‘Bitcoins’: Legal Conundrums Surrounding the Cryptocurrency

By: Vikrant Yadav

‘Bitcoin’ is one of the earliest cryptocurrencies[1] which has gained widespread prominence in the digital currency market today. It is a “peer-to-peer, electronic cash system”[2] which is based on an open source cryptographic protocol and is independent of any central authority. A transfer of bitcoins is a transfer of value between the involved bitcoin addresses, and every transfer gets recorded in the Blockchain, a public ledger, which in turn validates each transaction and ensures that there is no double spending.

Bitcoins have found increasing acceptance in the internet-zippie fraternity, and one of the primary reasons for this is that bitcoins are easy to ‘mine’ from the internet. Various websites offer bitcoins for playing games, filling up surveys, and referring people. Recently, a search engine company announced to pay bitcoins to its users depending upon their usage of the search engine.[3] Adding to the bitcoin-mania, many other popular websites, including some relating to real-estate, started accepting payments in the form of bitcoins. This emerging trend in the trade of bitcoins has made it imperative for the financial institutions to grasp its technicalities and regulate its trade.

Earlier, the Reserve Bank of India (RBI) had issued a press release on virtual currencies like bitcoins, litecoins, bbqcoins, dogecoins stating that “creation, trade and usage of virtual currencies as a medium for payment is not authorized by any central bank or monetary authority.”[4] Cautioning the virtual currency traders to various security-related risks, the RBI had thus declared bitcoins as unregulated. Trading in bitcoins, however, has not been declared illegal in India. This is essentially because bitcoins are lines of computer programs which are generated almost automatically with minimum human intervening-activity called as ‘mining’, where the latter is considered only a mere act of executing a computer program, not prohibited by any Indian law.

But since bitcoins remain unregulated, traders of bitcoins lie in a legally unprotected zone.  A bitcoin is not a ‘currency’ as per the Foreign Exchange Management Act, 1999. Moreover, it can neither be classified as ‘securities’ under the Securities Contracts (Regulation) Act, 1955 nor a ‘negotiable instrument’ as per the Negotiable Instruments Act, 1881. Since a bitcoin does not have a static value, it also cannot be a ‘Prepaid Payment Instrument’ as per the Payment and Settlement Systems Act, 2007.

However, bitcoins could well be protected under the Indian Copyright Act, 2005 as “computer programs”, and since computer software is deemed as movable property[5], a bitcoin would be liable to be taxed as relating to sale of “goods”. However, the taxing authorities in India are silent on this newfangled payment system. The fact that bitcoins have not yet caught the ire of the legislators in India, gives way to its frantic use to accomplish nefarious activities like money laundering, tax evasion and other related economic offences. Moreover, since bitcoin transactions are completely anonymous, they can be used for carrying out illegal activities like drug trafficking, arms smuggling, betting, gambling etc.

Silk Road, a US based e-commerce website, became an online drug paradise soon after it started accepting payments in bitcoins. A report says that the annual turnover of this anonymous marketplace reached $15 million per year just one year after it began its operation.[6] After the demise of the Silk Road brought about by the Federal Bureau of Investigation, new competitors emerged in the market and it is unclear whether the Silk Road precedent reduced the contraband activity using bitcoins. Also, many popular betting and gambling websites have made fortunes in bitcoins. One such website is Satoshi Dice, which earned profits worth $596,231 after the first six months of its operation in 2012.[7] The crux of the matter is that since bitcoins are an easy channel for a number of activities prohibited by law in India, if they go unregulated, it will give boost to a parallel economy which will mar the overall economic development of the country.

Another aspect of the bitcoin problem lies with the customer’s side due to the irreversible nature of bitcoin transactions. If a customer makes a bitcoin transaction by mistake, the payment system has no auto-correct mechanism to refund the wrongfully transacted money. Obviously, there can be a private settlement between a buyer and a seller on the basis of a mutual understanding, but since bitcoins are stored in e-wallets, which are basically escrow accounts, there may be an instance where a website winds-up its business overnight and flees without refunding the customer. The existing law in India has no forum or statute to safeguard a customer’s rights against such a situation which may arise in a bitcoin transaction.

Furthermore, there can be operational problems due to a design flaw in the bitcoin payment system. Suppose, the Blockchain updates the ledger once in every two minutes and the customer makes two transactions within two minutes, the problem of double-spending shall arise. It basically means that a customer will get to spend his bitcoins twice for two different purchases. It is unclear whether such a transaction will be deemed as ‘fraud’ or else a valid transaction as per the Indian law.

The value of a bitcoin is highly volatile in nature and hence, it puts its traders at a great market risk. From $1151 in January, 2014 to $405 in January, 2016, the plummeting exchange rate is not a happy story for any bitcoin trader. The absence of a central regulating authority in India will only continue to jeopardize the interests of customers transacting in bitcoins and encourage many illicit activities. With the $1 million funding of the Ahmedabad-based Zebpay, a bitcoin wallet startup in India, it becomes increasingly imperative for the Reserve Bank to take a better stand than ‘ignorance’ on bitcoins.

[1] Cryptocurrency is a digital currency which uses cryptography for security.

[2] Satoshi Nakamoto, ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ (Bitcoinorg, 31 October 2008) https://bitcoin.org/bitcoin.pdf

[3] Luna Kably, ‘Use a search engine and earn bitcoins’ The Times of India Tech (9 September 2015) http://timesofindia.indiatimes.com/tech/tech-news/Use-a-search-engine-and-earn-bitcoins/articleshow/48877892.cms

[4] RBI, ‘Press Release: RBI cautions users of Virtual Currencies against Risks’ (Reserve Bank of India, 24 December 2013) https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=30247

[5] Tata Consultancy Services v State Of Andhra Pradesh 1997 105 STC 421 AP.

[6] Nicolas Christin, ‘Traveling the Silk Road: A measurement analysis of a large anonymous online marketplace’ (2012) Carnegie Mellon University CyLab https://www.andrew.cmu.edu/user/nicolasc/publications/TR-CMU-CyLab-12-018.pdf

[7] Cyrus Farivar, ‘Bitcoin-based casino rakes in more than $500,000 profit in six months’ (Ars Technica, 23 January 2013) http://arstechnica.com/business/2013/01/bitcoin-based-casino-rakes-in-over-500000-profit-in-six-months/

(Vikrant is a student in the third year of study at Dr. Ram Manohar Lohiya National Law University, Lucknow.)