Table of Contents
INTRODUCTION
While there is no legal definition for “cryptocurrency”, the “Oxford Dictionary” defines cryptocurrency as “a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank”.[1] With the global outbreak of Covid-19, and numerous businesses and enterprises being forced indoors, people have turned to digital platforms for their business and income, including digital form of payment. This also increasingly paved the way for a greater acceptance of digital currencies like cryptocurrencies, e-cash etc., with Bitcoin, Bitcoin Cash, Ethereum being the most widely used of them all. While fiat currencies, that are issued and regulated by the chief financial institution of the country and valued as per the decisions of the sovereign authority of the state, cryptocurrencies, on the other hand, use cryptography to manage the creation of new units and secure transactions.[2] The value of the cryptocurrencies are not determined by the government, rather the individuals using them for making transactions assign its value. Thus, such transactions between two persons remain safe and secured even without the involvement of a trusted but unknown third party. Hence, “decentralization” and the “absence of intermediaries” are the most defining features of cryptocurrencies.[3]
In 2008, the pseudonymous Satoshi Nakamoto released a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System,” which introduced the mechanisms underlying modern blockchains, and in particular the decentralized consensus protocol based on proof-of-work.[4] Shortly afterwards, the same author released open source software, implementing these mechanisms, and started running this software themselves on the Internet, thereby creating the Bitcoin blockchain.[5]
UNDERSTANDING BLOCKCHAIN & BITCOIN
The fundamental benefit offered by digital currencies like “Bitcoin” is that they can be utilized completely based on the basic principle of demand and supply, as they possess no innate value, and neither are they stored in cash reserves. Thus, they offer a near-perfect system to transact, with anonymity and transparency at the same time.[6] Nevertheless, such anonymity provides scope for illegal activities like tax evasion, money laundering, illegal trading amongst many others. Cryptocurrency is “a system of currency that uses cryptography to allow secure transfer and exchange of digital tokens in a distributed and decentralized manner”.[7] Thus, while cryptocurrencies are digital currencies or assets,[8] “blockchain is a distributed database where those assets are generated, stored, and transacted on”. Once a transaction is initiated on a blockchain, it must be approved by the majority of nodes (computers) in the network through a “consensus mechanism”.[9] Depending on its accessibility, blockchain can be identified as “permissionless” and “permission blockchain”.[10] In “permissionless blockchain”, “transaction validators can join the network without a need for approval by a central authority”,[11] whereas in “permission blockchain”, “joining the network requires approval by the entity running the network”.[12] Traditionally developed on “permissionless blockchain”, Bitcoin was meant to be “peer-to-peer decentralized electronic cash with no intermediary involved in facilitating transactions”.[13] However, with its growing popularity and acceptance, in order to adapt to the requirements of its users, who were unable to access the blockchain database but sought to make business and transactions on the systemized online platform, “cryptocurrency exchange platforms” emerged as intermediaries for better facilitation of Bitcoin-based transaction and usage. These platforms function as a marketplace of cryptocurrencies, where either cryptocurrencies are exchanged only for cryptocurrencies or for fiat currencies, depending on the demand of the buyer and the conditions of transactions placed by the seller.
LEGAL STATUS OF CRYPTOCURRENCY
Cryptocurrency is Money
Cryptocurrency can be used as a means of payment, for goods and services. In 2013 the, U.S.A. recognized Bitcoin as a convertible decentralized digital money, while in 2017 Japan gave it the status of legal tender and has also become the world’s largest exchange market for this cryptocurrency.
Cryptocurrency is a Money Surrogate
Unlike the U.S. and Japan, that openly accepted Bitcoin, various countries like Denmark, while apprehending the drawbacks of digital currency, have refused to permit its usage as these cryptocurrencies are not issued by the state, and neither are their values fixed nor regulated by any of the states’ authorities.
