Bitcoins a viable currency?

Regulatory and legal issues

Abstract
Bitcoins are proposed to be the currency of next generation that is generated and transacted through
the internet. There can be transaction taking place physically and through internet . These are virtual
currency which can be exchanged for good and services. It has its own advantages and disadvantages
as well like every other technological innovations. Some of the advantages are low transaction cost ,
helps in combating poverty. Some of the disadvantages are like criminal use , money laundering ,
volatility and security breaches.

But there has been a strong debate over its regulatory,

standardisation and valuation . As it has not been accepted by any central bank nor reserve banks as
medium of exchange, each of them have been opposing to its use. Therefore there is requirement for
strong regulatory mechanism for controlling the use and criteria for valuation. In India Reserve bank
hold the authority for regulating currency . It has till date not accepted as a currency.

Bitcoins a viable currency? Regulatory and legal issues1

Bitcoin is a digital currency: it exists only online, 2 it is not backed by any country or government, and
its users operate anonymously. The Bitcoin software was for the first time, published on January 3,
2009, by a computer programmer named Satoshi Nakamoto 3. It operates via a peer-to-peer (P2P)
network.4 P2P networks are created when multiple individuals run the necessary software on their
individual computers and connect to each other; P2P networks do not have a centralized website,
server, or organizer. Bitcoin, has no management team nor any regulatory body and no physical
manifestation whatsoever. Once written, the Bitcoin software became entirely self-sufficient, and it
does not require oversight or tech support. Moreover, Bitcoin has no centralized location, either
geographic or virtual.5The P2P nature of the software, Bitcoin operates connectedly from each
computer running the software, making it resistant to centralized attack or regulation. 6 The program is
designed to solve a complicated math problem, the result of which is the creation of individual
bitcoins, which are each merely long strings of numbers. Computers running the Bitcoin software
contribute their computing power to the solving of the math problem, and users are rewarded by being
given the newly created bitcoins. 7 This process is known as mining the bitcoins, but mining occurs
rather slowly, and is getting slower.
Even as more computer processing power is devoted to the Bitcoin software, the program adjusts the
difficulty of the math problem over time so bitcoins are released at a predetermined rate. As mining
occurs more slowly and requires more computing power over time, some commentators have

1 Sourav Chandan Padhi, 5th Year, BBA.LLB(Hons), National Law University Odisha.
2Physical bitcoins are minted by at least one private entity, e.g., Physical Bitcoins by Casascius,
http://www.casascius.com, but tangible coins are completely unnecessary to the function of the
currency.
3Satoshi Nakamoto is widely believed to be a pseudonym for an individual or group of individuals.
Reuben Grinberg, Bitcoin: An Innovative Alternative Digital Currency, 4 Hastings Sci. & Tech. L.J.
159, 162 (2012).
4 Robert Stokes, Anti-Money Laundering Regulation and Emerging Payment Technologies, Banking
& Fin. Servs. Poly Rep., May 2013, at 1, 1.
5 See James C. Smith, Comment, Online Communities as Territorial Units: Personal Jurisdiction over
Cyberspace After J. McIntyre Machinery, Ltd. v. Nicastro, 57 St. Louis U. L.J. 839, 849 (2013).
6Joshua Davis, The Crypto- Currency, New Yorker, Oct. 10, 2011, at 62, 62.
7 Robert Stokes, Anti-Money Laundering Regulation and Emerging Payment Technologies, Banking
& Fin. Servs. Poly Rep., May 2013, at 2.
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criticized the Bitcoin system as being biased in favour of early adopters. 8 Unlike the usual form of
currency, it is in virtual form and can be used to make payments online as well as in physical stores.
With the enormous increase in the usage of internet and transactions through digital mode, creation of
a digital currency was inevitable. However, certain questions arise i.e. whether it is a safe form of
currency, if bitcoin has been accorded legal recognition and accepted as a digital currency and is
regulated or not.

