This article has been written by Sayandeep Pahari. In the article, he discusses the origin of cryptocurrency and the cryptocurrency and the legal implications of it.
The evolution of money is mystifying; from trading cattle to the daily global trade of billions of cybernetic algorithms representing monetary value in a stock exchange, technological progress can be regarded as one of the constants in our society. New advancements are developed to cater to the growing needs of humankind in this fast-paced society; cryptocurrency is one such innovation. The idea of Cryptocurrency was introduced through a white paper in 2008 by an anonymous going by the name of Satoshi Nakamoto. To be precise it is a highly peer-to-peer based digital currency system without the presence of any central authority. 2017 served a turning point to this technology when it became a worldwide phenomenon and its demand skyrocketed. The price of Bitcoin, the most popular form of Cryptocurrency soared more than a few thousand percents since inception, from around USD 100 to USD 11,000. It is safe to say that the international position on Cryptocurrency is not homogeneous; the nature of it is still being analyzed and examined and its legality is still a question. As a matter of fact, since 2009, there have been more than 1600 forms of Crypto-currency with the market capitalization of 500 Billion Dollars (December 14th, 2017), it has to be noted that the value of this currency is volatile in nature. 
Cryptocurrency is a subset of digital currency and it works like any Fiat Currency because it lacks any intrinsic value but derives its value from use which means, more the acceptance greater the value. It is called Cryptocurrency since it is ensured by layers of encryption (cryptography), which is finished by a procedure called Mining. In this procedure, Miners use powerful programming to confirm exchanges by unravelling complex scientific calculations. In fact, the machine utilizes its processor to tackle the complex calculation and eventually gets such money as a reward for its service. No one controls the calculation and the procedure, which makes the framework self-supporting. The record of the transactions, which is a pivotal part of the process is given support by a system of Blockchain, which is an automatic public ledger. The aim was to remove any transactional cost, it was reported that Bitcoins can save over 7 Billion Dollars every year in fees which had to be paid to third parties like PayPal, Western Union. In terms of legality, there are various issues related to such currency. The most basic one is the classification followed by authority, jurisdiction and regulation of it. In countries like Ecuador, Russia and Bangladesh, Bitcoin is completely prohibited, in China, Bitcoin is illegal for commercial use but legal for private individuals to hold, trade, mine, buy and sell. In some countries, it is banned due to already existing laws, such as Iceland whereas, Japan turned otherwise and legalized digital currencies. The Japanese Financial Services Agency (FSA) recognized Cryptocurrency exchanges that trade in digital currency like Bitcoins. 
This paper will examine the legal scenario of Cryptocurrency in India as well as the history, development and global significance of such currency. The aim is to understand whether such currency will benefit the economy or is it too volatile to be considered a currency. Considering the fact that, it has been nearly 3 years since the ruling Indian government’s demonetization, and leaving nearly most of India’s currency notes obsolete overnight. The government has since announced the “Cashless India” initiative to help the country’s population embrace digital payments, bank the ng, and finance with a conscious move away from cash. The Supreme Court has already directed the Indian govt. to regulate Bitcoins but there is no legislation in place yet but RBI has banned all its entities from dealing with such currency. Therefore, understanding the concept of Cryptocurrency is well due in order to understand the rationale behind not recognizing it by countries including India.
The concept of digital money was first envisioned by Nobel laureate, Milton Friedman in the late ’90s who said in an interview that internet is going to reduce the role of governments and pave a way towards reliable electronic cash (1999). The cryptocurrency was then introduced by Satoshi Nakamoto (pseudonym) through a white paper, in which he proposed a method to stop double-spending of money by the introduction of Bitcoins. He contends that purely peer-to-peer basis electronic money would not require the element of trust on third parties and also the transaction cost would decrease. (2008, Bitcoin: A peer to peer electronic cash system.)
Like the U.S Dollar Bitcoins are not backed by the government. At that point of time, Bitcoins were just an electronic currency and could not be exchanged for any other currency or commodity. Usually, transfers involving banks are subjected to strict rules whereas, CC’s are being issued with no customer identification which makes it difficult to track suspicious transfers (2008, William Hett, Digital Currencies and the Financing of Terrorism). It was observed that Bitcoins are exciting as it shows how cheap a transaction can get (2014, Bill Gates). It is a cryptographic achievement and not to be duplicated in the digital world has an enormous value (2014 Eric Schmidt, ex CEO of Google).
Since this technology possesses a Byzantine structure, it has to be analyzed with a lot of time and effort before being regularized, the absence of any regulations will waste the time of adjudicators, investors, and businessmen as it will be difficult to understand the legal implications of such. (2016 Beyond Bitcoin, Nishithdesai Associates). The underlying technology behind Cryptocurrency which is Blockchain might solve the inefficiencies and risks associated with third-party transactions. (2017 R Gandhi, Deputy Governor of RBI). It has to be stated that the price of Bitcoins skyrocketed suddenly and it created a ripple in the financial market; along with that came more scams and hacking cases. India’s central bank RBI has already issued warnings on different occasions to warn CC investors that they are solely responsible for the risks associated with it. All entities regulated by RBI has been fenced from dealing with entities dealing in Virtual Currencies (2018, BP Kanungo, Deputy Governor of RBI). Cryptocurrency is an interesting phenomenon, twenty years down the line it might become a daily part of people’s lives or just a trend which has been forgotten by then. (2018, Jason Labrum, President, Labrum Wealth Management)
In India, can CCs’ be regularized or is it better to stay out of it? This shall be answered in this paper by exploring the laws of the countries that has regularized it and analyze whether India has the legal infrastructure to support the same.
Statement of Problem
1) What is Cryptocurrency and how does it work?
2) What is the need of Cryptocurrency and what are the advantages and disadvantages associated with it?
3) The current legislation does not declare Cryptocurrency legal or illegal, but RBI has issued notifications warning about the risk associated with such currency and banned all the bodies under RBI to deal in Cryptocurrency. Therefore whether there is any need for legal reform? (This will be examined in this paper by comparing it with other countries, which have regulated the use of such currency).
The objective of the study
The government is not ready for the idea of Cryptocurrency. The technology is claimed to be a bubble technology as it is susceptible to various cyber threats and consumer risks. Cyber experts contend that such use of currency is the future and the governments have to adapt to such technology in the near future. Keeping such premise in mind, the objective is to understand:
1) The concept and functioning of Cryptocurrency.
2) The way it can be classified.
3) The need of Cryptocurrency (Bitcoins) in the Indian market and if so, then what laws can be implemented to ensure smooth functioning of the system. (This objective will be sought by examining Cryptocurrency scenario and its laws in other countries)
4) Whether banning such currency be helpful in the future, considering the fact that, India and other countries are taking steps to curb its use.
The basis of Cryptocurrency lies in the concept of anonymity and trust between the participating parties but the absence of any authority raises doubts on the transparency of its operation. The nature of this technology is still not clear and governments across the world are insisting on restricting such use. But it is contended that it is the future of currency as transactions become cheaper, secure and peer-based. What if instead of banning it, new laws can regulate to protect the consumers and the interests of the government. The hypothesis rests on the presumption that in order to understand and accept the technology, laws and regulation could be enacted and implemented as it is perceived as the mode of next-generation transaction.
The data for this research work is collected using doctrinal legal research from various sources available in this connection. In this doctrinal research work, legal data basis, books, journals, articles, newspaper, government notification, reports of various committees and policies will be analyzed, thereby highlighting the critical approach towards the use, nature, and legality of Cryptocurrency.
Historical Background of Cryptocurrency
The attempt to make a similar kind of technology can be traced back to 1980s in the Netherlands where smart cards were introduced in petrol pumps; these cards were given instead of cash to avoid robbery during the night. During the same period, David Chaum, an American cryptographer known as “the father of online anonymity” was figuring out the concept of electronic cash. He came up with the concept of the Blind signature, which made transactions secure. This technology can be explained using a simple illustration; A & B need to exchange message, which C has to sign and it is desirable that C is unaware of the contents and the parties involved. This technology allowed masking the message and the sender to C, the only thing he could do is to verify his own signature later. This concept later evolved into DigiCash with the help of David Chaum which dawned a new era of digital money in the market. Later, the company went bankrupt as there were not enough merchants to accept it, DigiCash required merchants to be at one end of the transaction. In 1996, Douglas Jackson launched e-gold, that Wired described in 2009 as “a private, international currency that would circulate independently of government controls”. It did not last long as organized criminals saw an opportunity to exploit the system and ultimately the company was raided and charged by the FBI. In 1998, a computer science graduate Wei Dai developed laid the basis for Cryptocurrency by working on b-money, which would empower online economies to work without tax or threat. The idea did not turn out practicable, but what it laid the groundwork for the future which was later acknowledged by Nakamoto. In 1999 PayPal was established which made internet users comfortable with the fact that money transfers can be done safely online.
