This article is written by Megha Dalakoti pursuing LLM from National Law University, Odisha. The article has been edited by Smriti Katiyar (Associate, LawSikho).
Governments across the world are struggling to regulate the use and exchange of cryptocurrencies due to the anonymity involved in the holding, mining, and transactions of cryptocurrencies. Can cryptocurrencies be used as a legal tender for the development of an economy?
A cryptocurrency is a virtual or digital form of currency capable of being represented in “tokens” or “coins”. There are some cryptocurrencies that have ventured into the physical world with different projects, however, there is a large section that remains entirely intangible. Cryptocurrencies function on the blockchain technology which facilitates a record of every transaction ever conducted in the form of a ledger. Every new block generated is verified by each node and thereafter confirmed, and hence, it is impossible to forge transaction histories. Cryptocurrencies are not issued by any central authority and hence, are immune from government interference or manipulation. It is a peer-to-peer based digital currency system. They are self-regulated currencies. The value of the cryptocurrencies is volatile in nature. It does not hold an intrinsic value, but the value is determined by its use i.e., more the users, greater the value. Countries are still examining and analysing the nature of cryptocurrencies. The legality and regulation of cryptocurrencies is still a big question to be solved. Can the legalisation of the cryptocurrencies be beneficial for the economy of a country? What are the challenges associated with such legalisation?
Due to the highly volatile nature of the first successful cryptocurrency i.e., Bitcoin and increasing related financial frauds, many countries took an initiative of banning bitcoins and other cryptocurrencies, its use, and exchanges. In 2015, Ecuador was the first country to ban bitcoin and launch its own electronic currency followed by China completely banning bitcoin transactions and dealings. There are few other countries which banned dealings in bitcoin or other cryptocurrencies such as Russia, Vietnam, Bolivia, Morocco, Columbia, Pakistan, etc. In 2018, the Reserve Bank of India banned cryptocurrency dealings in India. The ban was lifted by the Supreme Court of India in April 2020. Many countries have given recognition to cryptocurrencies by regulating them and recognising them as legal tender. Japan is the hub for cryptocurrency trading in Asia. Other countries like the US, Germany, Canada, France, Malta have also recognised bitcoin transactions as legal.
We will examine the legal position of Cryptocurrency in India as well as in Japan. The aim is to compare and understand whether such currency will benefit the economy or is it too volatile to be considered a currency. On the one hand, governments like the Indian government, are against the legality of cryptocurrencies and their use, due to the risk of financial frauds associated with the transactions, and on the other hand, Governments like the Japanese government, have legalised the cryptocurrencies. Understanding the relativity in the functioning of both the countries and challenges associated with the legalisation of cryptocurrencies is the prime objective of this comparative study.
Need for the comparative analysis
There are several questions in the minds of people about the nature of cryptocurrencies. Its highly volatile nature and anonymity in the transactions open the room for various illegal financial activities such as money laundering and tax evasion. Due to the associated risk, the Indian government is not ready to outrightly legalise dealings in cryptocurrencies. There is a bill pending in the Indian Parliament for the regulation of cryptocurrencies declaring their exchange as illegal. On the contrary, Japan has recognised bitcoin and digital currencies as legal property under the Payment Services Act. Many economists suggest that cryptocurrencies/digital currencies/electronic currencies are the future of the world economy and the governments will have to recognise them in the future. The objective of the study is to compare the Indian position to the Japanese position on the cryptocurrency regulations to analyse the two opposite economic situations and their approach in regulating the cryptocurrencies in the concerned market situation.
The dominating cryptocurrencies in the global market
The first-ever cryptocurrency to be considered original was ‘Bitcoin’. It was founded in 2009, on a white paper by a mysterious man who did not disclose his identity and preferred to be called by the name, Satoshi Nakamoto. Prior to bitcoin, there were many other failed attempts to introduce digital currencies with ledger secured by encryption into the market. The new bitcoins are formed by the process of mining using open-source bitcoin software. In 2010, a miner sold his 10,000 bitcoins for 2 pizzas to trade in bitcoin for the first time. The use of bitcoin increased in 2012 and 2013. By the end of November 2013, the price of bitcoin reached $1000 thereby dropping to $760 in December 2013 and to $580 in February 2014. The price crashed to $315 at the beginning of 2015 and to $215 in October 2015. The massive price drops were due to the fraud conducted by someone who stole 8,50,000 bitcoins from the world’s largest Bitcoin exchange. The people lost their trust and confidence in the security provided by the exchange. The bitcoin rose again in 2017 breaking through $1000. In October 2017, the price reached a high of $5000, doubled to $10000 in November and reached its all-time high of $19,783 in December 2017. The price dropped again to below $3500 by November 2018. There were several countries that banned cryptocurrencies following the massive drop and frauds involved in the crypto transactions such as India, China, Pakistan, Bangladesh etc.