Process of Mining of Bitcoin

The actual mining of Bitcoins is by a purely mathematical process. A useful analogy is with the search
for prime numbers: it used to be fairly easy to find the small ones (Eratosthenes in Ancient Greece
produced the first algorithm for finding them). But as they were found it got harder to find the larger
ones. Bitcoins the search is not actually for prime numbers but to find a sequence of data (called a
block) that produces a particular pattern when the Bitcoin hash algorithm is applied to the data.
When a match occurs the miner obtains a bounty of Bitcoins (and also a fee if that block was used to
certify a transaction). The size of the bounty reduces as Bitcoins around the world are mined.
The difficulty of the search is also increased so that it becomes computationally more difficult to find
a match. These two effects combine to reduce over time the rate at which Bitcoins are produced and
mimic the production rate of a commodity like gold. At some point new Bitcoins will not be produced
and the only incentive for miners will be transaction fees. 9
Advantages of Bitcoins
Low transaction cost-As there is no third-party intermediary, Bitcoin transactions are substantially
cheaper and quicker than traditional payment networks. And because transactions are cheaper, Bitcoin
makes micropayments and other innovations possible. It holds much promise as a way to lower
transaction costs for small businesses and global remittances, alleviate global poverty by improving
access to capital, protect individuals against capital controls and censorship, ensure financial privacy
for oppressed groups, and spur innovation .

8Derek A. Dion, Comment, Ill Gladly Trade You Two Bits on Tuesday for a Byte Today: Bitcoin,
Regulating Fraud in the Economy of Hacker-Cash, 2013 U. Ill. J.L. Tech. & Poly 165, 187.
9Ken Tindell, Geeks Love the Bitcoin Phenomenon Like They Loved the Internet in 1995, Business
Insider (5 April 2013).
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Potential to combat poverty- Bitcoin also has the potential to improve the quality of life for the
worlds poorest. Improving access to basic financial services is a promising antipoverty technique. 10
According to one estimate, 64% of people living in developing countries lack access to these services,
perhaps because it is too costly for traditional financial institutions to serve poor, rural areas. 11 The
cost involved in developing traditional branch banking in poor areas, people in developing countries
have turned to mobile banking services for their financial needs. The closed-system mobile payment
service M-Pesa has been particularly successful in countries such as Kenya, Tanzania and
Afghanistan.12
Stimulus for Financial innovations-One of the most promising applications of Bitcoin is as a platform
for financial innovation. The Bitcoin protocol contains the digital blueprints for a number of useful
financial and legal services that programmers can easily develop. Since bitcoins are, at their core,
simply packets of data, they can be used to transfer not only currencies but also stocks, bets and
sensitive information.13
Dearth of National Currency- Bitcoins have proven useful in countries and times when government
backed currency is difficult to come by, such as in Iran, 14 Cyprus,15 and parts of Africa. 16 If there is
simply not enough fiat currency available for citizens to make transactions for goods and services,
access to another form of trustworthy currency can supplement as a new means of exchange.
Commentators have speculated that access to Bitcoin can shield people from the effects of
hyperinflation citizens can convert their savings and salary from their national currency into bitcoins,