The introduction of Cryptocurrency is set in the background of the 2008 US Economic Crisis, which partly resulted from the deregulation of the financial market, the confidence of citizens on governments and banks went down. A lot of money was used to combat this credit crunch, which meant that the government was printing money to stabilize the economy. Such a huge amount of money was not backed by any economic productivity hence, raising a Tsunami of debt on several countries which resulted in an escalation of gold price. This crisis affected the world’s economy at large and motivated an anonymous, going by the name of Satoshi Nakamoto to publish a white paper which challenged the existing establishments by proposing to remove the involvement of any Financial Institution by the implementation of Blockchain Technology. Thereafter, he introduced Bitcoins, the world’s first Cryptocurrency, initially the price of Bitcoins was low but in 2011 it levelled with US Dollar on a leading exchange, in the very year the total worth of Bitcoins exceeded 1 Billion USD. As of 2018, the price of 1 Bitcoin is somewhat around 6000 USD. The price blew off the roof and attracted a lot of attention from investors, consumers to academicians and law enforcement.
Cryptocurrency provides anonymity and therefore it became the medium of exchange between deep web users, who could buy/sell products and perform illegal activities in the dark web without anyone’s interference. People started doing the transaction on a global scale which could not have been possible before. It opened a new dimension of e-commerce which was supported by a deep web marketplace called Silk Route. Forbes reported that soon after its launch and within a span of 18 months, the site was conducting business worth 1.9 Million USD every month. Following the success of Bitcoins, several developers started creating their own variation of Cryptocurrency like Namecoin, Ripple, and Peercoin. In the meantime, the Silk Route was raided by the FBI and the founder was arrested which brought down the value of Bitcoins for a while.
Well, this was not the end of it as the site came up again and gradually the currency found its acceptance across the globe. The First Bitcoin ATM in the world appeared at Waves Coffee House in Vancouver, the machine enabled Bitcoin proprietors to trade their computerized cash for ordinary money subsequent to being verified by their palm prints. In 2013, University of Nicosia started accepting Bitcoins as payment followed by Overstock, the first major retail website to accept Bitcoins in 2014. On March 3, 2017, the value of one Bitcoin exceeded that of an ounce of gold.
Nature & Characteristics
Beyond the layers of cryptography and the mathematical nature of Cryptocurrency lies the political, social and legal nature of it.
“Government is instituted for the common good; for the protection, safety, prosperity and happiness of the people; and not for the profit, honor, or private interest of any one man, family, or class of men; therefore the people alone have an incontestable, unalienable, and indefeasible right to institute government; and to reform, alter, or totally change the same, when their protection, safety, prosperity and happiness require it.”
– Massachusetts Constitution, Part VII, John Adams
Though it is stated that the concept of Cryptocurrency is apolitical as it is devoid of any authority, I contend that it is a product of technological libertinism. The diminishing of political control is a political act itself. The users claim that there are real issues with our current money related framework, which require radical arrangements. This philosophy can be traced back to the concept of Laissez-faire, where individual trade and transaction are devoid of any government interference hence, it can be associated with neoliberals.  Cryptocurrency unlike traditional monetary system is not dependent on the Central Bank of the State but rather backed by algorithms. These appeal to those who believe in free market, it is also an attempt to restructure the political aspect of money by considering individuals as sovereign entities engaging in free trade without any disruption. The vision of Cryptocurrency is not exactly a new idea, but in consonance with the vision of Austrian Economist and Nobel laureate, Friedrich Hayek. In 1970’s he argued for privatization and denationalization of money and said that “the cause of waves of unemployment is not ‘capitalism’ but governments denying enterprise the right to produce good money.” He wanted to isolate money from politics, meanwhile, the inflation soared more than ten per cent in the US and more than twenty per cent in Britain. Similarly, the introduction of Cryptocurrency was during 2008’s US Economic crisis, as a sign of distrust towards the control of money by the Government. Bitcoiners are not just restricted to banks but State as well. They state that the issue with our current money related framework is the system it ties the creation of cash fundamentally to the generation of debt.
This desire to remove the involvement of government is a distant dream and it betrays history. This concept of anonymity during such transactions is also not full-proof as governments can trace the movement of goods and services and hampering the banker’s interest will also attract a political reaction, which might come down in the form of heavy regulation. Cryptocurrency being claimed an independent form of currency and strikes the very politics of money. However, essentially accepting that the state can be circumvented is probably not going to work, CC needs a political methodology, and it must advance to address criticism.
It must be noted that EU, United States, Japan, etc. have developed a progressive approach on CCs’ because instead of banning it, they have regulated it and such reflects the libertinism of their political compass. More details about such regulations will be discussed in further chapters.
“In the world of Bitcoin, there are gold bugs, hippies, anarchists, cyberpunks, cryptographers, payment systems experts, currency activists, commodity traders, and the curious”
Cryptocurrency’s underlying philosophy is based on social relations and trust. The community around Cryptocurrency is held up with the belief that such currency will replace all social relations with regard to money with machine code i.e.; the cryptography and blockchain. Bitcoins are designed as a peer-to-peer network; it is the code involved which authenticates the transaction and not the parties contracting. The relationship of customers any financial institution is based upon trust, which can be ensured by the cryptography and blockchain in case of Cryptocurrency. Therefore, a set of computer algorithms existing in cyber reality is claimed to replace human interaction. In modern society, debt is created by loans and other services which yield interest to the sovereign. Voluntary or not, everyone in the market uses credit for what they do. Cryptocurrency is a change in the way in the realm of value and financial relations. Typically a transaction between parties require human interaction and several factors including the environment play a role in this event, CC changes the reality into a technical interaction and trust is transferred from the banker to the algorithm. This demonstrates the intention of the users to revolutionize the concept of money on how money has value and who controls it. The idea surrounding CC is detached from the way money works in reality, as well as how the people perceive Bitcoins differently which is present due to the asymmetry of information regarding CC.
The exchange of CC involves a lot of laws, starting from jurisdiction, and contract to investment, Information Technology, and criminal law. Lack of any central authority casts a shadow on the jurisdiction; most of the countries do not have a clear position on the legality of CC, some have tried to regulate it. In the meantime, there is no denying that the cryptographic money exists and utilized broadly and the volatile nature of the CC, susceptible to hacking, discourages government to regulate.
In India due to lack of legislation in this regard, it is being tackled aggressively by the Indian government by freezing accounts of CC exchanges to protect the rights of the investors. The RBI is the regulatory body of money markets in India, which has also gone ahead and issued a notification in this regard, cautioning the investors that the risk is going to be borne by them and no remedies are available as of yet.
The bare minimum which is required to be in place is regulation before legalizing CC. Such regulation can be brought after proper examination and analysis of CC. This can be done by introducing KYC and other laws to regulate the flow of CC. It is also important to note that Blockchain technology is being understood and accepted by governments including India and are trying to introduce BCT in not only in their financial system but other public record systems as well.
CC is essentially a unit of record or record, numbers in a PC screen traded online when exchanged between parties. Like physical money, it is unknown as in it can’t be followed back to a specific person. Now, why is the use of currency like Bitcoins becoming popular? This can be evaluated by understanding the characteristics of CC:
- Bitcoin, unlike money, cannot have inflation, because there is a limited number of Bitcoins which is only 21 million and its smallest part is one hundred millionth of a Bitcoin.
- Verification in transactions is secured by the way of a private and public key, therefore, by the way of Digital Signatures, authentication is made, which system is recognized legally in India.
- Cannot be counterfeited like a traditional
- It uses a timestamp server, which digitally timestamps data. The server groups processed transaction into a block and make it publicly available for everyone to see. The existence of a given transaction in the blockchain is proof that the transaction really exists and is valid. The blockchain keeps the transaction in a chronological order which ensures the integrity of the chain. As time goes by the size of the blockchain get larger as the transaction history increases. This means the chain becomes more secure and resistant to compromise.
- Intermediaries exist to prevent theft and people rely on them as they do not trust another person. Therefore, they need someone they both can trust. CC, on the other hand, does this by establishing a Proof-of-work (POW) system that makes sure that every block added to the blockchain is authentic. Due to its limited number, in the event of a transaction, it is observed by everyone as it is a public ledger. All of the transactions are public; however, the public keys cannot be associated with any individuals. The identities of the sender and receiver remain anonymous.
- Customers do not need to disclose their personal data. In systems like PayPal personal data is collected and the system has the power to freeze it without any warning. In Bitcoins, an owner has complete control over his/her wallet.
- The authenticity of each transaction is protected by digital signatures corresponding to the sending addresses, allowing all users to have full control over sending CC from their own CC address.
- There are no limits when it comes to trading using CC; in the absence of any Central Bank, there are no intermediary charges for transferring money to any part of the world. In the time of globalization, the cross-border transaction becomes seamless with CC’s.
- If we compare CC’s with gold, CC is fungible in nature. It means that the quality of gold cannot be judged easily: the same quantity of gold will have different chemical properties. This is not true for CC, which can be subdivided into truly equal parts.
- While some CC like Bitcoins is growing more popular, it’s still relatively unknown for the majority. Although more business is starting to adopt and receive CC, it is mostly done to be at the forefront of innovation and not a necessity.
- The speed of transaction is not as fast when compared to existing systems like Visa or MasterCard.
- Password or device if lost can be fatal; if the wallet is lost then recovering it is almost impossible.
- The transactions are irreversible.
- It is linked to illegal activities as this process provides anonymity and it does not provide legal recourse in any event including wrongful loss.
- The machine where the wallet is kept should be secured tightly, theft is a common occurrence along with the intrusion of the virus in the computer system.
- It is volatile in nature, the rate of demand and supply is inconsistent and therefore it acts abruptly.
