By Nandini Garg
India is continually striving towards becoming a “digital” economy. Both public and private sectors have made efforts in this regard. Widespread use of mobile phones and internet, e-filing of taxes, e-payments for purchases etc. evidence this. Virtual currency is one such hotbed in the era of digitisation, innovation and technology. A virtual currency, namely Bitcoin, was introduced in the year 2008 and since then the market frenzy surrounding it hasn’t taken a halt. Different states across the world have reacted differently towards virtual currencies. Although it is widely accepted that the technology behind virtual currencies is groundbreaking, some states have outrightly banned virtual currencies whereas some have openly promoted it.
Indians have taken up virtual currencies very enthusiastically and have actively traded in them by way of establishing exchanges, start-up companies and even associations. However, India is still struggling to come up with a concrete policy on it. The Reserve bank of India has continuously cautioned the users of virtual currencies against its risks and has recently put a complete prohibition on it. This prohibitory order was challenged in the courts and it remains to be seen how India comes up with a framework on use and regulation of virtual currencies.
Virtual currencies have a large footprint in the today’s financial markets and they cannot be overlooked. This article seeks to trace its journey in India. Part – I very briefly describes the concept of virtual currencies and its related aspects. Part – II looks at some of the glitches encountered by the virtual currencies markets worldwide. Part – III highlights the attempts made to regulate virtual currencies both at national and international level. Part – IV suggests the possible course of action that can be taken up to govern virtual currencies in India.
The origin of virtual currencies [“VCs”] can be linked back to the most popular VC – Bitcoin. Bitcoins became operational in the year 2009 after a paper called “Bitcoin – A Peer to Peer Electronic Cash System” was released under the pseudonym Satoshi Nakamoto. VCs are digital representations of value, issued by private developers and denominated in their own unit of account. They enable parties to make transactions electronically and allow greater independence and control.
VCs are primarily based on two tools i.e. blockchain and cryptography. Blockchain is an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way. These ledgers can be inspected by everyone and are not subject to any form of central control. Cryptography, on the other hand, is associated with the process of converting ordinary plain text into unintelligible text and vice-versa. It is a method of storing and transmitting data in a particular form so that only those for whom it is intended can read and process it.
A typical Bitcoin transaction is carried out by individuals from general public and government involvement (such as central bank) is absent. These individuals are often referred to as miners. They authenticate deals between parties by verifying details such as the total amount transacted, who are the parties etc. At least 3 miners authenticate a deal by solving complex cryptographical problems. Miners who do it first are rewarded with Bitcoins. Miners create blocks of information in relation to deals authenticated by them. These blocks later get incorporated into blockchain and are open for public inspection. Bitcoins earned by miners are stored in a virtual wallet having its own numbering and password. Only the wallet number is accessible to public and the identity of the wallet owner remains secret.
VCs are often confused with terms such as digital currency, cryptocurrency etc. Although some characteristics of VCs are similar with these currencies, it is necessary to understand the differences between them to fully appreciate the concept of VCs. Digital currency refers to the currency which exists electronically, in contrast to the traditional paper currency. Digital payment system providers/ e-money providers such as PayPal, Paytm etc. enable electronic settlement of paper currency transactions. Both VCs and cryptocurrencies fall under the broader umbrella of digital currencies. Since VCs usually employ cryptography technique for its operation, the term cryptocurrency is used.
Misuse of VCs. R. Gandhi, former Deputy Governor of Reserve Bank of India [“RBI”], has argued against the use of VCs based on two key elements viz., Confidence and Anonymity.
There are numerous loopholes in VCs which make it vulnerable to abuse. Some such loopholes are as follows: VCs are designed in such a way that any form of State control is eliminated. This gives a window to bad actors to enter and exit a VC network without any consequences. VCs network participants are spread across the globe and can quickly transfer payments across borders via a simple internet connection. This makes the task of controlling or trailing VCs transactions tougher. VC transactions are irreversible. No cryptocurrency currently provides a mechanism to reverse transactions even when someone falls victim to malicious actors. User-identification in a VC network is difficult. Many-a-times users employ different username for every new transaction, whereas some VCs like Monero are completely untraceable themselves.