10Muhammad Yunus, Banker to the Poor: Micro-lending and the Battle Against World Poverty (New
York: Public Affairs, 2003).
11Oya Pinar Ardic, Maximilien Heimann, and Nataliya Mylenko, Access to Financial Services and
the Financial Inclusion Agenda around the World (Policy Research Working Paper, World Bank
Financial and Private Sector Development Consultative Group to Assist the Poor, 2011).
12Jeff Fong, How Bitcoin Could Help the Worlds Poorest People, PolicyMic (May 2013).
13Jerry Brito, The Top 3 Things I Learned at the Bitcoin Conference, Reason (20 May 2013).
14Derek A. Dion, Comment, Ill Gladly Trade You Two Bits on Tuesday for a Byte Today: Bitcoin,
Regulating Fraud in the E-conomy of Hacker-Cash, 2013 U. Ill. J.L. Tech. & Poly 165, 188.
15Marketplace Morning Report: Bitcoin Continues to Spike in the Wake of Cyprus, Am. Pub. Media
(Apr. 3, 2013), http://www.marketplace.org/topics/economy/bitcoincontinues- spike-wake-cyprus.
16James Smith, Bitcoin Fuels Africas Banking Revolution, Conversation (July 12, 2013),
http://theconversation.com/bitcoin-fuels-africas-banking-revolution-16044.
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and when the value of the national currency plummets, the individuals net worth is thus stored in a
different currency that shielded from the hyperinflation of the national currency. 17
Disadvantages of Bitcoins
Despite the benefits that it presents, Bitcoin has some downsides for potential users to consider. It has
exhibited considerable price volatility throughout its existence. New users are at risk of improperly
securing or even accidentally deleting their bitcoins if they are not cautious. Additionally, there are
concerns about whether hacking could compromise the bitcoin economy.
Volatility- Bitcoin has weathered at least five significant price adjustments since 2011.41 These
adjustments resemble traditional speculative bubbles: overoptimistic media coverage of Bitcoin
prompts waves of novice investors to pump up Bitcoin prices. 18 The exuberance reaches a tipping
point, and the value eventually plummets. Newcomer investors eager to participate run the risk of
overvaluing the currency and losing their money in a crash. Bitcoins fluctuating value makes many
observers sceptical of the currencys future.
Security Breaches-As a digital currency, Bitcoin presents some specific security challenges. If people
are not careful, they can inadvertently delete or misplace their bitcoins. Once the digital file is lost, the
money is lost, just as with paper cash. If people do not protect their private Bitcoin addresses, they
can leave themselves open to theft. Bitcoin wallets can now be protected by encryption, but users
must choose to activate the encryption. If a user does not encrypt his or her wallet, bitcoins could be
stolen through malware.19 Bitcoin exchanges too, have als struggled with security , as hackers
successfully stole 24,000 BTC ($250,000) from a bitcoin exchange called Bitfloor in 2012 20
Criminal Uses-There are also reasons for policymakers to be apprehensive about some of Bitcoins
exaptations. Because Bitcoin is pseudonymous, policymakers and journalists have questioned
whether criminals can use it to launder money and accept payment for illicit goods and services.
Indeed, like cash, it can be used for ill as well as for good.
Another concern is that Bitcoin can be used to launder money for financing terrorism and trafficking
in illegal goods. Although these worries are currently more theoretical than evidential, Bitcoin could
indeed be an option for those who wish to discreetly move ill-gotten money. Concerns about Bitcoins
17Jack Hough, The Currency Thats Up 200,000%, Market Watch (June 3, 2011),
http://www.marketwatch.com/story/the-currency-thats-up-200000-1307029053200.
18Felix Salmon, The Bitcoin Bubble and the Future of Currency, Medium (3 April 2013).
19Stephen Doherty, All Your Bitcoins Are Ours Symantec Blog (16 June 2011).
20Devin Coldewey, $250,000 Worth of Bitcoins Stolen in Net Heist, NBC News (5 September
2012).
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potential to facilitate money laundering were stoked after Liberty Reserve, a private, centralised
digital-currency service based in Costa Rica, was shut down by authorities on charges of money
laundering.21
Regulation of Bitcoin across the globe
Governments worldwide are examining on the operational and aspect of Bitcoin. They have been
trying to get it within the broader ambit of payment network and how they can and should be
regulated given the decentralized and virtual components of the system. Government regulation
and/or guidelines are continually evolving and amendments occur regularly; a few examples are set
out below:

In U.S.A while the Federal Reserve has provided a degree of tacit approval, stating virtual
currencies like Bitcoin have legitimate uses and should not be banned, the IRS has not yet
issued tax guidance. Washington policymakers are actively studying digital currencies, and
taking steps towards solidifying their position and developing formal rules and regulation. In
the United States, the Internal Revenue Service considers Bitcoin as a form of 'property'
rather than a currency for tax purposes. However, the United States District Court (Eastern

District of Texas) has recently ruled that Bitcoin is a currency or form of money.
While the German finance ministry has formally acknowledged Bitcoin as a unit of
account (meaning it can be used for tax and private trading purposes in the country), the
German Bundes bank has become the latest big central bank to warn about the risks of
Bitcoin, amid rising concerns from regulatory authorities around the world as the virtual
currency grows in popularity. In Germany, Bitcoin is not classified as a foreign currency or

emoney, but stands as a financial instrument.

China has banned the countrys Bitcoin exchanges from accepting new inflows of cash,
putting the virtual currency in danger in its biggest market. Regulators were concerned that
people could use Bitcoins to skirt the countrys capital controls, and about the wide-spread
speculative demand for Bitcoins and potential for a price bubble. However, transaction
activity is reportedly continuing, with some exchanges finding ways to work around the

controls.
Bitcoin-friendly sovereigns such as Denmark, Poland, and Singapore are currently taking a
laissez-faire approach claiming that no regulation is needed presently, though the issue will

be revisited in the future.