- As it is a fairly new system, there are chances of technical glitches which might result in a loss.
- There is no minimum valuation guarantee by any authority.
Mechanism & Usage
CC is based on cryptography, a mode of encryption where it is cloaked and secured by a key. There are two types of keys:
- Symmetric ( private key cryptographic system)
- Asymmetric ( public key cryptographic system)
In the Symmetric system, only one single private key is used for both encryption and decryption of information, whereas the Asymmetric system involves a pair of the private key and public key for encryption and decryption. CC uses the Asymmetric system. The public key is meant for public consumption and the private key is to be kept safe. The private key is like a paperless signature of the owner, which should only be at his disposal. In this system, the private key is mathematically related to the public key and it is technically impossible to compute one key from the other. People may know the public key of a given signer and use it to verify that signer’s signature. But it is impossible for the person to forge the signer’s private key and use it in transactions. This is referred to as the principle of irreversibility.
The network of CC requires and runs on high-performance computers that have enough power to manage all of the transactions. Those computers are needed for mining. It was once economically viable to mine Bitcoins using a standard home-use laptop. Compared to today where it mined in massive mining firms. The ways one can obtain CC are as follows:
- By Mining; this is basically verifying transactions, for what one would get rewarded with a fraction of the particular crypto. The basis of mining is the idea of block rewards. Blocks are transactions that are recorded in the Blockchain. What miners do is ensure that such transaction is legit, as in to check whether the same coin is used again before an incomplete transaction and that the output and input expenses match. 
- Buying on an exchange; there are two kinds of exchange, Fiat exchange and CC to CC exchange. In the former, legal tender like US Dollar, Euros, INR can be exchanged against CC directly and in the later; CC’s are traded with one another.
- Accepting it for goods and services; Companies like Microsoft, Subway, and PayPal accept CCs. More acceptance of CC increases its popularity, therefore, making it less volatile.
People are accepting Bitcoins as a mode of payment, vendors do that in case of micropayment for digital music as it saves cost, when compared to traditional payment systems. Everyone does not accept it directly; some might receive it via an intermediary who changes the CC into real currency. The interaction between fiat money in circulation and CC and its application can be classified in the following manner;
- Closed Virtual Currency Scheme; It is not exactly connected to the actual economy, basically, there’s a subscription fee and the users are asked to do specific tasks in exchange of CC’s which can only be used to buy online goods and services in that community.
- Virtual Currency Scheme with Unidirectional Flow: VC’s can be bought directly in exchange for real currency. This can be used to buy goods/service outside the virtual world, unlike the above scheme.
- Virtual Currency Scheme with Bidirectional Flow: It is the combination of the above two schemes, here VC can be exchanged with any other currency and good/services can be availed with it in the virtual world as well as the real world.
Currently, CC’s are being used to revolutionize the way Contracts are enforced and Investment is raised in the form of; Smart Contracts and ICO (Initial Coin Offering).
It is a contract written in a code, which is then uploaded to the blockchain. Only when specific conditions are fulfilled, the program executes the term of the contract. These contracts act as “if-then” statements. Once such contracts are executed, it is recorded in the blockchain, which is tamper-proof theoretically. It is said so because blockchain is a public ledger and if any changes are made, it will be visible on the connected computers and hence it is theoretically impossible to tamper. Such contracts render middlemen obsolete. Anything like shares, monies, properties of value can be exchanged seamlessly in a transparent manner. Implementation of the smart contract is efficient in the manner that it stores and maintains registry without any involvement of human beings. It is beneficial for cost-cutting and prevents any tampering of records and contracts. Well, it sounds all perfect but why is such technology not used? This is because if there’s a bug or any glitch in the coding the blockchain will still execute the terms of the contract and the end results might result in chaos.
Ethereum, another of CCs is more focused on “Smart Contracts”. While the general contract is secured by the law, these contracts are secured by technology. This concept is not new; it was coined by Nick Szabo, a legal scholar and cryptographer said that specific contractual conditions can be programmed in hardware and software in such a way so that breaching becomes costly to the one who is breaching. He claimed that the vending machine is a prime example as it executes contract only when the coins/notes received is equal to the displayed price. Using cryptography this concept has been taken to the next level where it can be used to execute anything including auctions. Barclays Corporate Bank uses Smart Contract to change ownership and transfer funds.
Initial Coin Offering (ICO)
As the name suggests, it is similar to Initial Public Offer (IPO), which is the initial issue of stocks to investors. So ICO is similar IPO with less regulation with an involvement of cryptography. For a start-up, it is easier to opt for an ICO because it is cheap and it is better for an investor too as it is easier to participate. As the classification of CC stays unclear in most of the places ICO is sold as a digital product and not a financial asset, which relaxes the regulation in place.
This is similar to crowd-funding where the investors are given CC’s instead of bonds or shares in an IPO and such tokens would become functional as soon as the funding is met or the start-up launches. As it exists outside the ambit of governments, it has been misused for frauds and scams. In 2017, as the prices of CC went up it came under the attention of authorities and ended up either being regulated or banned. US Security Exchange Commission has discouraged investors from investing in such schemes as it can be an elaborate “pump and dump” scheme. In this scheme, stocks of lower price are sold at higher prices using misleading statements and then the offered sells such share, wherein the investors end up in the loss. Therefore, before investing in an ICO one needs to be very cautious. Facebook, Twitter, and Google have banned ICO advertisement in their platform and most of them were operating in bad faith.
The process of ICO is mostly used by upcoming CC companies by releasing a token which is connected with the project. If used in good faith, this can change the way money is raised by start-ups. The regulation of ICO in different countries will be explored later in this paper.
Legal status and implication of Cryptocurrency in (Germany and U.S.)
The view on CC is not the same in all the countries, there is no international consensus regarding the same and therefore it can be said that determination of the legal position of CC is still at a primary stage. Firstly, no government wants its citizen to operate currency in a peer-to-peer basis, which may disturb the flow of govt. issued currency; secondly, it has to be classified because on the basis of CC’s category the tax and other implications shall be imposed. Thirdly, CC’s are unstable and are prone to theft and hacking, therefore, protection of consumers remains a question. Keeping this in mind, some countries have explicitly banned it since CCs can be used to feed the purpose of terrorism and other illegal activities. The IMF in 2017 has said that governments should look into the legality and regulation of CC as it would affect the role of Central Bank and financial services of a country and if it is ignored CC might cause governments to, “run for their money”.  CCs reached its boom last year when Bitcoins hit 18000 USD and it was realized by many jurisdictions that a point has arrived, where it is better for them to adopt CCs and regulate it than banning it as it has turned into a high-value asset. Germany is one of the countries which regulated CC in 2013, the first country to do so. In this chapter, we will study the legal status and implications of CC in Germany, Japan, EU, and India. The consequence of CC regulations shall also be discussed in this chapter, which would help us to conclude whether India is ready for CC.
Before going into the details of legal understanding we have to understand how CC’s can be classified or categorized. Firstly let us understand, whether an alternative form of payments like CCs fulfills the role of money in the economy. If so, then it can be considered as a currency. This will be examined in the following points by comparing Bitcoins to traditional currency:
- Mode of exchange: Money is a mode of exchange because it is accepted in exchange for goods/ services, for discharging a liability and also for imposing liability in the form of debt. Therefore, the key feature of money is, whether it is acceptable or it is nothing but a piece of paper. CCs like Bitcoins have garnered attention as well as acceptance. For example, in Czech Republic Bitcoins can be used to buy goods like shoes, beer and for services like a haircut, massage etc. CC can be also used to perform “discharge of debt” just like any legal tender, it only depends on the creditor who might or might not be accepting Bitcoins to relieve the creditor of his/her liability. CC exchanges have eased up the process by setting CC prices in local currency and exchange CCs as per its currency exchange rates. There are services where a retailer does not have to receive Bitcoins directly, instead of through such an exchange platform they get an equivalent local currency, which was originally paid in Bitcoins. This allows the transfer of Bitcoins without having the seller running into the risk of holding a CC. As this is a new technology and also volatile in nature, not everyone is interested in holding CCs.
- Store of value: An instrument can be said to have a “store of value” if it retains purchasing power over a considerable period of time. Though CCs’ volatile nature acts as a hindrance from having stable value, it is often contended that it is more stable than other currencies, whose supply might double overnight causing its value to drop by two times. Whereas, in case of Bitcoins the supply is limited which is a boon and a curse at the same time because limited supply might maintain its value, but if its use reaches the level of fiat currencies it would act as a deflationary force as the money supply won’t increase with economic growth. It is suggested that CCs do not exhibit this character of money as it is unstable. CCs are also devoid of other functions of traditional currency like it cannot be deposited in a bank but in digital wallets, which is susceptible to hacking, as well as it lacks insurance which dilutes any form of consumer protection for the CC owners.
- Unit of account: There is no strict definition of this term but economists consider it as something whose value can be determined by referring it to other goods. For example, the price of something can be expressed in fiat currency like US Dollar but CCs of equivalent money can be accepted which makes it a “unit of account”. Germany has classified Bitcoins under this term, which will be discussed later in this chapter. Furthermore, CC’s lack of correlation with traditional currencies in terms of exchange rates makes it difficult for owners to hedge.
