarded anonymously. One now wonders whether this anti-authoritarian approach to currency merits celebration or skeptical contemplation.
Reacting to the Bitcoin
For a phenomenon that is highly complex to create, and even more technical to understand, cryptocurrency has burst on to the scene and is here to stay. While the Bitcoin is still the most popular cryptocurrency, others such as Ethereum and Litecoin are not far behind. After its entry into the market the number of transactions using Bitcoins has only increased, prompting financial regulators of many countries to start taking Bitcoins seriously. In April this year, Japan passed a law recognizing Bitcoins and other cryptocurrencies as legal tender. By doing so, countries can proceed to regulate activities involving the use of the said cryptocurrencies without altering their basic code or structure.
In India, a host of companies have mushroomed since 2012, which allow users to buy and sell Bitcoins. Indian merchants have also begun to accept Bitcoins as a mode of payment. The latest push for use of Bitcoins came when the Central Government’s demonetization policy came into effect in November, 2016. It is now estimated that India has about 6, 00,000 Bitcoin users. As a response to the growing use of cryptocurrencies, the Finance Ministry held a public consultation on the Central Government’s online platform, MyGuv, to solicit opinions on the need to regulate the same. Regulatory bodies in India, such as the RBI, have also taken cognizance of the use of cryptocurrencies by Indian citizens, but have issued warning notifications asking consumers to proceed cautiously since the same has not been authorized as legal tender by the RBI. In the wake of the WannaCry cyberattacks in May, wherein the hackers demanded ransom in the form of Bitcoins, the Central Government actively considered regulating cryptocurrencies to ensure cyber security and consumer protection.
In the next post, the need for regulating Bitcoins will be more clearing spelled out, and the manner in which such regulation can be carried out will be analysed.
[This post has been written by Ramya Chandrasekhar and edited by Nayana Dasgupta, both 5th year law students at WBNUJS, Kolkata].
 Aroon Deep, ‘Finance ministry holds public consultation on regulating virtual currencies’ (Medianama 24 May 2017) https://www.medianama.com/2017/05/223-virtual-currencies-consultation/ accessed 15 August 2017
Reserve Bank of India, ‘RBI cautions users of Virtual Currencies against Risks’ (24 Dec 2013) <https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=30247> accessed 14 Aug 2017;
Reserve Bank of India, ‘RBI cautions users of Virtual Currencies’ (1 Feb 2017) <https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=39435> accessed 14 Aug 2017