Cryptocurrency is Electronic Money
“Electronic money” is broadly defined as the “electronic storage of monetary value on a technical device that can be widely used to make payments in favor of not only the issuer, but also other companies, and that does not require the mandatory use of bank accounts for transactions, but acts as a prepaid instrument to a bearer”.[14] According to the “Electronic Money Directive, electronic money is a monetary value which follows from the submitted requirements to the issuers: this value should be stored electronically; the electronic money itself must be issued in order to receive funds”[15] and thus, cryptocurrency can be recognized as such.
Cryptocurrency is a Security
The “U.S. Securities and Exchange Commission (SEC)”, in their investigation report pertaining to a blockchain startup, said, “The DAO pointed out that the issuance of Initial Coin Offering (ICO) tokens, which is a unit of value issued by a private organization in the blockchain system, must be considered to be securities regardless of what the thing the investors had invested their money in was called and how it worked.”
Cryptocurrency is Property
The “Internal Revenue Service (IRS) of the United States” had published directions pertaining to the taxation of transactions with Bitcoin and other cryptocurrencies, according to which they can be qualified as “currency, property or investment instruments”.[16] The U.S. Federal Taxation System considers “Bitcoin to be a property”, and thus, when the owners of Bitcoins sell them, they would be entitled to a financial gain arising from the “capital gains” instead of the “exchange rate differences”.
https://legalreadings.com/common-civil-code/
MERITS OF TRANSACTIONS IN CRYPTOCURRENCY
Avoiding Fraud
Since all event and transaction details pertaining to the usage of cryptocurrencies are stored on blockchain databases, their authenticity is prevented from being forged or altered subjectively by the sender. Thus, the problem that needs to be addressed doesn’t lie in the technology applied in these digital currencies, rather the inefficient and inadequate law enforcement that make rarely successful attempts in investigating financial crimes.
Immediate Settlement
Bitcoin allows instantaneous financial transactions, that neither require the physical presence of the parties nor is limited to the ever changing values as determined by the government, as is the case of fiat currency. Christine Lagarde, as the Managing Director at IMF, had stated in its report titled “Virtual Currencies and Beyond: Initial Considerations”, that “virtual currencies and their underlying technologies can provide faster and cheaper financial services and can become a powerful tool for deepening financial inclusion in the developing world”.[17]
Lower Fees
Neither the blockchain database, nor the other intermediaries handling the Bitcoin exchange businesses, charge any transaction fees if a transaction is completely peer-to-peer. That is, “a truly decentralized transaction would utilize a global network of computers or miners, that use blockchain technology to jointly manage and permanently record the transaction”. However, a myriad of digital currency exchanges, like “Coinbase”, that acts as an intermediary similar to “PayPal”, impose a small amount of transaction fees.[18] Nevertheless, unlike the charges levied by the conventional currency exchange or payment portals, these fees are insubstantial.
RISKS INVOLVED IN CRYPTOCURRENCY & BLOCKCHAIN TECHNOLOGY
Although every blockchain-based asset has an individualistic operative value as determined by its user, they also carry with them certain costs and risks as an asset, by reason of their dependency on technology and the changing economic system. These include:
Controlling Costs
“Controlling costs” are the “costs the investor incurs from the behavior of a party that is positioned with sufficient influence to exert control on the blockchain, i.e., the entrepreneur, issuer, intermediary offering the tokens, or any person in a position to significantly maneuver the blockchain business and its operation”.[19] Generally, these costs are incurred in cases of “transactions between the controller and the blockchain”, “transactions where value is transferred from a particular blockchain holder to other businesses held by the controller, as other tunneling efforts”, and lastly, “fraud and misuse of funds by the controller”.
Monitoring Costs
“Monitoring costs have a pernicious effect on the ability of investors to evaluate their investment’s merit ex ante and to assess its performance ex post”. Therefore, a thorough understanding of costs should be a key factor in assessing the adequacy of the potential securities regulation of the blockchain.