But the scenario is changing rapidly with the introduction of Bitcoin ATMs in different parts of the world, the nature of CC is evolving and its growing similarities with traditional money may change CC’s classification in the near future.
Therefore, it can be concluded that CCs does not perform the same functions as traditional currency. Nonetheless, these characteristic does not stop CC from becoming a medium of exchange, maybe it cannot be classified as a “currency” but can be categorized as a “commodity” / “asset”?
CC as a commodity/asset
A commodity can be defined as an interchangeable good or material which has monetary value; basically, it can be used to create wealth and asset. Let us take the example of gold because CCs have similarity with it; neither of them is governed by a single body, both have limited supply unlike traditional currency, which can be printed by the governments. Furthermore, just like something of infinite supply, the price of gold fluctuates more than that of traditional currency, which is also the case with Bitcoins. Therefore, it can be said that CC and gold are somehow similar and hence it does not leave out the possibility of CC being characterized as a commodity.
Further, let us examine the characteristics of the object, which can be generally defined as a commodity. Firstly, a commodity can be exchanged for fiat currency just like CCs can be. Secondly, it has the ability to be possessed and directed by the owner, the same feature is found in CCs, where the owner can store (possess) Bitcoins in his digital wallet and decide how and when to alienate it. All these characteristics show that the owner can have complete control over CCs just like a regular good, which can be tangible or intangible. We will discuss more its classification with reference to countries in the latter part of the paper. Classification will determine the legal consequences of CC.
The first country to recognize and classify CC is Germany. In 2013, Bitcoins were recognized as “units of account”, which is legally binding as a financial instrument. This is in accordance to Section 1(11) sentence 1 of the German Banking Act (Kreditwesengesetz – KWG), which says that “ Financial instruments within the meaning of this Act are securities, money market instruments, foreign exchange or units of account and derivatives”. This is not to be confused with legal tender, as it is more similar to foreign currency. This falls under the system of private –law agreement where such currency is considered as a private mean of payment, similar to a barter system where the parties decide the mode of exchange. Furthermore, this privilege to transact in CC comes with a set of rules and regulations, which are looked after by the financial regulatory authority of Germany called, The Federal Financial Supervisory Authority (German: Bundesanstalt für Finanzdienstleistungsaufsicht) aka BaFin. The first step to use this currency is to possess an express license to do so granted by BaFin, which is required to keep a check on the users and also protect them from fraud and other illegal activities like money laundering. Any person who has to use a banking or financial service in Germany has to obtain a written authorization from BaFin. Hence the operators, as well as the consumers, have to get an authorization.
It is to be noted that the laws regarding CCs in Germany have been derived from the existing laws just by classifying CC as a “unit of account” as mentioned above. Now, the ambit of licensing and licensee is huge as this type of currency is not limited by any geographical or political boundaries; the courts and regulatory authorities are of the opinion that serving German customers would attract the requirement of licensing irrespective of the fact that whether companies, dealing in CCs have their place of business on German soil. Conducting such activities without a license is a punishable offense with imprisonment not exceeding three years or fine under Section 54 of the German Banking Act.
Germany’s inclusive legislation of their banking system has perpetuated the adoption of virtual currency in their system without much hassle. The lawfulness of granting a license to the participants is the only concern unlike other sovereigns including India where the basic objection lies in the fact, that CC is a decentralized form of currency which cannot be controlled by the authorities. Now, let me delve into the details of granting a license to CC participants, we need to understand the intricacies because it is the basis of CC’s legality in Germany.
Before conducting business in Virtual Currency a written permission is required from Federal Banking Supervisory Office. This can be done by submitting an application for a license, which should contain the following documents as per Section 32 of the German Banking Act:
- Satisfactory proof of the resources required for conducting such business.
- Names of the manager.
- Information necessary to assess the trustworthiness of the applicants and the managers mentioned above.
- Necessary information to determine the professional qualification required to manage the institution of the owners. This is also applicable to the persons mentioned in 2 & 3.
- A viable business plan showing the nature of the business, the organizational structure and planned internal monitoring procedures.
- If there are shareholders in the said institution then the following is also required:
- Name of the holders.
- The amount or percentages that are being held.
- The data required for assessing the trustworthiness of these holders or of the legal representatives or of the general partners,
- If these holders are required to draw up annual accounts: their annual accounts for the last three financial years, along with the auditor’s reports compiled by the independent external auditor if such reports are to be prepared.
- If these holders belong to a group: particulars of the structure of the group and, if such accounts are to be drawn up, the consolidated group accounts for the last three financial years, along with the auditor’s reports compiled by the independent external auditor if such reports are to be prepared.
- The facts indicating a close relationship between the institution and other natural persons or other enterprises.
- The granting of the license will be subjected to terms and conditions set by the Federal Banking Supervisory Office in accordance with the Act. Licenses can also be limited to certain Banking business and financial services.
- Before granting of a license, the Office shall also consult the guarantee scheme appropriate for the institution.
- Finally, the Office shall publicize the granting of license and notify other concerned government departments regarding the same.
The license shall be refused by the Federal Banking Supervisory Office if the above conditions are not met, sufficient documents are not produced and also, if:
- The head office of the institution is not situated in Germany.
- Facts which are known, warrants the assumption that, the institution is associated with other institutions or individuals through corporate ties which impair the supervision of the institution.
- Facts which are known, warrants the assumption that, the institution is a subsidiary of a body, located outside Germany and the body is not supervised effectively in the state where it is registered or has its head office or whose appropriate supervisory body is not prepared to cooperate satisfactorily with the Federal Banking Supervisory Office.
Therefore, it can be said that becoming a licensee demands enough transparency to mitigate the risks associated with CC.
Taxation laws are not usually designed to support a system like CC therefore, it is necessary to classify in accordance with the existing laws. The main aim to tax CC was to tax the profits earned out of it, hence Bitcoins are classified as an “economic asset” (Wirtschaftsgut) which is subjected to income tax in accordance to Section 22 and 23 of the German Income Tax Act. Only the commercial transactions regarding CC is taxed in Germany, private transactions between individuals or exchanging Bitcoins in CC is not subjected to tax.
Other legal issues (Criminal and Civil)
Though Germany has regularized the use of Bitcoins, it does not mean that all the issues regarding CC have been addressed. Regardless, with the licensing requirements and close supervision, it is very difficult to understand the origin of Bitcoins due to its decentralized structure and hence it is speculated that CC is utilized for money laundering purposes. A theory suggests that the sudden rise in CC price is due to more money being hidden in form of CC to evade tax implications by hiding the origin of money. According to German Law, all kinds of “economic asset” are subjected to money laundering regulations. The confusion arises when Bitcoins can also be classified as “book money” (Buchgeld) because it is not physically present just like “book money” and it only exists in the virtual space. Germany has adopted Bitcoins in their existing system and therefore traditional criminal law does not apply. Let us take the example of theft; generally, theft is applicable to a physical object, which can be removed without its owner’s consent. Bitcoins being only virtually existent is not considered a physical object and therefore cannot be subjected to the existing laws of theft. There are provisions which protect against the manipulation of data and computer fraud i.e.; hacking but does not necessarily protect against the theft of virtual good. Further, the provisions on data protection and integrity provided by Section 303a of the German Criminal Code is the only recourse available for prosecution of such offenses, which provides a narrow relief mechanism. Sec 303a of the Code says that:
“(1) whosoever unlawfully deletes, suppresses, renders unusable or alters data shall be liable to imprisonment not exceeding two years or a fine.
(2) The attempt shall be punishable.”
Classifying Bitcoins under the civil law has also posed a challenge to the existing system. German law classifies objects into objects which can be covered by rights like physical objects, claims and a number of objects, which are covered by Intellectual Property Rights. Now, Bitcoins does not fall under any of the above categories, which makes it difficult to deal with CC during civil disputes. CC can only be included in IPR but that too comes with several issues. The German Copyright Act protects works which represent personal intellectual creation through Section 2 (2) and contains special rules for the protection of software under Section 69c of the Act. But, Bitcoins does not exhibit any of the above characteristics because it is not a personal intellectual creation (it is a result of the software process) nor is it software. Hence, it cannot be categorized within the existing set of options available under IPR, which causes the dilemma of classifying Bitcoins appropriately in the German legal system.
Business involving CC falls under the purview of contracts, but the nature of Bitcoins raise several issues. Though a transaction involving Bitcoins is legal we have to see whether CC can be classified within the existing meaning of the contract in Germany. For example, if someone buys a product in exchange of money it will be termed as a sale contract; similarly, buying Bitcoins (product) in exchange of money is also a contract of sale. Section 433 of German Civil Code mentions the contractual duties in a purchase agreement, which says that:
- By a sale/purchase agreement, the seller of the item is obliged to deliver it to the buyer and procure ownership for the buyer. The seller must transfer the items to the buyer free of material and legal defects.
- The buyer shall pay the agreed price and accept the delivery of the thing.
