This is the second of a two-part blog, which seeks to address various issues pertaining to the creation, use and regulation of crypto-currency in India.
In the last post, we looked at the technology behind Bitcoins. In doing so, certain unique benefits of using Bitcoins were highlighted. To recap, Bitcoins are decentralized currency, transacting using Bitcoins is faster and cheaper as no intermediate authorizations are necessary, and a public record of all Bitcoin-based transactions against the user’s public key is available.
Value of a Bitcoin
But all of these unique benefits and calls for substitution of fiat currency with Bitcoins function under one premise, that a Bitcoin itself has some value.
Well, does it? This question in itself is slightly fallacious, as it assumes that fiat currency also has a value of its own. Contrast gold (commodity currency) with hundred rupee notes (fiat currency).[i] Both can be used as a form of payment for purchase of goods and services. However, gold has an intrinsic value of its own, owing its utility in some other form, such as jewellery. Hundred rupee notes on the other hand do not possess an inherent value, but is assigned a value (of ‘being’ hundred rupees) by the Central Government, which assigns such value based on the economic conditions of the country. A perfect example is the demonetization policy implemented in November, 2016. The Central Government revoked the status of a legal tender granted to the five hundred rupee and the thousand rupee note. So while these notes still existed and were being circulated in market, they ceased to have any value
While Bitcoins in India have not (yet) been recognised as legal tender in India, they still possess some value. How? Because Bitcoin supporters are growing in number. This means that more number of people desire Bitcoins, and as demands grows, basic micro-economics tells that the price, or in this case, the value of the Bitcoin increases. So, for example, more fiat currency would have to be traded to acquire one Bitcoin. As on the date of writing this blogpost, one Bitcoin or 1 BTC is equivalent to a whopping 2.90 lakh Indian rupees. Thus, while the value of fiat currency is decided by some amount of state intervention and regulation, the value of the Bitcoin is decided solely by the market.
So do we regulate the Bitcoin as currency?
Because there is already widespread acceptance of the Bitcoin as a form of tender, recognizing the Bitcoin as a form of currency and then regulating it seems to be the most feasible option, as in being done in some jurisdictions. In a judgment issued in September last year, Judge Alison Nathan of the Southern District Court of New York has even stated that Bitcoins are ‘money’ as under the American federal money transmission statute.
In India, a concise legal definition of ‘currency’ can be found in Section 2(h) of the Foreign Exchange Management Act, 1999 –
“currency” includes all currency notes, postal notes, postal orders, money orders, cheques, drafts, travellers cheques, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments, as may be notified by the Reserve Bank;
While the definition is an inclusive definition, any kind of currency that does not fit within the categories specified needs to be specifically notified as currency by the RBI. Since Bitcoins do not fall under any of these categories, specific notification is required. While the RBI certainly possesses the power to notify Bitcoins as currency, the question however, is whether there is a need to do so and a political will to do so.
The need certainly exists. Because of the silence of the law regarding the status of Bitcoins, a variety of Bitcoin exchanges have sprung up in India. These are platforms where Bitcoins can be traded against certain kinds of fiat currencies, with some portion of the value of the exchange being kept by the exchange itself as a commission fee of sorts. Further, the Bitcoin has and is continued to be used to finance purchase of illicit goods and services. The (in)famous Silk Road, an online black market (for all things dark and dangerous) used Bitcoins as the mode of payment. Because of the encrypted record-keeping on the blockchain, it is hard to trace the transaction back to an individual in the real world.
Another problem that exists, is the possibility of Bitcoin exchanges crashing (either due to a hack or due to overloading of the network).
The largest Bitcoin exchange in Japan, Mt Gox, crashed in 2014, allegedly due to mismanagement, and this in turn, led to the disappearance of about 7,40,000 Bitcoins. And since the crash occurred before the coming into force of Japan’s law on virtual currencies, there was no clarity on whether an investigation should be undertaken into the crash as the Japanese government claimed that Bitcoins were not “under their jurisdiction”. Additionally, there is no recourse that can be availed from other centralized financial institutions such as the IMF in the event of such a crash, since the Bitcoins themselves are not a centralized currency. Ancillary problems such as hoarding of Bitcoins also continue to exist.
