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Legalities of a Bitcoin



Introduction


Let us just dive back into the history to understand the concept of money. Even during the time of Aristotle[1] money has always been seen as something that is considered 1) as a store of value, where people can consider it as an asset which they can store and use it at a later time for their benefit. 2) It should be used as unit of account, which means it sets a common base to compare the value of goods and service. 3) It should be used as a medium of exchange, however it can’t be considered as commodity, but as something that persons can use to intermediate the swapping of goods and services provided. Thus these three conditions are necessary to accept the concept of money. It is also important that the state fixes the value of the money as an “Act of faith”. Therefore if we take an example of Indian currency, a note is worth 500 rupees is because the state has set the value for it. This is called fait money.

As the state fixes the value of a note, it is important to note that the state has a centralized institution to regulate the use of money. This centralized institution is responsible for issuing the notes and coins. Each of these coins and notes has a specific value that has been set by the State. For example, in India, the Reserve Bank of India is responsible for printing and issuing the notes and coins. The Reserve Bank of India has a fleet of banks under it which regulate and keeps a track of the transactions that are made using the notes and coins. These notes and coins are largely used in the field of commerce where people use notes and coins as a medium of exchange for goods and services obtained.


From Crisp Notes Transaction to Electronic Payments – A Major Technological Progression

Further with the technological improvements, commerce was introduced on the internet. The mode of payment for the goods and services has also shifted towards the process of electronic payments. These electronic payments and transactions were made through third parties, which in turn are under the observation and regulation of the centralized bank created by the state. Though most of the transactions were safe, it still laid down the concern of safety and inherent weakness of this trust based model as rightly observed by Sathoshi Nakamoto, a pseudonymous writer, in his paper that was published in the year 2008, he observed that these online transaction model did raise concerns over non-reversible transactions and mediation in regard to the same[2]. To understand better, let us say you were window shopping on an online shopping website and you accidently pay for an item which you weren’t intending to buy. Since the transaction is already done, it raises the question of the possibility of reversible transaction. Sometimes it isn’t possible and would require the financial institution to interfere and mediate the disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for nonreversible services.

Further he also expresses his concern on how these third parties being the intermediate in the financial transaction between two people or entities exploit them by gaining access to more information than granted. There are a certain percentage of frauds involved in such practices which are unavoidable. However, this wouldn’t be a problem if the transaction happened through physical currency. Therefore sharing vulnerable information with these intermediaries as a part of E-commerce transaction is worrisome. Thus he introduced the concept of Bitcoins which is considered to be a proof of trust, to be relied on an electronic payment. Transaction through these Bitcoins offers a direct transaction between two parties without involving intermediaries or a trusted third party. Hence, saving us from paying these third parties a certain percentage of fees and also most importantly it protects us from sharing vulnerable information that could be misused by them. Let us understand the concept of Bitcoins and narrow down our analysis.

There is a well knit community in the internet world which believes in the development and usage of Bitcoins[3]. This community is closely connected through nodes to maintain an online distributed ledger as we already know that Bitcoin transactions are free from centralized authorities of the state. This distributed ledger is better known as “blockchain”. It basically keeps a record of all the transactions that have ever been taken place with regard to the Bitcoins or any Crypto Currenices and is shared and agreed upon by the entire internet world or internet community through each individual node. A node is a computer maintaining a copy of the ledger. So let us take an example, if I have a bitcoin and I want to send it to my friend or exchange it with a commodity, I announce to the internet world that I am doing so with my transaction. Then the entire internet community will update this in their ledger that they are maintaining using the nodes. The entire internet community is updated in regard to my transaction. This transaction is validated by all the members of the internet community who are maintaining their own ledger. Once it is validated, it is termed as a block. Now this block is added to a chain of previous transaction that has been validated by the internet community, thus it forms a block chain. It is important to consider that hackers can’t hack these transactions and mislead the community because it is well protected by an algorithm and the transaction history opens only when the algorithm is solved[4].



Shortcomings of Bitcoin and its legal status


Bitcoin transactions indeed seem fascinating in its operation. However these transactions are vulnerable and are susceptible to various threats and flaws. Bitcoin transactions have limited transaction speed. It may take quite some time for the validation of the transaction which is of course not feasible in the rapid growth in the world’s economy and business. Further it is important to note that Cyber-attack/threat is still a matter of concern in regard to the Bitcoin transactions. Since the transactions are pseudo anonymous, most of the nodes that validate the transaction could be taken over by a malicious agent. Further this malicious agent can control and meddle with basic rules of algorithm making the distributed ledger compromised, defeating the primary purpose of the entire decentralized online transactions. Since a centralized authority govern these transaction is missing, there is a possibility of tampering with the records of transaction which in turn will require validating the entire block chain of transaction.


Further it is also important to consider the possibility of money laundering with the help of Bitcoins. Bitcoins can be used as means to launder money and commit fraud. Let us consider the possibility of money laundering using Bitcoins. To lauder physical currency, we mostly buy a fake car wash center and mix the dirty money with the profits made out from the car wash center. Similarly in Bitcoins, we substitute the idea of fake car wash with the idea of gift cards. The transactions in Bitcoins are pseudo anonymous. Bitcoin just displays the transaction between one node to another, hence making it easier to launder money using Bitcoins. It is important to consider that there is no centralized authority to monitor the transaction made using Bitcoins. Thus, it drew the attentions of “ransomeware” hackers, who launched cyber-attacks on their targets. They started encrypting the victim’s data and demanded payments to be made through Bitcoins. As we already know Bitcoin transactions are pseudo anonymous, it is difficult to trace these hackers. This also raises concerns over national security, terrorist funding and most importantly to launder money.