Therefore, it can be observed that for executing a contract of sale, there is a transfer of movable property in exchange for money. But CC is not classified money, therefore when one buys an item with CC, it does not fulfill all the criteria required for a purchase/sale agreement. The situation does not change even when Bitcoins is bought in exchange of money because Bitcoin is not physically movable and hence such transaction does not meet the requirements of Section 433 of the German Civil Code. This would not be the case if CCs could be termed as rights, which is an individual’s authority to omit or require an action but Bitcoins do not fall under the general explanation of rights. It is not a claim like a fiat currency because there is no authority, which gives Bitcoins a value or even accepts Bitcoins in exchange for money. The legal path through which Bitcoins get legal validity is through Section 480 of the German Civil Code, which allows one to make necessary modification to exchange, basically what barter system is. The extent of modification is not mentioned in the Act and hence, it is safe to presume that Bitcoins, which is a kind of asset, can be transferred through this provision. Therefore, it can be concluded that though CC is legally used in Germany, their civil law system has not adopted CCs in a concrete manner.
Administration Issues and Observation
It has been established in the previous chapters that CC is considered an economic asset in Germany, which means that it can be held as a security and accordingly can be enforced if required. In case of CC, the question is, can a creditor seize a debtor’s Bitcoins (asset) if it was held as a security in their contract? The German Civil Code lists items or assets which can be seized during security enforcement which includes the seizing of a physical asset, but Bitcoins are not physical objects and hence cannot be subjected to such provision. This means that a creditor may take away the physical device, where the debtor’s wallet or private key is stored but it does not enable the creditor to use the data, which are CCs in this case.
Bitcoins are not money; therefore any loss of it won’t qualify as a pecuniary loss. This could be covered by Section 253 of the German Civil Code which says that money can be demanded in compensation for any damage that is not a pecuniary loss only in the cases stipulated by law.
Germany has shown a very progressive attitude by implementing and regulating CC like Bitcoins in their economy, but the civil and criminal legal system has not adapted completely to the concept of virtual currency. The narrow definitions and interpretation of the existing legislation have discouraged the complete adoption of CC, as the nature of it is perplexing and new. But, all these challenges do not rule out the possibility of enacting a comprehensive legislation which would deal with virtual currencies and provide suitable legal recourse when required.
The United States has expressed strongly against the idea of decentralized currency, The US Department of Justice has classified private currency system as a defiance of federal law system. A currency system which is peer-to-peer based would be in direct conflict with fiat currency and therefore cause unwarranted issues in the financial market. Section 2 of the U.S Stamps Act prohibits to, “make, issue, circulate, or pay out any note, check, memorandum, token, or other obligation for a less sum than $1 intended to circulate as money or to be received, used in lieu of lawful money of the United States”. The intention behind this provision was to obstruct the circulation of any other currency, other than what the government circulates. There are no licensing requirements in the U.S as of yet but that certainly has not stopped the usage of Bitcoins in the States. In December 2014, a bill was introduced in the Congress titled, “The Crypto-currency Protocol Protection and Moratorium Act” with the intention to restrict any “statutory restriction or regulation” on Cryptocurrency for five years (moratorium period), with effect from June 15, 2015. The term CC in the bill was mentioned as, “a popular term encompassing code-based protocols supporting an electronic, non-physical media for the exchange of value, and for the sake of both clarity and the avoidance of confusion in the mind of the public, based on the prior use of this term by the Internal Revenue Service in its initial guidance (see Notice 2014–21, released March 26, 2014); this term is used herein. However, it is believed Cryptocurrency encompasses the same protocols as those covered by terms such as digital currency, virtual currency or electronic currency”
The Notice 2014-21 issued by the IRS sheds some light on how the federal government perceives the concept of CC. In the said notice CC / Virtual Currency has been discussed, it has been introduced as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance — but it does not have legal tender status in any jurisdiction.” It has been referred as a convertible currency because a CC like Bitcoins has an equivalent value in fiat currency. Bitcoins can be traded, transferred and exchanged for U.S Dollars and other government-issued currencies like Euros, Pounds.
The bill criticized the existing classification of Bitcoins, which treated CC as property for tax purposes and does not take its multi-faced characteristics into consideration. Unfortunately, the bill of, “The Cryptocurrency Protocol Protection and Moratorium Act” was not passed, leaving the challenged regulations in its initial form.
New York is the only state in the U.S which has regularized Bitcoin by developing a licensing system like Germany. The New York State Department of Financial Services has formulated rules and regulation regarding the use of such currency. In this Regulation of Virtual Currencies, it has been defined as, “means any type of digital unit that is used as a medium of exchange or a form of digitally stored value.” Virtual Currency shall be broadly construed to include digital units of exchange that have the following characteristics:
- It has a central repository or administration;
- And are decentralized and have no centralized repository or administrator;
- May be created or obtained by computing or manufacturing effort.”
Not all online currencies fall under the scope of Virtual currencies. If the online currency exhibits the following characteristics it won’t be regarded as a Virtual currency:
- Digital units which are solely used in some gaming platform, and have no other application outside the said platform.
- Such units cannot be exchanged or converted into fiat currency.
- Cannot be exchanged for real-world goods and services.
- Digital units which are a part of some customer program, where such units are exclusively used to purchase, redeem goods and services from the issuer or be converted to similar units for similar programs but cannot be exchanged with Fiat currencies or Virtual currencies. (Example: Redeemable Points available to Wal-Mart customers after making a certain amount of purchase).
- Digital units for prepaid cards.
The requirement of license for engaging in Virtual Currency Activity is defined in Section 200.3 of the Regulation. Virtual Currency Activity is referred to as the following activities involving New York Resident:
- Transmitting, receiving or transmission of Virtual currency except when it is done for non-financial purposes.
- Keeping the possession of someone’s CC by any means like storing, holding or even keep it in custody.
- Buying and selling Virtual Currency as a customer business.
- Performing Exchange Services as a customer business.
- Controlling, administering, or issuing a Virtual Currency.
Persons engaged in any of the above-mentioned activities would require a license, without which the person is prohibited from engaging in such activities. Section 200.4 of the Regulation provides the documents required for an application of such license. This part will show how diligent the State is before granting license to someone, I have summarized the requirements in the following points:
- The name, address and other relevant details of the applicant and also the name, type and form of organization and details regarding the jurisdiction where it is established.
- The complete details and list of affiliates of the applicant and their relationship in context of the license.
- Detailed biographies of applicants and their director, Principal Officer, Principal Stockholder, and Principal Beneficiary of the applicant including their experience, qualification, position which shall be attested by them.
- A background report on the above-mentioned persons prepared by a recognized independent investigatory agency.
- For each of the above-mentioned individuals or anyone who would be appointed by the applicant, or anyone in the organization having access to any customer funds containing virtual or fiat currency shall provide; a set of completed fingerprints or receipt indicating the vendor (which vendor must be acceptable to the superintendent) at which, and the date when, the fingerprints were taken, for submission to the State Division of Criminal Justice Services and the Federal Bureau of Investigation the date of when it was taken.
- The current financial statement of the applicant, projected balance sheet and target income of the following year, from the date of application.
- A description of the proposed, current, and historical business of the applicant, including detail on the products and services provided and to be provided, all associated website addresses, the jurisdictions in which the applicant is engaged in business, the principal place of business, the primary market of operation, the projected customer base, any specific marketing targets, and the physical address of any operation in New York.
- Details of all banking arrangements.
- Affidavits mentioning any pending or threatened civil, criminal, administrative action or litigation, or proceeding before any tribunal, court, governmental agency against the applicant or any of the above-mentioned persons in 3.
- Verifications from New York State Department of Taxation and Finance declaring the applicant free of any tax obligation.
- Copies of insurance policies, if any for the applicant, customers or its members.
- Explanation of methodology which shall be used to calculate the fiat equivalent of Virtual Currency.
- Any additional information required by the Superintendent, if any shall be submitted to his/her satisfaction.
After receiving all such documents and using his/her sole discretion within the ambit of the Regulation, the Superintendent shall approve the application by granting a conditional license. Each licensee should comply with all federal, state laws, rules and regulation. A licensee shall delegate a compliance officer to monitor and check compliances. Each Licensee should also maintain and enforce written compliance policies, including policies with respect to anti-fraud, anti-money laundering, cybersecurity, privacy and information security, and any other policy required under this Part, which must be reviewed and approved by the Licensee’s board of directors or an equivalent governing body.
All these rules and regulations put a very tight security against any fraud, theft or other illegal activities that might be committed using VC. The regulations have also acknowledged the fact that VC have an equivalent fiat value and can be exchanged with it.
Classification of Bitcoins
- Bitcoins as a form of asset
U.S government has not had a strict position on the categorization of CC. According to IRS, CCs is considered as a personal property, which is different from real property. Personal property is defined as any property which does not come under the purview of real property. Further, personal property can be divided into two categories:
(1) Corporeal personal property, including items like merchandise, and jewellery.
(2) The incorporeal personal property comprised of such rights as stocks, bonds, patents, and copyrights.
The CC comes under the purview of incorporeal personal property according to the IRS because it is intangible in nature. But, several court rulings have decided otherwise by referring to Bitcoins as money from a legal perspective.
- Bitcoin as a form of currency
In the case of, Security Exchange Commission v. Trendon T. Shavers and Bitcoin Savings and Trust the following was noted:
“[Bitcoin] can be used to purchase goods or services, and as Shavers stated, used to pay for
Individual living expenses. The only limitation of Bitcoin is that it is limited to those places that accept it as currency. However, it can also be exchanged for conventional currencies, such as the US dollar, Euro, Yen and Yuan. Therefore, Bitcoin is a currency or form of money, and investors wishing to invest in BTCST provided an investment of money.”
