Context

Vitalik Buterin, co-creator of the crypto network Ethereum, has made a 1 billion dollar cryptocurrency donation for India’s relief funds as the country battles the latest deadly COVID-19 wave.

Definition

The 2019 Bill defined cryptocurrency as any information, code, number or token, generated through cryptographic means or otherwise, which has a digital representation of value and has utility in business activity, or acts as a store of value or a unit of account. According to professionals a system must need these six points to be called a cryptocurrency system:

• The system does not require a central authority; its state is maintained through distributed consensus.
• The system keeps an overview of cryptocurrency units and their ownership.
• The system defines whether new cryptocurrency units can be created. If new cryptocurrency units can be created, the system defines the circumstances of their origin and how to determine the ownership of these new units.
• Ownership of cryptocurrency units can be proved exclusively cryptographically.
• The system allows transactions to be performed in which ownership of the cryptographic units is changed. A transaction statement can only be issued by an entity proving the current ownership of these units.
• If two different instructions for changing the ownership of the same cryptographic units are simultaneously entered, the system performs at most one of them.

History/Background

• In 1983, the American cryptographer David Chaum conceived an anonymous cryptographic electronic money called ecash. Later, in 1995, he implemented it through Digicash, an early form of cryptographic electronic payments which required user software in order to withdraw notes from a bank and designate specific encrypted keys before it can be sent to a recipient.
• In 1998, Wei Dai published a description of “b-money”, characterized as an anonymous, distributed electronic cash system.
• Shortly thereafter, Nick Szabo described bit gold. Like bitcoin and other cryptocurrencies that would follow it, bit gold (not to be confused with the later gold-based exchange, BitGold) was described as an electronic currency system which required users to complete a proof of work function with solutions being cryptographically put together and published.
• In 2009, the first decentralized cryptocurrency, bitcoin, was created by presumably pseudonymous developer Satoshi Nakamoto. It used SHA-256, a cryptographic hash function, in its proof-of-work
• In April 2011, Namecoin was created as an attempt at forming a decentralized DNS, which would make internet censorship very difficult.
• In October 2011, Litecoinwas released. It used scrypt as its hash function instead of SHA-256. Another notable cryptocurrency, Peercoin used a proof-of-work/proof-of-stake
• On 6 August 2014, the UK announced its Treasuryhad been commissioned a study of cryptocurrencies, and what role, if any, they could play in the UK economy. The study was also to report on whether regulation should be considered.

Types of cryptocurrency

• The most common and valued cryptocurrency is Bitcoin.
• All the other cryptocurrencies other than Bitcoin are together as a set are known as alternate coins or commonly called “Altcoins”. Most famous alt coins are:-
• Litecoin
• Cardano
• Polkadot
• Stellar(XLM)
• Binance Coin
• By the end of March 2021 the total share of altcoins in the cryptocurrency market was estimated to be at 40% of the total market value.

How it works?

• Cryptocurrencies work using a technology called blockchain. Blockchain is a decentralized technology spread across many computers that manages and records transactions. Part of the appeal of this technology is its security.

What is Blockchain Technology?

• Simply, blockchain is decentralized, distributed and public digital ledger.  Blockchains is a new type of network infrastructure (a way to organize how information and value move around on the internet) that create ‘trust’ in networks by introducing distributed verifiability, auditability, and consensus.

• Blockchains create trust by acting as a shared database, distributed across vast peer-to-peer networks that have no single point of failure and no single source of truth, implying that no individual entity can own a blockchain network, and no single entity can modify the data stored on it unilaterally without the consensus of its peers.
• New data can be added to a blockchain only through agreement between the various nodes of the network, a mechanism known as distributed consensus. Each node of the network keeps its own copy of blockchain’s data and keeps the other nodes honest – if one node changes its local copy, the other nodes can reject it.

• Imagine a blockchain as a ledger—because that’s essentially how most blockchains function. Each block of data represents some new transaction on the ledger, whether that means a contract or a sale or whatever else you’d use a ledger for.
• Interestingly, blockchains leverage techniques from a field of mathematics and computer science, known as cryptography, to sign every transaction (e.g. the transfer of assets from one person to another) with a unique digital signature belonging to the user who initiated the transaction.

