Cryptocurrencies

Why in news:

The Supreme Court has struck down a ban on trading of virtual currencies (VC) in India, which was imposed by a Reserve Bank of India order in April 2018.

Whar are virtual currencies/cryptocurrencies?

• Cryptocurrency is a decentralized digital currency transferred directly between peers and the transactions are confirmed in a public ledger – which is accessible to all the users.
• Bitcoin, Etherem, Litecoin, Tether and LIbra (proposed cryptocurrency by facebook) are some of the examples of virtual currencies.

Features and benefits of cryptocurrencies

• Features and valuation - The prominent feature in the design of cryptocurrencies architecture is decentralized control, which means - no single authority, institution, individual or group controls the flow of transactions, supply or valuation of the currency. Rather, the collective computing power of the miners ensures seamless operations while demand-supply dynamics drive the valuation.
• Public ledger - A cryptographic algorithm/function encrypts this transaction using the digital signatures of the parties to establish their authenticity. Once validated, the transaction reflects in the public ledger, maintained by so-called miners.
• Mining - The process of maintaining this ledger and validating the transactions is better known as mining.
• Authenticity –
  • Traditional banking is based on underlying assets and values and primarily the trust on the banking authority of a nation. In virtual currencies the authenticity lies on the cryptographic proof of present to historic transactions and also validation by miners.
  • The concepts of cryptography and protocols which are based upon the principles of advanced mathematics and computer engineering makes cryptocurrencies secure and hard to duplicate or counterfeit.
• Anonymity - The transactions do not reveal the identities of the parties but rather uses their cryptographic signatures to identify them while maintaining their anonymity.

Supreme court judgement

• The RBI in its 2018 order had banned trading of all virtual currencies in India. The order restricted all entities regulated by the RBI not to deal with virtual currencies including maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral etc.
• The Supreme Court has struck down this ban on trading of virtual currencies (VC) in India.
• The court in its judgment said that the ban proposed on trading of virtual currencies was not proportionate and that the RBI itself had not found any adverse impact or harm done by the activities of these VC exchanges.

Concerns of stakeholders

• The entities dealing with cryptocurrencies earlier protested the RBI move stating that it was arbitrary because the government did not have a clear position and was unreasonable because it was actuated by moral concerns.
• The government had proposed a legislation criminalizing mere possession of cryptocurrency but was not introduced in Parliament.
• Entities who are into virtual currencies argue that digital/virtual currencies both private or government backed are integral part of digital economy and digital countries.
• They also argue that the stability of fiat-currencies is not absolute either because money is finally validated not by the signature of a central bank’s governor on banknotes, but by market consensus.

Some of the issues with cryptocurrencies

• Cryptocurrencies are virtual and decentralised, well beyond the control or authority of the state.
• They are prone to losses arising out of hacking, loss of password, compromise of access credentials, malware attack etc. 
• The value of cryptocurrencies are based on speculation, there is no underlying or backing of any asset for virtual currency. Huge volatility and crashes in the value of such currencies were noticed in the recent past.
• Cryptocurrencies are being traded on exchange platforms set up in various jurisdictions whose legal status is also unclear. Hence, the traders of virtual currency on such platforms are exposed to legal as well as financial risks.
• Sales made or salaries paid in the form of cryptocurrencies could be used to avoid income tax liability. Tax evaders might find their tax havens in form of cryptocurrencies.
• The absence of information of counter-parties provide anonymity, which has been largely criticized to be used in illicit and illegal activities.

Way forward

• Cryptocurrencies are hard or nearly impossible to regulate but government should not shy away from entering into the sector which is dynamic and evolving.
• In Russia, US and Japan, regulators have classified cryptocurrencies as either property or legal payment methods to co-opt them in a bid to stop money laundering.
• Owing to the concerns regarding the perceived potential of cryptocurrencies for tax evasion, US Government had issued a notice in 2014, labelling them as “intangible property” and deemed trading in cryptocurrencies to be taxable and subject to capital gains taxes.
• The People’s Bank of China has done trial runs of its prototype cryptocurrency, taking it a step closer to being the first major central bank to issue digital money.
• Also taking lessons from above nations,  government should make efforts to integrate them into formal channels by trying to improve the know-how and tech capabilities of government machineries.

Practice Question

Q. What are the risks and challenges associated with virtual currencies? Should the government ban such transactions and trading all together?