In the popular case of, United States v Ross William Ulbricht, the court noted that:
“The money laundering statute is broad enough to encompass use of Bitcoins in financial transactions. Any other reading would – in light of Bitcoins’ sole raison d’être – be nonsensical.
Congress intended to prevent criminals from finding ways to wash the proceeds of criminal activity by transferring proceeds to other similar or different items that store significant value. … One can money launder using Bitcoin.”
In, United States v Murgio , it was noted that:
“[Bitcoins] can be accepted as payment for goods and services or bought directly from an exchange with a bank account. They, therefore, function as pecuniary resources and are used as a medium of exchange and a means of payment”.
The above observations show that the judiciary is bent on declaring CC as a currency, but there are conflicting rulings too. For example, in the case of Florida v Espinoza, it was observed that, “while Bitcoin can be exchanged for items of value, they are not a commonly used means of exchange.” Generally, a currency should be a commonly used means of exchange and according to this case CC does not meet the criteria.
- Bitcoins as security
The definition of security in U.S legal system is very wide, there is certain requirements which if met would qualify an object as security. Section 2 (a) (1) of the Securities Act, 1933 defines security broadly as to include any financial instruments which constitutes an investment and can have security laws enacted. Securities also include investment contracts, which is a contract between two parties agreeing to invest a specific amount of money and distribute its profit/loss as agreed upon. The U.S Supreme Court in the case of, SEC v. Howey Co clarified that;
“The test of whether there is an “investment contract” under the Securities Act is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others; and, if that test be satisfied, it is immaterial whether the enterprise is speculative or non speculative, or whether there is a sale of property with or without intrinsic value.”
A parallel of this can be drawn with the scheme of Initial Coin Offering because; Bitcoins can be categorized as “property” which apparently lacks any “intrinsic value” as such. The broad definition of Security has therefore covered Cryptocurrency as a security.
- Bitcoins as a commodity
The definition and basics of the commodity have already been discussed in one of the previous chapters. Therefore, I would directly jump to the U.S perspective of Bitcoins as a commodity. According to the Commodity Exchange Act, it is defined in Section 1(a) 9 as:
“… wheat, cotton, rice, … and all other goods and articles, except onions … and motion picture box office receipts (or any index, measure, value, or data related to such receipts), and all services, rights, and interests (except motion picture box office receipts, or any index, measure, value or data related to such receipts) in which contracts for future delivery are presently or in the future dealt in.”
Future contacts have been clarified in the case of, Dunn v. Commodity Futures Trading Commission as “… agreements to buy or sell a specified quantity of a commodity at a particular price for delivery at a set future date …” It is contended that, as Bitcoins can be subjected to future contracts, it can be classified as a commodity in accordance to the above explanation. If a CC is categorized as a commodity, it will come under the authority of Commodity Futures Trading Commission and therefore anyone who deals in CC, which can be classified under commodity, will come under the purview of Commodity Futures Trading Commission. The broad definition of security has given space to such interpretation, which adapts the concept of CC in it.
Taxation of Bitcoins
Bitcoins are treated as “property” for tax purposes by IRS, and such classification implies that:
- Digital currency payments made to independent contractors and service providers must be reported
- Profits and losses from the sale of digital currencies are subject to capital gains when being used as capital assets.
- Wages paid to employees in digital currencies are taxable and must be reported.
The sales tax perspective of Bitcoins is still under discussion, everything rests on the final classification of Bitcoins, which if treated as currency shall be labeled as, “income” and “property” if it is treated as an asset. The technicalities in identification of tax assessee is also challenging when dealing in Bitcoins because the technology is new and intricate.
Observation and Inference
The categorization of Bitcoins is not very clear, but it is not an illegal object in the United States. The current legal system of U.S is not strong enough to support CC without any modification or legislations. Though, some of the existing laws tend to support the system of CC, it is not flexible enough to adapt the technological advance of CC. The virtual nature of CC hinders the law to treat it equally along the line of commodities, security and currency. Another factor that comes into play is the different types of CC, there are several kinds of CC besides Bitcoins and each of them exhibits some unique characteristics, which makes it hard to generalize the legal position of it. The problem is only regulations won’t solve the difficulties of CC in the legal space, civil and criminal law should be developed too in order to provide more protection to the consumers. The only government wing which has identified Bitcoins as money is the judiciary, but the current authority only lies with Security Exchange Commission and Commodity Future Trading Commission hence, more laws are required to handle CC effectively in the U.S.
Position of Cryptocurrency in India
The current position of CC
The position of Cryptocurrency in India is at a primal stage, it is neither legal nor illegal as there are no legislative documents declaring either. Recently, the Finance Minister of India, Arun Jaitley in his 2018 Union budget speech declared CC as an illegal tender, but assured that the government will explore the underlying technology of Blockchain Technology. Though this speech provides a peak into the intention of the current ruling party, it does not rule out the possibility of regularizing CC in India like several other countries in the near future. Further, the speech does not form any legal basis on the classification of CC. Indian government is discouraged from recognizing CC because it is perceived that the only use of it is to finance terrorism and carry on illegitimate activities, which was expressed in the speech given by the Finance Minister. In the past RBI has issued notification asking the consumers not to use to CC because the government does not recognize it or provide any consumer protection in this regard. 
Lack of rules and regulations did not stop India from having CC exchanges; there were/are numerous exchanges like Zebpay, UnoCoin, and CoinSecure operating in India. On Apr 5, 2018 the RBI in order to stay out of CC business barred banks and financial institutions under it to deal in any sort of CC, RBI clarified that it shall not deal or offer services to any person or entities involving CC vide a circular. Three months time has been provided to dissolve the relationship with such entities, dealing in CC. As a result, banks under RBI which is most of the banks are not allowed to facilitate sale, purchase or even enable anyone to withdraw money or deposit money in relation to CC, which means investors won’t be able to transfer money from crypto-exchange to bank or vice versa. Such a decision is estimated to affect nearly 50 lakh Indians, who have invested in CC. In a move to digitize India, this is a step backward because RBI already set up a multi-disciplinary panel to study CCs’ and was supposed to release a report discussing its position in the Indian economy and design a framework. Instead, RBI decides to stop involving itself in the CC market, which is a confusing move and have left many investors and businesses in the dark. The aim of RBI lies in protecting the interest of the consumers and such a sudden step to curb the use of CC served a heavy blow on CC users. 
It has to be noted that in 2017, the Supreme Court of India expressed its intention to regularize CC, which is contrary to the action of RBI. In the case of, Dwaipayan Bhowmick Vs Union of India & Others, a PIL was filed under Article 142 of the Constitution of India praying the court to issue directions clarifying the nature of CC and set up a special committee to frame appropriate regulation to deal with CC in India. The lack of any framework had rather left the market unregulated, which can harness all sorts of criminal activities. The PIL said that, regularizing the CC within the legal framework would be a game changer as it would restrict users from using it in illicit activities. CC being a global phenomenon cannot be stopped or banned because it is all on the internet; the best thing therefore is to set up a mechanism to keep a check on it. Also, it would help to boost the economy because a lot of investors and companies are looking forward to pool India’s IT resources and develop a trading hub for example; BitBay a company from Poland made its entry in the Indian Market in Aug, 2017. The SC consequently sought responses from the government but all the respondents have not filed any counter affidavit. On 2nd April, 2018 the SC ordered and granted last and final opportunity to the Respondents to file counter-affidavits within a span of 4 weeks. Such response from the government shows its intention to classify and regularize CC or entertain public interest as such.
Recently, RBI prohibited financial institutions and banks to conduct any business or services in CC via a circular. As a result, the affected party, Kali Digital has approached the Delhi High Court to seek relief regarding the constitutional validity of the circular. The Court has accepted the petition and sought response from the Ministry of Finance, GST Council and RBI regarding the challenged circular. The petition states that the circular issued by the government is in violation of Fundamental Rights as guaranteed by the Indian Constitution and have contended the following;
- Article 14, which states that, “The state shall not deny to any person equality before the law or the equal protection of the laws within the territory of India.”. The Cryptocurrency Company, which has been a registered company, should be protected like any other company and there should be no discrimination, it is contended that the RBI is discriminating companies dealing in CC.
- Article 19 (1) (g), which states that, “All citizens shall have the right to…. to practise any profession, or to carry on any occupation, trade or business”. There is no such laws which declare the business of CC as illegal therefore, this circular is obstructing the fundamental right of citizens.
Further, they have expressed anguish over government’s failure to devise a framework on CC, which has caused uncertainty and difficulties in the Crypto business in India.
Such unwarranted move by the government is leading many Crypto companies to move outside India’s jurisdiction to conduct their business. In the following chapters I will try to examine whether the existing legal system of India can adapt Bitcoins and other CC.