Bitcoin was soon followed by Ethereum (ETH), Litecoin (TCC), Dash, Ripple (XRP) and many others. Today, there are several altcoins and cryptocurrencies being traded in the global market. The countries are launching their own digital currencies to move ahead in the race.
After facing a huge drop in 2018, bitcoin revived again in 2020 registering a meteoric rise and a surprising comeback. In 2020, bitcoin surged over 200 percent along with other cryptocurrencies such as Ether, Ripple, Litecoin, etc. The trading and use of cryptocurrency have increased in the last few years as they can reduce transaction costs to a great extent. Cryptocurrencies are real and the new price records have burst the bubble-myth of numeral economists across the world. They are the future of the world economy which sooner or later, will be realised by all the nations.
Can cryptocurrencies be recognised as currency?
There are several legal and regulatory challenges involved in the recognition of a cryptocurrency as a currency. Firstly, the cryptocurrency must meet the attributes of a currency to be recognised as a currency. Secondly, it is essential to regulate the cryptos and ensure stability in their value. Thirdly, it is important to analyse the possible impact of such recognition on the different sectors of the economy. Fourthly, the authorities must ensure that there is no potential misuse of the cryptocurrency for illegal activities as there are numerous malpractices that can arise due to the bad regulation of the cryptocurrencies such as money laundering, currency diversions from exchanges, frauds, etc.
It is important to ensure that a cryptocurrency meets the characteristics of a currency from the legal and economic perspective to be recognised as a currency.
A currency is:
- Worthy of being used as a medium of exchange;
- Accepted for having an intrinsic value;
- A fixed value; and
- Controlled by a central authority.
Virtual currencies are worthy of being used as a medium of exchange for buying and selling goods. They do not hold any intrinsic value and are enforced by the government as legal tender. Cryptocurrencies are divisible and homogeneous in nature. They are durable and easy to carry from one place to another. They have a limited number of products and do not have a stable value. The value increases with the increased number of users. Cryptocurrencies are not controlled by any central authority as they are self-regulated by decentralised technology. This raises a big question on the jurisdiction aspect.
Cryptocurrencies may help in reducing heavy transaction costs in cross-border transactions. Cryptos have a limited supply and hence, cannot suffer inflation. The cryptos based on blockchain technology are reliable and secure as there is a record of every transaction on the chain.
There are several risks associated with cryptocurrency holdings. It may be hard to recover the holdings if the password or device or wallet is lost. The transactions once made are irreversible. As the process of transactions provides anonymity, it may give rise to illegal activities and there is no legal recourse available for that. There is no minimum valuation guaranteed by any authority of any cryptocurrency. As the system is based on technology, any technical glitch may result in unwarranted loss.
Cryptocurrencies hold many attributes of a currency but cannot be regarded as a currency for not having a fixed or stable value and being self-regulated. They are capable of being accepted as a legal tender as they can be accepted as a medium of exchange.
Legality and regulation of cryptocurrencies in India
The economy of every country is governed by the monetary policies of its financial system. In India, the Reserve Bank of India (the central bank) plays an important role in formulating monetary policies and maintaining the stability of the financial system. The Reserve Bank of India (RBI) performs various functions such as regulating bank rates, modifying tax rates and structures, issuing banknotes, controlling credit limits, printing currency, foreign exchange, controlling monetary liquidity, imposing restrictions on imports through import duties, modifying tax rates and structures, etc. RBI derives its regulatory and administrative powers from various legislations enacted by the Parliament of India namely, the Banking Regulation Act, 1949 (Banking Act), the Reserve Bank of India Act, 1934 (RBI Act) and the Payment and Settlement Systems Act, 2007 (PSS Act), and related rules and regulations.
Prior to 2017, cryptocurrencies were being freely traded by random people across the country. For the first time in 2013, RBI warned the virtual currency holders and traders against the risk associated with the dealings in virtual currencies via press notes. However, people did not pay much heed to the warnings of the RBI and they continued transacting in cryptocurrencies. There was a massive increase in the number of users of cryptocurrencies by 2017 and bitcoin was performing exponentially well in the market. Again in 2017, RBI issued press notes stating that the entities dealing in virtual currencies are not authorized to do so and are doing that at their own risk. Further, a circular dated 6 April 2018 issued by RBI restrained all its regulated entities from engaging in crypto transactions in all manners and were given 3 months’ time to end such affairs. The circular did not prohibit the use of cryptocurrencies but the regulated banking exchanges from dealing in their transactions.