Advantages

• Low transaction Fee: Because miners are simply rewarded cryptocurrency from network itself, there are typically little or no fees for core transactions.
• Ownership: With your digital key, access to your currency is yours alone. Unlike money you store at a bank, your use of cryptocurrency cannot be frozen or limited by any entity.
• Identity Protection: Paying with credit/debit cards requires submitting sensitive banking information that could be stolen or compromised. Cryptocurrency can be sent directly to a recipient without any information other than total amount you want to send.
• Risk-free for sellers: Payments using Cryptocurrency can’t be reversed, which means merchants don’t have to worry about stopped payments. The blockchain makes it difficult for you to be defrauded.

Disadvantages

• Privacy Concerns: The privacy of users’ data is at stake. There is concern regarding privacy of users data in using cryptocurrencies as all the transaction information is stored in distributed ledger (called blockchain), which is publicly visible. Thus Hacker can easily observe how the money flows.
• High Volatility: The price of Bitcoin suddenly rose to almost $20,000 and then dropped to $6,000. Due to such incidents, it is complicated for the investors to trust the ecosystem.
• Destination for black money: The fear among regulators and policymakers is that cryptocurrencies, being an alternative source of value to fiat currency, could be misused to launder black money or finance terrorist activities.
• Cybersecurity Concerns: Cryptocurrencies are prone to cybersecurity breaches and hacks. Various attacks are common, even companies and governments are not full proof to them. For example, the Swiss blockchain company, Trade.io, has reported that crypto tokens worth almost $8 million have been stolen from their cold wallet.
• Dark activities: The possibility that the new money will nurture illicit activities and markets like drug selling, weapons etc. through Darknet is always high using cryptocurrency anonymously. It also increases the risk of its use in various terrorist activities across the border.
• Monetary control and economic behavior: It could dramatically change global monetary policymaking. People will exchange their national currencies for the new digital coin in order to buy and sell the many products that will be priced in it. This will further impact the profit of banks and will put stress on their balance sheet.
• Inflation: Governments and policymakers will have reduced ability to control inflation. Usually, when inflation picks up, central banks take steps to control it through various monetary rates. Cryptocurrency will be out of control of the central bank so liquidity control will be an issue.

Cryptocurrency and India

• The country, at present, has around 75 lakh cryptocurrency investors who have together pooled over Rs 10,000 crore into Bitcoins and other such digital currencies.
• The prices have surged by over 900%, courtesy of the worldwide boom – a single bitcoin that used to cost around Rs 4 lakh in 2020 now costs somewhere around Rs 41 lakh now.
• FM Nirmala Sitharaman has said that the Centre will take a “calibrated approach” and leave a window open for experiments with blockchain technology.

Legitimacy of Cryptocurrency in India

• Finance minister Arun Jaitley, in his budget speech on 1 February 2018, stated that the government will do everything to discontinue the use of bitcoin and other virtual currencies in India for criminal uses.
• He reiterated that India does not recognise them as legal tender and will instead encourage blockchain technology in payment systems. “The government does not recognise cryptocurrency as legal tender or coin and will take all measures to eliminate the use of these cryptoassets in financing illegitimate activities or as part of the payments system,” Jaitley said
• In early 2018 India’s central bank, the Reserve Bank of India(RBI) announced a ban on the sale or purchase of cryptocurrency for entities regulated by RBI
• In March 2020, the Supreme Court of India passed the verdict, revoking the RBI ban on cryptocurrency trade.
• In 2021, the government is exploring the creation of a state-backed digital currency issued by the Reserve Bank of India, while banning private ones like bitcoin.