Technological Risk
The damage caused by a human error or any technical flaw in the blockchain-based asset cannot be rectified by annulling the investment contract. This hence, keeps the investors at a risk of being exposed to cyber attacks, malicious databases and interventions, unauthorised manipulations of data by third parties, amongst others. The smart contracts regulating the transaction of cryptocurrencies work on minimal human assistance and more on automated technology, that in spite of the contract’s incompleteness stemming from coding mistakes, uncertain risks etc. As a consequence, the expenses of identifying the errors and troubleshooting the blockchain investment contract are inordinate. Because information regarding facts leading to a mistake is so scarce, in particular “given the unique coding language used by each blockchain, it may make the most sense to assign the costs of a potential mistake to the seller, who is the cheaper information-gatherer”.[20]
Systemic Risk
Blockchain-based assets obstruct transparency and contractual flexibility, as the smart contracts restrict the changes that can be made to them, due to their high costs and minimal human intervention, which hence, pave way for potential “widespread financial distress in the markets, defined in the literature as a systemic risk”.[21] Financial crises are often preceded by such a period of time wherein one or more classes of assets are sold and bought at prices far in excess of their basic values.[22] The precision of cost signals depends partially on the presence of well-informed and well-aware dealers in the concerned trading marketplace.[23] The absence of adequately informed traders can build the measure of commotion encompassing the price signals made in that market.[24]
Ownership Rights and Registration
“When ownership of assets is difficult to trace and prove this can lead to conflict and entitlement disputes, as well as underdevelopment” due to what economist Hernando de Soto calls “dead capital.”[25] Soto and the other proponents of blockchain technology, propose and advocate that “putting registration onto a blockchain will address these issues: it could make the land registration available to millions of people in a way that is permanent, transparent, corruption-proof, and faster and cheaper than traditional registration”.
LEGAL REGULATION OF CRYPTOCURRENCY IN DIFFERENT COUNTRIES
In Australia, cryptocurrency is not subject to licence, as it is not considered to be a financial product, however, those activities that are correlated to fiat money or other financial instruments are mandated to be carried out only by way of licensed trading and business. The “Australian Digital Currency Industry Code of Conduct” developed by the “Australian Digital Currency & Commerce Association” lays down the protocol that needs to be followed whilst executing any kind of cryptocurrency-related trade or business, though these are mandatory only for the members of the “Association”.[26]
After the USA, Canada has the second most Bitcoin ATMs in the world at a staggering number of 880, that is, 7.5 percent of the world total.[27] Due to its growing preferability and popularity, activities like the exchange of cryptocurrencies, their usage to purchase or avail other goods and services, or even fiat currency is liable to taxation.
In China, according to a report, in 2019, cryptocurrency worth around 50-billion US Dollars were moved out of the country in spite of the government’s restriction that allows the Chinese citizens to buy upto 50,000 US dollars in a year from any financial institution. In September 2017, the Chinese authorities had banned “Initial Coin Offerings” (ICO), and subsequently, the exchange platforms that traded cryptocurrencies or provided facilitation services were also forced to shut down. However, it is not unlawful to hold Bitcoins and other digital currencies or even to purchase or sell them in China. This ambiguous attitude of the authorities towards cryptocurrency has created multitude confusion amongst its traders. At the same time, “Beijing has been tightening already strict scrutiny over cryptocurrencies as the People’s Bank of China (PBOC) prepares to launch its own digital currency, partly as a response to the threat from currencies like bitcoin”.[28] Nevertheless, in the announcement of the National Bank of 2013, “cryptocurrency is defined as a virtual commodity,[29] not a currency, and may be taxed with the value-added tax, and income and profit in the cryptocurrency are subject to a corporate tax, individual income tax and capital gains tax”.
In India, the regulation of cryptocurrency remains ambiguous. While the Supreme Court struck down the Reserve bank of India ban on cryptocurrency, their regulation is not only prohibitory, but obscure as well. “Cryptocurrencies are not legal tender in India, and while exchanges are legal, the government has made it very difficult for them to operate.”[30] They cannot be used for payments as fiat currency.