Later, The circular dated 6 April 2018 issued by RBI was challenged before the Supreme Court in Internet and Mobile Association of India v Reserve Bank of India via a writ petition filed by the Internet and Mobile Association of India, on the grounds that RBI lacked the jurisdiction in prohibiting the crypto-exchanges from dealing in cryptocurrencies since cryptocurrencies were not ‘legal tender’ in India; RBI completely banned an activity which was not declared to be illegal; the ban being arbitrary and imposing irrational prohibitions. The Supreme Court of India vides judgement dated 4 March 2020 struck down the RBI ban observing that there was no negative impact of cryptocurrencies on the regulating agencies of RBI.
It is not illegal to trade and hold cryptocurrencies in India, presently, as there is no law to regulate cryptocurrencies in India. Cryptocurrencies are not legal tender in India, but the crypto exchanges are legal to operate. However, the Government of India is willing to regulate cryptocurrencies by imposing a ban on their use. A draft, “Banning of cryptocurrency and regulation of official Digital Currency Bill, 2019” seeking to prohibit mining, holding, selling, trade, issuance or use of cryptocurrencies in India, is pending in the Parliament of India. The Government of India is willing to actively encourage blockchain technology, its use and its application. However, it is against the use of virtual currencies. Crypto transactions are encrypted and can only be tracked by involved parties. In this way, the holdings and transactions of the investors are kept away from the prying eye of the regulators. People can evade tax by converting their money into cryptocurrency and making further currency transactions. The non-regularisation of cryptocurrencies in India is resulting in various scams and crimes. The crypto transactions are reportedly being used for terror funding and hawala transactions. There have been several cryptocurrency scams in recent years. The various investors from India have lost more than $500 million (an estimated figure) in these scams. In September 2020, Delhi-based crypto transacting platform, Pluto Exchange, duped more than $2,72,000 amount from around 43 investors and shifted the business from India to Dubai. Recently, a cryptocurrency trader based in Gujarat was being arrested and investigated by the Enforcement Director in connection with an online betting racket involving Chinese operators, which exposed a scam of cryptocurrency trading through multiple exchanges involving nearly INR 1000 crore.
There are several positive aspects of cryptocurrencies that the Indian government seems to overlook. In the economic slowdown, the cryptocurrency assets promise high rates of return becoming a magnet to many Indian investors. If regulated via good legislation, the crypto business can do exponentially well in India. India has a very large number of crypto investors trading in cryptocurrencies. Banning cryptocurrencies in the era of technological advancement cannot be a solution for competitive economies. Hence, it is essential and the need of the hour to bring clear legislation regulating cryptocurrencies in India, immediately.
Legality and regulation of cryptocurrencies in Japan
Japan is home to a huge number of crypto traders and users. The crypto asset market of Japan has grown expediently after its regularisation in 2018. In Japan, the crypto asset exchange businesses are regulated by the “Payment Services Act.” Japan was the first country to use the term “crypto-asset” as the legal term for cryptocurrencies.
In Japan, all banking and investment operations are regulated by the Financial Services Agency. The FSA determines the legitimacy of the cryptocurrency and lays down the standards for the operation of a cryptocurrency exchange. The exchanges operating in the country have formed their own self-regulatory body, Japan Virtual Currency Exchange Association, to follow certain rules and best practices while operating in Japan, to make crypto operations safer and more legitimate for Japanese consumers establishing a medium between government regulators and exchange operators. The new rules formed by the Association amid Coincheck fraud set a maximum cap of 20% on user funds that can stay in hot exchange wallets and the excess will be automatically transferred to the cold storage for security purposes.
All the crypto exchanges in the country are required to register themselves with the FSA and get licensed with the FSA before starting any crypto business in the country. This helps FSA to keep track on knowing your customer data and impose anti-money laundering measures. Recently, FSA announced an outright ban on private coin trading in the country amid increasing money laundering crimes. As a result, the crypto exchanges have withdrawn many coins from their exchanges.
History of the legislation
Following the alleged hack of Mt. GOX (the world’s biggest crypto exchange based in Japan) and thereafter, its application for Insolvency with the Japanese government in 2014, the Japanese government started to develop new regulations for cryptocurrencies. The regulators did not shut down the exchanges but rather decided to regulate the exchanges. For this purpose, two groups namely, a study group and a working group were established in 2014 and 2015 in the Financial Services Agency (FSA) to submit a report on “sophistication of payment and settlement operations”. The final report submitted by the working group recommended “the introduction of a registration system for cryptocurrency exchange businesses; subjection of cryptocurrency transactions to money laundering regulations, and the introduction of a system to protect cryptocurrency users.