Cryptocurrency Bill India 2019

• Cryptocurrency cannot be used as a legal tender or currency at any place in India.
• The bill prohibits everyone to mine, generate, hold, sell, deal in, issue, transfer, dispose of or use cryptocurrency in the territory of India.
• The central government is allowed to declare Digital Rupee to be the legal tender with the consent of Reserve Bank of India.
• The use of Distributed Ledger Technology (DLT) for creating a network for delivery of any financial or other services or for creating value , without involving any use of cryptocurrency is not prohibited.
• Direct or indirect use of cryptocurrency shall be punishable with fine or imprisonment of 1 year which may be extended o 10 years or both.
• The court is empowered to transfer any fees recovered to the consolidated fund of India.
• The central government on the recommendation of the investigating agency without being bound to it is empowered to grant immunity for any offense under this act.
• The bill also provides that no such immunity can be granted by the central government in cases where the proceedings for any such offence have been instituted before the date of receipt of application for grant of such immunity.
• The Bill promises to “allow for certain exceptions to promote the underlying technology of cryptocurrency (blockchain) and its uses.”
• The way the technology is built, an ownerless, consensus-driven, distributed ledger like a blockchain needs cryptocurrency to grease its wheels.

International Scenario

United states of America

• The U.S. has the highest number of cryptocurrency users, the highest number of Bitcoin ATMs and also the highest Bitcoin trading volumes globally.
• The US government, in 2013, accepted bitcoin as a decentralized virtual currency that can be used for performing transactions. It was classified as a commodity by CFTC in September 2015.
• Bitcoin is also taxable as a property. To sum up, bitcoin is legal in the USA, however, there is no clarification about the legalization of other cryptocurrencies.

Japan

• Japan has eliminated the consumption tax on Bitcoin trading on April 1, 2017, when it officially declared Bitcoin as a legal tender. Japan also eliminated the possibility of double taxation on trading of Bitcoins.
• Japan is now widely considered a hub for cryptocurrency trading/exchange in Asia.

Canada

• Bitcoin is viewed as a commodity by the Canada Revenue Agency (CRA).  This means that Bitcoin transactions are viewed as barter transactions, and the income generated is considered as business income. The taxation also depends on whether the individual has a buying-selling business or is only concerned with investing.
• Canada considers Bitcoin exchanges to be money service businesses. This brings them under the purview of the anti-money laundering (AML) Bitcoin exchanges need to register with Financial Transactions and Reports Analysis Centre of Canada (FINTRAC)
• In addition, some major Canadian banks have banned the use of their credit or debit cards for Bitcoin transactions.

European Union

• On Oct. 22, 2015, the European Court of Justice (ECJ) ruled that buying and selling digital currencies is considered a supply of services, and that this is exempt from value-added tax (VAT)in all European Union (EU) member states.
• Some individual EU countries have also developed their own Bitcoin stances.
• In Finland, the Central Board of Taxes (CBT) has given Bitcoin a VAT exempt status by classifying it as a financial service. Bitcoin is treated as a commodity in Finland and not as a currency.
• The National Revenue Agency (NRA) of Bulgaria has also brought Bitcoin under its existing tax laws.
• Germany is open to Bitcoin; it is considered legal but taxed differently depending upon whether the authorities are dealing with exchanges, miners, enterprises, or users.

China

• Bitcoin is essentially banned in China. All banks and other financial institutions like payment processors are prohibited from transacting or dealing in Bitcoin. Cryptocurrency exchanges are banned.
• The government has cracked down on miners.

Way Forward

• A worldwide regulatory authority must be established to control the volatility, security and inflation of the cryptocurrency market.
• While the number of merchants who accept cryptocurrencies has steadily increased, they are still very much in the minority. For cryptocurrencies to become more widely used, they have to first gain widespread acceptance among consumers.
• The more popular they become, the more regulation and government scrutiny they will likely to attract, which erodes the fundamental premise for their existence. And therefore the central authority must be made so in keeping mind that the fundamental of the cryptocurrency existence must not be mended.
• For cryptocurrencies to become part of the mainstream financial system must :
  • Be made mathematically complex (for frauds and hackers) but graphically easy for the users to make them understand better.
  • Be Decentralized but with adequate consumer safeguards and protection.
  • Preserve user anonymity without being a conduit for tax evasion, money laundering and other nefarious activities.