In Russia, in April 2017, the “Central Bank of the Russian Federation recognized virtual currency as a digital commodity”, and in February 2018 the “Russian Duma began discussion of cryptocurrency legislation, a draft Federal law on digital assets”.[31] The bill provides that “mining is an entrepreneurial activity aimed at creating a cryptocurrency and/or validation in order to receive remuneration in the form of cryptocurrency”. [32]
In the United States, both the federal and state govern the circulation of cryptocurrency, though their definition and regulation for the same varies from state of state. The “Financial Crimes Enforcement Network (FinCEN) doesn’t consider cryptocurrencies to be legal tender but since 2013 has considered exchanges as money transmitters (subject to their jurisdiction) on the basis that tokens are another value that substitutes for currency”. The “Internal Revenue Service (IRS), by contrast, regards cryptocurrencies as property- and has issued tax guidance accordingly”.[33] The “Securities and Exchange Commission (SEC)”, a major US regulatory body, has indicated that it considers “cryptocurrencies to be securities”. In March 2018, it had stated that it was “looking to apply securities laws comprehensively for digital wallets and exchanges”. By contrast, the “Commodities Futures Trading Commission (CFTC)” has adopted a friendlier, “do no harm” approach, describing bitcoin as a commodity and allowing cryptocurrency derivatives to trade publicly.
South Korea is one of the largest hubs for Cryptocurrencies, particularly Bitcoin, and other virtual currencies that exist without the backing of any country’s central bank. It is the world’s No. 3 market in Bitcoin trading.[34] “Cryptocurrency exchange regulations in South Korea are strict and involve government registration and other measures overseen by the South Korean Financial Supervisory Service (FSS)”.[35] In early 2020, the “South Korean National Assembly passed new legislation today that will provide a framework for the regulation and legalization of cryptocurrencies and crypto exchanges”.[36]
CONCLUSION
A paradigm shift has been brought about in the global economy structure and the international trade market by blockchain technology, that has introduced a “technology that is inherently difficult to modify and sufficiently versatile to be able to act as an alternative to both currencies and securities”. Cryptocurrency is a one of its kind, revolutionary product of years of technological experimentation and development, that has the potential to bring advancement to both the fields of information technology as well as international economy. In the span of a few years, it has taken the form of an easily accessible and efficient medium of exchange, while also paving way for the probability of it replacing fiat currency in the upcoming years. Therefore, in the near future, circulation and mining of cryptocurrencies will become an integral part of the market economy. Unlike the conventional fiat currencies that are issued and regulated in the fiscal market by individual states, digital currencies, can be issued by both the states as well as the individual commercial banks, and are not limited by the physical territorial boundaries of the world. This however, introduces an imbalance into the exchange market as the state authorities and digital currency issuer banks remain no longer in harmony with each other, as the issuer of cryptocurrency is decentralized, and it exists only virtually. “Virtual currency possesses the nature of obligations rights as well as property rights, since it may be both a means of payment and a commodity.” Although countries like the United States of America, South Korea, Canada have welcomed the utility of cryptocurrency with open arms, there still are a number of countries that showcase a complete inability to respond adequately and competently to innovations and technological progress. Nonetheless, the steady rise of decentralized frameworks and digital currency like Bitcoin, will definitely prompt transformative changes in the international legal system and global economy.
An inclusive and expansive jurisdiction, and holistic international state regulation of cryptocurrency will enable the establishment of conditions that will guarantee the execution of genuinely lawful and safe cryptographic money relations. Regulation and management of assets and securities that involve multifaceted amalgamations of code requires an elevated comprehension of the technology, including “due diligence procedures”, “financial management and cyber security standards” and their proper implementation to provide security against database theft, cyber fraud, misappropriation of assets.