After the submission of the report to the Financial Council of the Financial Service Agency, a bill was submitted by the government to the Diet (Japan’s parliament) for the amendment of the Payment Services Act. As a result, the Act was amended in 2016 and the amendments took effect on April 1, 2017. The cryptocurrencies were regularised in Japan with the objective of protecting users of crypto assets and combating money laundering and terrorist financing.
In 2018, due to the hacking attack on one of the largest crypto asset exchanges of Japan, Coincheck Inc., $530 million worth of cryptocurrency was lost by the exchange. This led to the revision of policies governing cryptocurrencies to strengthen the regulatory framework. The revisions were made to the “Payment Services Act” and “Financial Instrument and Exchange Act” and came into force on May 01, 2020. The term “Virtual Currency” was revised to “Crypto Asset”; the regulations governing exchange services were made stricter, and the regulations governing crypto asset custody services were enhanced. Similarly, Electronically Recorded Transferable Rights (ERTRs) were established; new regulations governing Crypto Asset Derivative Transactions were introduced along with the regulations governing ‘unfair acts’ in Crypto Asset or Crypto Asset Derivative Transactions. Under the law, Crypto Asset is treated as a ‘property’ and not money or fiat currency. There is a possibility of using central bank digital currencies as cash equivalent in the future if it is technologically feasible.
Current legal position
Under the legislation, cryptocurrency is accepted as a method of payment and not as a fiat currency or currency. It is legal tender. To provide crypto-asset exchange services to the residents of the country, an exchange is required to register itself as a “Crypto Asset Exchange Service Provider”. All the crypto-asset exchange service providers are required to establish security systems to protect the information they possess. Cryptocurrency exchange businesses are required to keep accounting records of all the cryptocurrency transactions and submit annual reports on business to the Financial Services Agency. According to the National Tax Agency, the profits by Sale of cryptocurrencies are to be regarded as miscellaneous income and not capital gains.
There have been several financial frauds since the legalisation and regularisation of cryptocurrencies in Japan. There have been reported cases of cyberattacks on crypto wallets and money laundering. In an investigation, it was found by the National Police Agency of Japan that there had been 158 cyber-breaches for a total of $540 million lost in the first six months of 2018 alone. The largest loss was suffered in the case of Coincheck i.e., $517 million, making it one of the worst attacks ever. Another breach was at a crypto exchange called Zaif, of nearly $60 million. There is a lot to improve for the Japanese government to secure customer information and funds. Hope the new reforms will make a positive impact on the regularisation of cryptocurrencies and will provide customer security.
Comparing the Indian and Japanese position
In India, cryptocurrencies are neither regulated nor banned. The government is planning to take steps to curb its use and exchange by enacting legislations seeking to prohibit all private cryptocurrencies in India. Also, the government might introduce its own national digital currency using crypto technology. The “Cryptocurrency and Regulation of Official Digital Currency Bill” aims to provide a systematic framework for the production of the official digital currency to be regulated by the Reserve Bank of India.” The banning of cryptocurrencies cannot be a solution to the problems attached to the use of cryptocurrencies. Indeed, it is difficult to regulate cryptocurrencies by legalising them in the Country. It involves a lot of risk and loss of assets. But it wouldn’t be wrong to suggest that the crypto market attracts a huge foreign investment which is essential for the development of an economy. Japan is a technology-driven country and encourages technology and is still struggling to find a suitable solution to the problem of cyberattacks. The Indian economy has the capability to attract a large crypto investment in case it legalises these currencies. The problem rests with the control and supervision of these transactions. Japan has amended its laws recently to curb the problems of cyber attacking. If Japan’s attempts are successful, then India and other countries can take the example from the regulatory authorities of Japan for the regularisation of cryptocurrencies in their countries.
India should focus on bringing suitable legislation for regularising cryptocurrencies rather than focusing on banning them. The use of a nationalised digital currency can also show an effective result in boosting the economy. The legislation should ensure that effective levels of verification are processed to determine crypto transfers money laundering or terrorism financing risk. Cyber Agencies should be developed for the discernment of related transactions. Once legalised, cryptos can be used as exchange tokens in the country. The regulators of Japan have approached the crypto regulations with a hands-off approach and helped digital assets to prosper and evolve. With the new amendments in the crypto asset framework, Japan is again poised to lead the way for other countries on how to regulate crypto assets in 2021 and beyond.
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