Possibilities of CC classification in India
We first have to understand the structure of government in India before delving into the need of a legal framework surrounding it. India is a democracy and has a federal system of government, which gives power to both Centre and the States to legislate in accordance to the Constitution. Under A246 of the Indian Constitution, the Parliament and the State Legislatures have power to enact laws as per matters enumerated in Seventh Schedule of the Constitution. The Seventh Schedule consists of three lists; Union List (List I), State List (List II) and Concurrent List (List III). These lists specify the subjects on which the Center, State or both of them can legislate upon;
In accordance to the list, only the Union/ Central government has the power to legislate on CC because Entry 36 of List I mentions, “Currency, coinage and legal tender; foreign exchange” and Entry 46 of List I mentions, “ Bills of exchange, cheques, promissory notes and other like instruments.” It is most likely that CC shall be categorized among the above-mentioned items. It must be noted that the Constitution is the supreme law of the land and no legislation can violate its basic structure or act contrary to it. Simply put, the concept of CC should not be in conflict with the Constitution, it is interesting to observe that CC which roots itself on the concept of privacy is a recognized fundamental right in India but, necessary constraints should be provided to avoid chaos. Therefore, regularizing CC would be fruitful to make India truly digital.
The power vested in the government by the people does not rest on one body, but on three separate branches where the powers have been distributed by the Constitution namely; the Executive (which includes the Prime Minister, the President and the Council of Ministers), the Legislature ( the Parliament, which is responsible for legislating laws and policies of the government) and lastly the Judiciary ( adjudicating body of India, which includes the Supreme Court, High Courts and its subordinate courts). While discussing, the legality of CC in Germany and United States, we have established that all the government wings does not necessarily share a common opinion on CCs’. Similarly, in India the Executive policies are bent on restricting the use of CC whereas, the judiciary seems like having an intention to regulate it. Further, no bill has been presented in the Parliament in this regard, which excludes the legislature from the existing CC scenario.
To understand whether CC can adapt in legal ecosystem in India, I will try to answer the following questions:
- Can CC be considered a legal tender in India within the purview of existing laws?
The term legal tender has not been defined in any of the existing statues in India, what can be gathered is its characteristics, and therefore by analyzing the features of an object we can identify whether it qualifies as a legal tender or not. Legal tender is basically bank note and other equivalent instruments which is commonly used and is acceptable by the government and banks. Section 26 of RBI Act considers the money issued by RBI as legal tender.
The statutes related to this subject are RBI Act of 1934, Coinage Act of 1792 and FEMA of 1999. The definition of currency is not specified in RBI Act, but the definition of foreign currency is referred in the Act to be the same as FEMA. An inclusive definition of currency is mentioned in Section 2(m) of the FEMA which states that currency includes “all currency notes, postal notes, postal orders, money orders, cheques, drafts, travelers 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” and currency drawn or expressed in INR is “Indian Currency” in accordance to FEMA.
The legislature has been very strict to restrict the ambit of legal tender; Section 22 of the RBI Act states that the sole right to issue bank notes belongs to the RBI. Therefore, it is difficult for CC like Bitcoins to adapt into the Indian legal system as a currency or a legal tender until and unless it is notified by the RBI.
Unfortunately, RBI does not consider CC as a legal tender. As discussed above this declaration has been challenged and is pending before the honorable judiciary.
- What is the status of Virtual Currency in India?
In the previous question the meaning of currency in the Indian context has been discussed, now CC is a sub-set of Virtual Currency, whose recognition in India will be dealt in this question.
“express um facit cessare tacitum” is a Latin maxim which means ,‘when there is express mention of certain things, then anything not mentioned is excluded’. In the above answer it is made clear that only the RBI can issue currency. Therefore, VC which has not been notified as a legal tender in India by RBI is excluded from the purview of currency. The maxim, which I have used, has been upheld by the Supreme Court in the cases of, Shankara Rao Badam & Ors. v. State of Mysore & Anr and Union of India & Anr. v. Tulsiram Patel.
Therefore, it can be concluded that CC cannot be categorized as a legal tender in India.
- Can Bitcoins or other CCs be treated as a commodity?
A commodity basically means an object which has a commercial purpose, the term commodity has not been expressly defined in Indian statues, and the closest definition of commodity can be equated with the definition of, “goods”. The definition of “goods” is mentioned in the Sale of Goods Act, 1930 which defines good as, “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”. This definition does not mention whether a good should have any physical characteristics and therefore it does not rule out the possibility of Bitcoins being classified as a good. Further, this is not an exclusive definition and can be interpreted liberally to include CC.
The Supreme Court has classified computer software as “goods” in the case of Tata Consultancy Services Vs State of Andhra Pradesh, although it is debatable whether CC qualifies as computer software, it still throws light on how intangible computer codes is perceived as far classification goes. SC in the above case stated that;
“computer software is intellectual property, whether it is conveyed in diskettes, floppy, magnetic tapes or CD ROMs, whether canned (Shrink-wrapped) or uncanned (customized), whether it comes as part of computer or independently, whether it is branded or unbranded, tangible or intangible; is a commodity capable of being transmitted, transferred, delivered, stored, processed, etc. and therefore as a ‘good’ liable To sale tax.”
The explanation demands the property capable of being transferred, transmitted. Can Bitcoins fulfill the above? It has to be noted that, Bitcoins are stored in an electronic space called e-wallets, which is protected by a private key (which has been discussed in Chapter 5). This private key is used to authorize and verify transactions. Similar parallel can be drawn with any of movable objects, where the lock and key is tangible unlike e-wallet and private key. Hence, like any movable property it can be stored (in e-wallet) and transferred as per the owners wish and if CCs’ can be classified as goods, it can be taxed and monitored by the State.
- Can CC come under the purview of, “securities”?
The term, “securities” refer to the instruments presented to investors by an investee upon investing, such instruments are the representation of the object of investment without transferring the possession of the actual object. This has been defined in Section 2(h) of SCRA, 1956 which includes:
“(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;]
[(ic)security receipt as defined in clause (zg) of Section 2 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;]
[(id) units or any other such instrument issued to the investors under any mutual fund scheme;]
(ii) Government securities;
(iia) such other instruments as may be declared by the Central Government to be securities; and
(iii) Rights or interest in securities;
Firstly, Bitcoins or any other CC lacks the very essential feature of being described as, “security” because CCs are not backed by any underlying capital, its price depends upon demand and supply therefore, it does not qualify as “security”. Secondly, it is not issued by anyone in particular but is created by computer algorithm. It also cannot be categorized as, derivatives because it does not fulfill the primary criteria of being a security. Hence, it can be understood that CC cannot be categorized as anything except property in India.
Application of CCs’ in a Contract
If a person wants to enforce a contract using CC, will he/she be successful? There can be two case scenarios; one where Bitcoins is the consideration in the contract and second when it is the object of contract. According to the Indian Contract Act, 1872 a “contract” is a legally enforceable agreement and the necessary elements to a legally enforceable agreement include:
- The parties should be competent to contract i.e.; should be a major, which is 18 years old.
- There should be free consent i.e.; without any coercion, misrepresentation, undue influence, fraud and mistake.
- There should be a lawful consideration with a lawful object, which has not been expressly declared void. 
Consideration is defined as, “When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise”
From this definition, the word “something” can be construed to include the transfer of CCs’.
Bitcoins can be used as consideration because the nature of consideration is not specifically defined in the Act except, the factor that it must not be unlawful in nature as it has been expressed in Section 23 of ICA, 1872. Section 23 states that, if the Court regards an object as immoral and against the public policy, it will turn into an illegal object. But the term, “public policy” and “morality” is subjective and it is dependent on the society and the circumstances, there are not hard and fast rules to decide whether something is immoral, further CC has not been discussed in this light. The Judiciary till now has not expressed anything which can construe CC as an illegal object or consideration.
Therefore, CCs’ can qualify as a consideration because it has not been declared as an unlawful object. CC can also be an object to a contract because of the same reason; there is no law which declares it illegal.
The situation changes when CC is examined under the Sale of Goods Act, 1930 where money is an essential element for completion of a contract. Section 2(10) of the Act states that “price” means the money consideration for a sale of goods, and money refers to a legal tender, which CC is not. This implies that CC’s cannot be used as a consideration to buy goods under the Sale of Goods Act, 1930.
Intellectual Property Issues
Intellectual Property refers to tangible properties, which are a product of human intellect. The rights provided to the owner of such tangible property by law are termed as Intellectual Property Rights. It includes copyright, trademark, patent and design. The ever evolving technology has led to develop new ways to protect different kinds of Intellectual properties; it shall be examined if Virtual Currencies qualifies as an Intellectual property as it is a tangible property. It has to be noted that the property should have an underlying commercial value in order to get such protection.
A patent can be only registered in India if the invention or process consists of; originality, non-obviousness and utility, a patent provides exclusive right and control to the inventor. The creation and authentication of Bitcoins involves a process called mining as discussed in Chapter 4, mining is executed by using specific software and hardware combination to solve complex algorithm and verify transactions. Though it consists of commercial utility and is a new process, which completely revolutionized the concept currency works, it is not an exclusive process and is available to the public ( open-source software), therefore no rights can be attached to any owner because there is none. The Patents Act, 1970 states that, a mathematical or business method or a computer programme per se or algorithm does not qualify as an invention. Hence, it can be concluded that Bitcoins or CCs’ cannot be patented by any mean.