The above choices would almost certainly address the generally lacking, ineffectual and restricted jurisdictional extent of current nearby government laws and guidelines across the world. Numerous legitimate arrangements and terms at present being relegated to blockchain-sponsored resources are either misinformed, unseemly, or non-existent. Buyers, speculators, issuers, coders and developers deserve internationally applicable moral guidelines, appurtenant across borders and best practices that are explicitly custom-made to our resource class, as building up and executing high expert principles are indispensable for the development of the cryptocurrency and digital currency sector.
ENDNOTES
[1] Oxford Dictionaries, “Cryptocurrency”, available at: https://en.oxforddictionaries.com/definition/cryptocurrency (last visited on January 26, 2021).
[2] Andy Greenberg, “CryptoCurrency”, Forbes, April 20, 2011, available at: https://www.forbes.com/forbes/2011/0509/technology-psilocybin-bitcoins-gavin-andresen-crypto-currency.html (last visited on January 26, 2021).
[3] Hatim Hussain, “Reinventing Regulation: The Curious Case of Taxation of Cryptocurrencies in India” 10 NUJS Law Review 792 (2017).
[4] Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System” Bitcoin.org 1-5, available at: https:// bitcoin.org/bitcoin.pdf (last visited on January 26, 2021).
[5] Shlomit Azgad-Tromer, “Crypto Securities: On the Risks of Investments in Blockchain-Based Assets and the Dilemmas of Securities Regulation” 68 American University Law Review 69 (2018).
[6] International Monetary Fund, Virtual Currencies and Beyond: Initial Considerations, available at: https://www.imf.org/external/pubs/ft/sdn/2016/sdnl603.pdf (last visited on January 26, 2021).
[7] Eli Dourado and Jerry Brito, “Cryptocurrency” The New Palgrave Dictionary of Economics 1 (2014), available at: https://doi.org/10.1057/978-1-349-95121-5_2895-1 (last visited on January 26, 2021).
[8] Kevin Kim, “What is Cryptocurrency & Why the Term Doesn’t Apply to Most Coins & Tokens Today” The Blockchain Review, July 02, 2018, available at: https://medium.com/blockchain-review/what-is-cryptocurrency-why-the-term-doesnt-apply-to-most-coins-tokens-today-ca971cbb48ac (last visited on January 26, 2021).
[9] Asress Adimi Gikay & Catalin Gabriel Stanescu, “Technological Populism and Its Archetypes: Blockchain and Cryptocurrencies” 2019 NJCL 64 (2019).
[10] Ibid.
[11] European Parliament, “Cryptocurrencies and blockchain: Legal context and implications for financial crime, money laundering and tax evasion” (Policy Department for Economic, Scientific and Quality of Life Policies, 2018) available at: https://www.europarl.europa.eu/cmsdata/150761/TAX3%20Study%20on%20cryptocurrencies%20and%20blockchain.pdf (last visited on January 26, 2021).
[12] Ibid.
[13] Supra 4.
[14] European Central Bank, “Report on Electronic Money” (August 1998), available at: https:// www.ecb.europa.eu/pub/pdf/other/emoneyen.pdf (last visited on January 27, 2021).
[15] European Parliament, “Directive 2009/1 10/EC” (September 16, 2009).
[16] IRA Financial Group, Cision PR Web, (2014), available at: http://www.prweb.com/releases/bitcoins-self-directed-/ira-taxproperty-currency/prwebl 1704323.htm (last visited on January 27, 2021).
[17] A. Rosic, “7 Incredible Benefits of Cryptocurrency” The Huffington Post, November 23, 2016, available at: huffingtonpost.com/ameerrosic-/7-incredible-benefits-of- 1 b 13601 10.html (last visited on January 27, 2021).
[18] Ibid.
[19] Lucian A. Bebchuk & Assaf Hamdani, “The Agency Costs of Controlling Minority Shareholders” 38 Journal of Financial and Quantitative Analysis 695-719 (2003).
[20] Anthony T. Kronman, “Mistake, Disclosure, Information and the Law of Contracts” 7 Journal of Legal Studies 1-4 (1978).