Norway classifies Bitcoin not as money but rather as an asset subject to capital gains tax.
Thailand banned the buying and selling of Bitcoins, as well as sending or receiving the
currency from other jurisdiction.

Regulations in India
21Liberty Reserve Digital Money Service Forced Offline, BBC NewsTechnology (27 May 2013).
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As per the Foreign Exchange Management Act, 1999,currency is defined as all currency notes,
postal notes, postal orders, money orders, cheques, drafts, travellers cheques, letters of credit, bills of
exchange and promissory notes, credit cards or such other similar instruments, as may be notified by
the Reserve Bank.22 According to the definition, RBI has the power to include bitcoins within the
definition of currency. Currency other than Indian currency is termed as foreign currency, and
regulated by foreign exchange laws. Most likely bitcoins can be governed by foreign exchange laws.
Further, Bitcoins can also be included within the definition of security which states that such other
instruments as may be declared by the Central Government to be securities
In absence of an established framework for recourse before customers and in the absence of a
regulation or a SEBI guideline strictly governing virtual currency or bitcoins in India, the same can be
brought, for the time being, under the ambit of the Payment Systems and Settlement Act, 2007, its
corresponding rules and the Draft Guidelines for issuance and operation of Prepaid Payment
Instruments in India which under regulation 3.2 allows only banks authorised by the RBI to provide
Mobile banking transactions.
Under the Payment Systems and Settlement Act, a restrictive and regulatory law, The default position
with regard to commencement or operation of a payment system is that it cannot be done without
authorisation issued by the Reserve Bank. A Payment System, defined under Section 2 (1), has a very
broad definition and all systems except stock exchanges and clearing corporations set up under stock
exchanges carrying out either clearing or settlement or payment operations or all of them are regarded
as payment systems.
Hence, operation of BitCoins may also be brought under its ambit and Section 5 of the Act provides
that any person desirous of commencing or carrying on a payment system may apply to the Reserve
Bank for an authorization under this Act. Therefore, since BitCoins act as a virtual currency and carry
out payment or settlement actions in order to legally operate the BitCoin business in India an
authorisation needs to be taken from the RBI prior to its commencement.
In the year 2000, RBI had notified ATM Cards and debit cards as currency. Therefore, RBI has the
power under FEMA to also notify Bitcoins as currency if it is able to justify that it is similar to
currency notes, credit cards, etc. But RBI, in its press release on December 24, 2013, had warned that
the creation, trading or usage of virtual currencies, including Bitcoins, as a medium for payment is not
authorised by any central bank or monetary authority. However, it has not banned the use of Bitcoins
in India as such.
Bitcoins as viable medium of exchange.

22 S.2(h) , Foreign Exchange and Management Act 1999.

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Today Bitcoins are accepted by major companies such as Expedia, Dish Network, Overstock, etc. and
the India website highkart.com provides the facility to pay with Bitcoins only, it is not a universal
medium of exchange. It is not being backed by any government or any institution which guarantees
the receiver the certain value .There is universalisation of value or any pre-determined value nor there
is basis of determination of value of Bitcoins. The value is fixed on the basis of Demand and supply.
A medium of exchange or currency valuation cannot be simply based on demand-supply. It requires a
proper legal framework backing the whole system of transaction. There is extreme volatility in its
value of a Bitcoin and the fear that it could be used for money-laundering transactions. The lack of a
clear underlying legal framework is particularly worrisome.
In India where basic necessity for people is uncertain , use of bitcoin is a distant dream. As it is
backed by technology and internet. India does not have proper infrastructure ,as everybody in the
country do not have access to internet nor technology. Bitcoin cannot be a viable medium of exchange
nor measure of value.
But it is apparent that there is continuing interest in Bitcoins in India. Therefore, it is perhaps time for
the authorities concerned to lay down a legal framework to govern the transactions concluded using
Bitcoins as well as devise a method to tax such transactions. With a new tech-savvy Prime Minister in
Narendra Modi it may well be time for India to officially welcome a tech-savvy currency as well.
As currency should always fulfil four essential that is medium of exchange , measure of value ,
standard for deferred payments ,store of value for future use. If Bitcoins can fulfil the basic essential
then it can be viable medium of exchange. If specific laws for Bitcoins are brought in and it is
regulated through proper institutional mechanism for administration then it can be accepted as
currency.