A computer program can be copyrighted according to the Indian Copyright Act, 1957. It is covered under, “literary works” and computer program is defined as, “set of instructions expressed in words, codes, schemes or in any other form, including a machine readable medium, capable of causing a computer to perform a particular task or achieve a particular result.” The software which facilitates the generation and trading of Bitcoins is open-source software, which means that the code can be accessed by public and modified according to ones need. The alteration in the code furnishes different results like generation of new codes and components which can be copyrighted, but it will be very difficult to understand the differences and determine the author. Further, the code does not generate any commercial until and unless it has been developed into a new CC like Ethereum, which is different from Bitcoins.
In India, “trademark” means a mark capable of being represented graphically and which is capable of distinguishing the goods or services of one person from those of others and may include shape of goods, their packaging and combination of colours. The essential features of a trademark lie in its uniqueness, distinctiveness so as to enable the consumers to distinguish one product from another.
The entire wave of CCs was started by Bitcoins, which has eventually become a generic word for CCs, therefore, it is difficult to prove its uniqueness, as the word is used in different contexts by different companies based on their services relating to CCs’. Therefore, the main intention of trademarking the word, ”Bitcoins” is defeated as the term “Bitcoins” is used by many entities in different manners and it won’t provide the public with any distinctiveness to differentiate its origin. But when the same word is amalgamated with some other word or has been visually modified to provide uniqueness, it can be registered as a Trademark. But, CC like “Ethereum” which has been developed by an organization is a registered Trademark.
Tax Implications of CC in India
CCs were almost overlooked by the government until the point, where the price of Bitcoins skyrocketed and generated huge profits to its owners this year. Gradually, the tax authorities started issuing notices to participants, who have gained from Bitcoin transactions. CCs’ are not recognized in India as a legal tender therefore, the only way it can be taxed is by treating it as a capital asset.
Capital Asset according to Income Tax Act, 1995 means, “any kind of property held by an assessee, whether or not connected with his business or profession..”
The definition does not restrict itself to one kind of property, so it can include intangible property like Bitcoins. As long as CCs’ is used as investment instrument, the profits arising out of it can be taxed as capital gains. Further, it can be classified as long-term or short-term capital asset depending on the time the property was being held. If the property is held for more than 36 months, it is categorized as a long-term capital asset or else it is a short-term capital asset. The difference is important because the tax implication is different in each case.
Persons conducting business in CCs’ would involve frequent Bitcoin transactions, and such cannot be deemed as a capital asset but “income from business and profession.”
A miner, who uses their computer to facilitate mining of Bitcoins also get a part of the CC (as a consideration) after successful verification, this can be deemed as business income as well. But if it is considered as a capital asset, it may not have any tax implications because a miner spends no cost of acquiring the Bitcoins because it is self generated during the mining process. In the landmark case of Commissioner of Income Tax vs. B.C. Srinivasa Setty it was noted that, in a case where the cost of acquisition were not ascertainable, the computation mechanism could not come into play. The same can be applied in the case of mining, where the cost of acquisition cannot be ascertained by a miner.
CC is encrypted with heavy mathematical functions which makes it the most secured form of currency. But recent case studies throw a different impression; the biggest hack was in 2014 where a Japan based CC exchange, Mt.Gox lost Bitcoins equivalent to 620 Million Dollars and it is alleged that this was the result of weak management in the company. There has been a lot of instances involving the theft/hacking of CC, but it has not discouraged the CC community a lot. Instead, new security measures and verification processes have been developed to avoid such backdrops. During such instances, legal framework of a country on Information Technology and CC serves as a guardian angel; laws related to I.T. can be applied in the case of CC, but it is not enough considering the multi-faced characteristics of CC. In this part, I will examine whether Indian laws are capable of handling the challenges and hurdles related to CC usage.
Under the Information Technology Act, 2000, “computer” means, “any electronic magnetic, optical or other high-speed data processing device or system which performs logical, arithmetic, and memory functions by manipulations of electronic, magnetic or optical impulses, and includes all input, output, processing, storage, computer software, or communication facilities which are connected or related to the computer in a computer system or computer network”
Bitcoins can fall under the purview of computer because:
It is a system, which fulfills the functions mentioned in the definition.
- It is transacted via computers in a network of connected computers.
Hence, the offences related to computer, mentioned in the Act can be used to deal with CCs. The I.T Act covers the following issues:
- Hacking – Section 43 of the IT Act states that, whoever without the consent of the computer owner; accesses his/her computer system. The term, “hacking” had been replaced by, “computer related offences” which gives a wider ambit to the meaning. This act may also include:
- Destruction, suppression and misappropriation of output from a computer process.
- Alternation of computerized data.
- Alternation or misuse of programs.
The above mentioned Acts encompass everything from introducing a virus to the computer system to initiating a Distributed Denial of Service (DDos Attack). Section 66 of the I.T. Act declares such act as a criminal offence. It states that whosoever with a criminal intent (dishonestly and fraudulently) commits such acts shall be punishable by imprisonment up to three years or with fine upto INR five lacs or both. “Dishonestly” and “Fraudulently” is to be construed from Section 24 and Section 25 of IPC.
- Identity Theft– Section 66C of the IT Act makes unauthorized, fraudulent and dishonest use of digital signature a criminal offence. For example, if someone dishonestly uses my private key to access my Bitcoin e-wallet without my authorization, it would qualify as an offence under this Section. The criminal shall be penalized with imprisonment upto 3 years and a fine, which may extend upto INR One lac. 
Further, Section 66D of the Act regards Impersonation with regard to an electronic signature a criminal offence. The offender shall be imprisoned upto 3 years and a fine, which may extend upto INR One lac.
- Cyber- Terrorism– the I.T. Act states that computer-related offences with the intention to threaten the unity, integrity, security or sovereignty of India or to strike terror in the people or any section of the people. Section 66F (I) provides a punishment of imprisonment which may be extended to lifetime. Coming back to CCs, the decentralized structure and anonymity can be misused to fund terror activities, which can result in a threat to national security and economy. Supposedly, CCs are popular and highly valued in the Indian market and classified as, “securities”; in such a situation it is quite possible that a cyber-terrorist can hack into the network and disrupt the system. Such an activity might destabilize the Indian economy, defeat public order and cause serious harm to the sovereignty of India.
The Financial Action Task Force, which is an inter-governmental organization to combat money laundering also states the virtual currencies like CC is a threat as it can be used to sponsor illegal activities. The technology-based on encryption makes it more difficult to track the wrong-doers. The existing legal framework is efficient enough to tackle the challenges posed by CC.
Conclusion and suggestion
Science has always helped to transform mere imaginations into reality. CC is one such example where the entire concept of money and the role of government have been challenged, this has led governments either to regulate it or ban it. In my opinion, regulating and developing mechanisms to control CC would give governments more security than by banning it completely; regulating it like Germany would generate huge revenues to the government whereas, banning CCs would not serve well in the long run because more and more countries are beginning to recognize CCs. Further, recent observations by expert suggest that Bitcoin and other Cryptocurrencies might become the biggest international currency by market capitalization.
The existing legal environment must modify itself to integrate, recognize and regulate CCs. It might be surprising to know that companies like Microsoft are also accepting Bitcoins. People who compared this technology to a bubble or a scam are turning out to be incorrect. In fact, in India one of the largest conglomerates, Reliance Jio is planning to launch its own CC called JioCoin, which is also reported to include smart contracts. A survey conducted by The Indian Express found that CCs’ worth INR 17,800 crore has been traded, which implies that the citizens are growing keen to invest in CCs’ though there are no legal recourse or structure protecting our citizens.
The risks associated with CC are the same for every other software; and also just like any tangible objects, CC can be stolen or hacked too. Bitcoins operates on computer networks interacting with each other, it is said that the network will remain secure as long as the number of computers dedicated to run the network is more than the number of computers trying to attack it.
The Indian government, instead of curbing its use, should use this opportunity to break down the barriers associated with fiat currency and become a global CC investment hub, which would attract a lot of business and investment. The laws and regulations in this regard should be designed carefully as CCs’ involves a lot of intricacies and trying to bring it under the existing laws would bring unnecessary complications because the current laws were not formulated by having CCs’ as a factor. The existing laws provide minimum security to the consumers hence, India should develop a licensing system for CC exchanges and design a KYC ( Know Your Customer) procedure like Germany and U.S. to monitor the users and provide transparency to the operation. Given the nature of CC, companies should also be allowed to develop self-regulatory laws, backed by the government’s sanction instead of designing restrictive laws. Legislations, if passed should be devised with the help of CC companies and experts to encourage the use of CCs. Strict and clear legislation in India regarding this matter would help to eliminate any future conflict between the Judiciary and Executive, and also provide clarity to the citizens regarding the use of CC.
Germany has been dubbed as the “Bitcoin capital of Europe” by the Guardian. The German National Tourist Board, have also been encouraging and accepting CCs’ as a mode of payment to fulfil their intention of becoming “an innovation driver”. The faster approach has led Germany to avoid confusion and generate revenues out of CC transactions, unlike U.S and India. Whereas German business considers CC to be very transparent due to its algorithm, U.S and India are definitely making progress to catch up with the concept of C.C. India might as well have a promising CC industry if the available resources are pooled effectively; the vast I.T Sector is coupled with the implementation of effective regulations would attract investments, encourage new businesses, generate revenues and create employment. The current state of policies has rather disrupted the business in India, leaving the citizens in a state of chaos and despair. This technology is not going to burst but expand, social media giant Facebook is also planning to launch its own CC.
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