Bitcoin is not bound to a bank or government and allows users to spend money anonymously. Since there is no regulator be it, SEBI, authorities under FEMA or under Prevention of Money Laundering Act or even the Income tax officials have got no power to track, monitor and regulate such crypto money account to crypto money account transfers[5]. Thus, opening a huge scope for money laundering and terrorist funding, posing a threat to the country’s economy and national security, also the digital assets can’t be retrieved even if the perpetrator is caught. This leads to the fact that Bitcoins are still in the first stage of development and needs certain changes to mature into a trusted medium of transaction[6].


Just like most of the countries, even Indian laws are against the idea of Bitcoins as medium of transactions. The Reserve Bank of India is mainly concerned over the isolation of the centralized authority in the online transactions. Bitcoins in India are not given a status of legal tender and is thus not recognized as a sanctioned currency. A legal tender basically means the recognition by the state as a form of currency. With Bitcoin gaining popularity in the internet community, it created concern for the country’s financial stability, the practice of money laundering and frauds. Therefore in the year 2017, inter-ministrial committee (IMC) was constituted by the Ministry of Finance, Government of India under the chairmanship of the Secretary of the Department of Economic Affairs (DEA) under the Ministry of Finance, Government of India to formulate polices and legal framework for regulation of Crypto currencies in India[7].


In July 2019, the IMC has released its report and proposed the Banning of Crypto currency and Regulation of Official Digital Currency Bill, 2019, criminalizing carrying on any activity connected with Crypto Currencies in India, including mining, buying, selling or storing Crypto Currencies, and their use as a means of raising funds or for investments. The Said Bill proposes to impose a fine of an amount up to Rs. 25,00,00,000/- or an imprisonment up to 10 years. However this bill is yet to be passed and thus the lack of any concrete mechanism pending the regulatory framework in said regard has left a lot of vacuum and which has resulted in total unaccountability and unregulated Bitcoin (crypto money) trading and transactions.



The Apex Court’s standpoint on the possible threat of Bitcoins


In the case of Internet and Mobile Association of India and others v. Reserve Bank of India[8] The Supreme Court quashing the Reserve Bank of India’s contention on the ban of providing banking services to crypto currency dealers, it rejected the argument that Virtual Currencies (VCs) were just goods/commodities which cannot be regarded as real money. Further in the same judgment, the Supreme Court held that – “It is clear from the above that the governments and money market regulators throughout the world have come to terms with the reality that virtual currencies are capable of being used as real money, but all of them have gone into a denial mode (like the proverbial cat closing its eyes and thinking that there is complete darkness) by claiming that VCs do not have the status of a legal tender, as they are not backed by a central authority”. Thus the Supreme Court expresses its concern over the regulations of the Bitcoin transaction. The Hon’ble Apex Court concurs with the concerns of the RBI and clarifies that RBI has the power to regulate the use of Bitcoins but it can not ban the banking services to Crypto currencies dealers. Hence, the legal backup for Bitcoin transaction being a concern for money laundering and terrorist funding awaits RBI’s regulations. This creates a window for all the crypto currency dealers to launder money until RBI passes a circulation to regulate the transactions under the Know Your Customer (“KYC”) norms and Anti-Money Laundering (“AML”) standards[9]. By expanding the scope of such norms and standards, holding the perpetrators accountable for such acts will be feasible.



Conclusion


Considering possible frauds and concerns over the national security and economy the RBI had issued notification[10] in regard to stop its services to customers who are indulged in the practice of Bitcoin transactions. However the Hon’ble Supreme Court quashed the notification. It seemed that the issuance of the Notification was largely influenced due to absence of laws and regulations for dealing in Crypto Currencies and their treatment as legal tender. Similarly, the findings, proposition and suggestions of the IMC are suggestive of the fact that there lies a dearth of cogent and evidentiary database and reasoning to address the issue of regulating the Crypto Currencies and in such dearth or absence, the IMC has proposed to a restrictive and banning measure rather than a regulatory measure.[11]. Therefore until a concrete regulatory framework is framed, the concept of Bitcoin transactions has left a lot of vacuum and has resulted in total unaccountability and unregulated Bitcoin trading and transactions.


[1] Aristotle (Politics, 1255b–1256b)

[2] https://bitcoin.org/bitcoin.pdf

[3] Sathoshi Nakamoto’s Paper on Bitcoin: A Peer-to-Peer Electronic Cash System

[4] Ibid

[5] Dwaipayan Bhowmick vs Union Of India, WP (Civil) No. 1076/2017

[6] Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies

[7] Ibid.

[8] Writ Petition (Civil) No. 528/2018

[9] Master Circular – Know Your Customer (KYC) norms / Anti-Money Laundering (AML) standards/Combating of Financing of Terrorism (CFT)/Obligation of banks under PMLA, 2002, dated July 1, 2013, DBOD.AML.BC.No.24/14.01.001/2013-14

[10] Prohibition on dealing in Virtual Currencies (VCs), Notifications, RBI, April 6, 2018.

[11] Draft of Banning of Cryptocurrency & Regulation of Offical Digital Currecny Bill, 2019




Author Details:Shubhamujwal NM is a student atRamaiah College of Law.

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