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Bitcoin and crypto-currencies


Learning objectives
  • What is Bitcoin’s legal status as a currency, especially because it is not regulated by a Central Bank? Is it a currency (like money), is it a security (like a share held in a company) or a piece of property? How does Bitcoin derive its value?
  • Payments related issues – How are Bitcoin operators regulated? Do payment gateway regulations govern Bitcoin operators?
  • How do foreign exchange regulations apply to Bitcoin transactions? Are international transactions with Bitcoin as the mode of payment violative of Foreign Exchange Management Act?
  • Why are money laundering issues inherent in Bitcoin transactions?


How are legal regimes currently dealing with Bitcoin?

Background and concerns around bitcoin
Globally, every currency has been regulated by a central bank of the country or the relevant region. For example, the US dollar is regulated by the Federal Reserve, British Pound is regulated by the Bank of England and the Indian rupee is regulated by the Reserve Bank of India. However, the emergence and growing popularity of Bitcoin as an electronic currency which does not have any regulator and which can be used to purchase products and services has stirred concerns around the globe on whether the currency should be regulated.

Bitcoin, a currency created in 2009, gained popularity extremely quickly.It has been in the news due to various regulatory reasons and possibility of circumventing regulations that apply to ordinary currency transactions. Across the world, governments and lawmakers have been relatively unsure and uncoordinated on regulation of Bitcoin.

Bitcoinis a virtual currency - transactions are recorded in electronic ledgers and are not available in paper or coin form. It is also called a crypto-currency, because the record of ongoing transactions and balance values are protected through cryptography. To transact in Bitcoin, users make payments using Bitcoin ‘wallets’ over a Bitcoin ‘exchange’ (which are entirely electronic). Bitcoin balances are calculated and maintained in an electronic ledger, and values are secure and protected through cryptography.

Bitcoin users, exchanges, lawyers and business advisors must be aware of the legal treatment of Bitcoin, the regulatory framework and risks associated with its use.
Bitcoin transactions can take place globally without the intervention of a central bank and without currency exchange commissions. Typically, central banks such as the Reserve Bank of India have the ability to regulate international transactions due to their control over foreign exchange, but this is not possible for Bitcoin transactions. Two critical concerns raised by Bitcoin transactions are:
  • Possibility of violation of foreign exchange laws due to the absence of any central regulator. Bitcoin transactions take place over Bitcoin exchanges but there is no regulator.
  • Money-laundering, i.e. showing illegal money or the proceeds of crime as legal earning because there is no mechanism in the Bitcoin system to identify how a person purchasing Bitcoin has earned the money
  • It may also be difficult to seize a bitcoin account by law enforcement authorities, as compared to an ordinary bank account or a dematerialized account (which holds securities). This is because there is no centrally regulated authority in the home jurisdiction (i.e. India). However, courts or the government have the ability to direct ‘internet service providers’ or to block access to bitcoin exchanges (where bitcoin is bought or sold), if it can be demonstrated that the grounds for blocking of a website under the Information Technology Act are met.
Can Bitcoin transactions be regulated under existing laws (if the Parliament doesn’t pass a new law)?
In late 2013, RBI issued a press release warning citizens of the risks of transacting in Bitcoin, and stated that it does not regulate Bitcoin transactions currently (see here). The press release also mentioned that RBI was itself examining the applicability of existing regulations to virtual currency regulations. Since then there has been no update.

We suggest you refer to this article published on the website of Centre for Internet and Society (an Indian think tank), which examines the applicability of the following systems of law to Bitcoin transactions:
  • Foreign exchange laws
  • Securities laws
  • Derivatives regulations
  • Negotiable Instruments Act
  • Prepaid payment instruments as per Payment and Settlement Systems Act, 2007
  • Sale of Goods Act, 1930
The article concludes that Bitcoin is not governed by any of the above legal frameworks presently. It is however possible for it to be captured within the scope of:
  • foreign exchange laws if it is specifically notified as a ‘currency’ by the Central Government (as per its powers under Foreign Exchange Management Act, 1999), or
  • by securities legislation if it is notified as a ‘security’ (as per its powers under Securities Contracts (Regulation) Act, 1955
At the same time, note that there is no exclusion of Bitcoin transactions from money-laundering (showing proceeds of crime as legitimate earnings) – hence nothing prevents investigative authorities from proceeding against a person holding Bitcoin or involved in Bitcoin trade for money laundering.

How are legal regimes currently dealing with Bitcoin?
As we stated above, in IndiaRBI has not passed specific regulations for Bitcoin (or virtual currency at all), but merely warned the general public that virtual currency use has its own risks.

In the United States, the Financial Crimes Enforcement Network (FinCEN) issued guidance which included virtual currencies within the ambit of its regulations. Recently, Interpol has created a virtual currency for imparting forensic training to detect virtual currency crimes (see Forbes story here). The German Federal Financial Supervisory Authority has held that Bitcoin is legal currency, but its operation requires a license (see this article, page 451).

Are donations in Bitcoin acceptable in India?
The article from the Centre of Internet and Society referred above argues that ‘Bitcoin’, despite being outside the ambit of foreign exchange laws as they stand today, will be covered by the law for foreign donations (Foreign Contribution Regulation Act), since receipt of Bitcoin from foreign sources qualifies as foreign contribution. Hence, receipt of Bitcoin would need to be reported under the law to the Central Government (Ministry of Home Affairs).
From the perspective of market
  • Bitcoin value is volatile and can fluctuate drastically in a short period
  • Market acceptability of Bitcoin is not so universal – it has been adopted by limited places. Certain entities such as the Wikimedia Foundation have recently started accepting donations in bitcoin (see here).
Likely tax effects of Bitcoin transactions
From the perspective of tax, Bitcoin could be treated either as currency, or as property. US Internal Revenue Service has actually issued guidance on the treatment of Bitcoin for tax purposes (see here and here). There is no specific guidance in India, but keeping in mind tax law concepts, Bitcointransactions are most likely to be taxed in two ways:
  1. The value of Bitcoin balances held by a person (in correlation with a currency) fluctuates continuously, even if the total balance in the Bitcoin wallet of that person is constant – for example, the value of 100 Bitcoin may be more on 1st April 2015 than it was a year back. In case there is appreciation, it could be taxed as a capital gain. However, in that case, tax authorities will also have to consider loss or erosion of value of Bitcoin as a capital loss and allow it to be offset against other capital losses.
  2. It may be possible to treat receipt of Bitcoin when a product or service is provided in exchange for Bitcoinas income and pay income tax. 

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