[21] Hal S. Scott, “Reducing Systemic Risk Through the Reform of Capital Regulation” 13 Jornal of International Economic Law 763-764 (2010).
[22] Martin Neil Baily, Matthew S. Johnson et al., “The Origins of the Financial Crisis” Brookings, November 24, 2008, available at: https://www.brookings.edu/research/the-origins-of-the-financial-crisis/ (last visited on January 27, 2021).
[23] Ronald J. Gilson & Reinier H. Kraakman, “The Mechanisms of Market Efficiency” 70 Virginia Law Review 549 (1984).
[24] Id. at 575.
[25] Scott, Michael, “Blockchain Proponent and Economist Hernando de Soto Honored with Global Award” Bitcoin Magazine, April 10, 2017, available at: https://bitcoinmagazine.com/articles/blockchainproponent-and-economist-hernando-de-sotohonored-global-award/ (last visited on January 27, 2021).
[26] Irina Cvetkova, “Cryptocurrencies Legal Regulation” 5 BRICS Law Journal 128 (2018).
[27] Felix Mollen, “Crypto ATMs Grew 80% in 2020. Every Hour There’s a New Machine Installed” CryptoPotato, November 08, 2020 available at: https://cryptopotato.com/crypto-atm-grows-80-percent-2020/ (last visited on January 28, 2021).
[28] Samuel Shen, Alun John, “Hit by cryptocurrency curbs, Chinese fund managers look elsewhere to ride bitcoin bull” Reuters, November 23, 2020, available at: https://www.reuters.com/article/us-china-crypto-currency-expansion/hit-by-cryptocurrency-curbs-chinese-fund-managers-look-elsewhere-to-ride-bitcoin-bull-idUKKBN2830N3?edition-redirect=in (last visited on January 28, 2021).
[29] People’s Bank of China, “Notice on Precautions Against the Risks of Bitcoins” (Ministry of Industry and Information Technology, China Banking Regulatory Commission, China Securities Regulatory Commission, and China Insurance Regulatory Commission, 2013), available at: http://www.miit.gov.cn/n1146295/n1652858/n1652930/n3757016/c3762245/content.html (in Chinese), archived at https://perma.cc/S4DN-DXHD (last visited on January 28, 2021).
[30] Vaishali Basu Sharma, “Will 2021 Be the Year When India Finally Clarifies Laws Around Cryptocurrencies?” The Wire, December 23, 2020, available at: https://thewire.in/tech/will-2021-be-the-year-when-india-finally-clarifies-laws-around-cryptocurrencies (last visited on January 28, 2021).
[31] Supra note 26, at 141.
[32] Ibid.
[33] “Cryptocurrency Regulations in the United States” ComplyAdvantage, 2021, available at: https://complyadvantage.com/knowledgebase/crypto-regulations/cryptocurrency-regulations-united-states/ (last visited on January 28, 2021).
[34] Yoochul Kim, “Behind South Korea’s Cryptocurrency Boom” MIT Technology Review, December 07, 2020, available at: https://www.technologyreview.com/2017/12/07/147244/behind-south-koreas-cryptocurrency-boom/ (last visited on January 28, 2021).
[35] “Cryptocurrency Regulations in South Korea”, ComplyAdvantage, 2021, available at: https://complyadvantage.com/knowledgebase/crypto-regulations/cryptocurrency-regulations-south-korea/#:~:text=In%20South%20Korea%2C%20cryptocurrencies%20are,a%20closely%2Dmonitored%20regulatory%20system (last visited on January 28, 2021).
[36] Danny Crichton, “South Korea passes one of the world’s first comprehensive cryptocurrency laws” TechCrunch, March 5, 2020, available at: https://techcrunch.com/2020/03/05/south-korea-passes-one-of-the-worlds-first-comprehensive-cryptocurrency-laws/ (last visited on January 28, 2021).
BY SHRISTI DAS | SCHOOL OF LAW, KIIT UNIVERSITY