However, as with government regulation of any activity, there exists a legitimate risk of excessive surveillance and state intrusion. If, for example, bitcoin exchanges are required to disclose the identities of their customers to the RBI on a quarterly basis, this data could be the subject of massive privacy violations. Therefore, even if any regulation to curb the abuses specified above is undertaken, it needs to have robust privacy laws, in the absence of which, it is almost ineffective.
And the political will?
The Indian Government has taken cognizance of the explosion of crypto-currencies, and set up an Inter-Disciplinary Committee in April to look into the issue and prepare a report. This report, though not yet public, has been submitted to the Finance Minister recently, and it is only a short matter of time before a statute or an executive order is passed in relation to crypto-currencies.
It is likely that any policy regulating crypto-currency will be through the lens of preventing illicit transactions and punishment of those engaging in the same. The policy might also be a response to the threat that financial regulatory bodies face, in terms of loss of legitimacy, if a decentralized currency like Bitcoin even has the potential to substitute centralized currency. If this is the case, then the motive of the government and the substance of the policy need to be questioned and critiqued, as the rationale might not ensuring secure growth of the Bitcoin and protection of Bitcoin users, but rather intended to curb growth of virtual currencies through over-regulation.
Some suggestions for the mode of regulation
The decentralized model of the Bitcoin cannot be regulated, because the cryptography behind the Bitcoin does not permit such regulation. Further, because of the use of public keys, it’s hard to regulate Bitcoins at the stage of transacting, i.e. exchanging Bitcoins for goods and services. But, an indirect form of regulation is possible by targeting Bitcoin exchanges and/or the place where fiat currency enters the transaction. Through such targeting, existing laws pertaining to regulation of transfer of fiat currency can be applied to these exchanges, and call for greater transparency on their part. Laws pertaining to KYC checks and monitoring of individual transactions, from the user’s part, can also be used. Bitcoins can be treated as a kind of income, thereby generating tax revenue for the state. Finally, a certain degree of privacy (albeit certainly higher than the standard for data protection in the Information Technology Act, 2002) can also be accorded to users of Bitcoins, to ensure that there is not excessive surveillance of their transactions. By using such indirect regulation, all the unique benefits of Bitcoins (as discussed in Part I) can be retained, while ensuring some degree of transparency and providing some legal recourse in the event of any abuse of Bitcoins.
There have been suggestions to treat Bitcoins as goods or assets, and any transaction involving them as a barter. Other suggestions include treating the Bitcoin as either a security, a derivative or a prepaid instrument.All of these suggestions are premised on a strict definition of currency as a centralized form of tender. Even if this definition were to be watered down, critics argue that the Bitcoin is too unstable a currency. The question therefore still remains whether any of these form viable alternative of regulating crypto-currency, and one hopes that the report submitted by the Inter Disciplinary Committee with undertake this comparative analysis.
[This post has been written by Ramya Chandrasekhar and edited by Nayana Dasgupta, both 5th year law students at WBNUJS, Kolkata].
Pritam P Hans, ‘Solving the Riddle’ (MoneyTodayFeb 2012) <http://www.businesstoday.in/moneytoday/cover-story/rupee-dollar-value-drop-factors-for-fall/story/21881.html> accessed 14 Aug 2017
 Misha Tsukerman, ‘The Block Is Hot: A Survey Of The State Of Bitcoin Regulation And Suggestions For The Future’ (2015) 30(385) Berkeley Tech L. J 1127, <http://scholarship.law.berkeley.edu/cgi/viewcontent.cgi?article=2084&context=btlj> accessed 13 Aug 2017.
 For a brilliant comparative analysis, see Vipul Kharbanda, ‘Can Bitcoin Be Banned by the Indian Government’ (CIS 24 Dec 2013) https://cis-india.org/internet-governance/Bitcoin-legal-regulation-india accessed 13 Aug 2017.