Exploiting these gaps hackers stole about $530 million from a Japanese cryptocurrency exchange, Coincheck, in January this year. This is believed to be the largest crypto heist to date. India had a similar experience in April, 2018 when Bitcoins worth over Rs 20 crore were stolen from Coinsecure, a Delhi based cryptocurrency exchange. But the biggest number of incidents has cropped up from initial coin offerings, which is a means of raising funds for cryptocurrency entrepreneurs. As per a report released by Ernst & Young more than 10 percent of the funds — as much as $1.5 million a month — were stolen in 372 initial coin offerings made between 2015 and 2017.
Hackers are also tinkering with different hacking techniques to suit cryptocurrencies. Amongst such techniques ransomware and cryptojacking have been identified as the two biggest threats to user security in 2018 and are briefly described below.
Cryptojacking. In order to keep to the abusers at bay, cryptocurrency transactions requires miners to solve complex cryptographical problems. Mining is very processor intensive and it requires a lot of power. In order to save this huge power expenditure some miscreant-miners use the technique of cryptojacking. Cryptojacking allows these miscreant miners to use the memory, processor power, and electricity from someone else’s computer system to generate cryptocurrencies for themselves. This form of mining is usually targeted at big establishments having multiple systems. It is not considered to be legitimate as it operates without user’s knowledge or consent.
India witnessed its first cryptojacking attack in April 2018. More than 2,000 computers of the Aditya Birla Group were hacked to mine a virtually untraceable digital currency called Monero. A recent report by the UK’s National Crime Agency and the National Cyber Security Centre throws some light on this upcoming phenomenon. The report notes that thousands of websites worldwide secretly mine cryptocurrency and “cryptojacking will likely become a regular source of revenue for website owners.”
With the introduction of cryptocurrencies, ransomware attacks are on an upswing. In an ordinary ransomware attack, data or information stored in computer systems is stolen and encrypted. Ransom is then demanded for data retrieval. Ransomware disrupts day-to-day functioning of the systems and causes temporary or permanent loss of data. Hackers these days demand payment of cryptocurrencies as ransom. Cryptocurrencies enables concealment of not only hackers’ identities but also the trail of ransom money. Two major ransomware attacks which hit the globe in 2017 were WananaCry and Petya. The attacks spread as many as 150 countries and infected the systems of government agencies, banks, hospitals, companies etc. Around 37 incidents of ransomware attacks have been reported in India till June, 2017. Of these, 34 incidents were of Wannacry and Petya ransomware.
Regulation of VCs. Regulation of VCs has remained contentious till date. VC does not perfectly fit in as currency, goods, foreign exchange or any other category defined under various legislations. It can be governed by single or multiple regulatory authorities. First signs of VCs regulation came up in December 2013 when RBI issued a warning to users of VCs against its risks.
The very digital/electronic nature of VCs make them prone to losses arising out of hacking, loss of password, compromise of access credentials, malware attack etc. The traders of VCs are exposed to legal as well as financial risks as the legal status of VCs, such as Bitcoins, is not clear in many countries. Several jurisdictions have reported use of VCs for illegal activities such money laundering, financing of terrorism etc. Trading in VCs takes place on a peer-to-peer basis, without any government control, leaving no room for redressal of customer grievances. VCs obtain their value from pure speculation without any underlying asset. The users are exposed to potential losses on account of high volatility in value.
Such warnings have been issued on more than one occasion and no entity/company is licensed/authorised to operate any schemes or deal in VCs. The finance minister of India, in his 2018–19 budget speech, stated that cryptocurrencies are not deemed as legal tender and strict actions might be taken against investors in cryptocurrencies.
Indian VCs enthusiasts received a solid blow on April 6, 2018, when RBI put a blanket prohibition on dealings in VCs. Any ongoing provision of services in VCs was also ordered to be terminated within three months. A slew of court petitions followed the announcement. A total of five writs, challenging it, were filed in courts. The Supreme Court is set to hear all the matters together on July 20, 2018 and has barred filing of any further suits.
However, RBI constituted an inter-departmental group in the midst of this VCs clamp down. The group is tasked to explore the possibilities of introducing central bank digital currency in India. The government of India also formed a committee, under the chairmanship of Subhash Chandra Garg, to suggest regulatory measures after studying the present status of VCs both in India and globally. Both the bodies are set to submit their reports by June and July of this year respectively. The Supreme Court on an earlier occasion had issued a notice to several government authorities to provide a Bitcoin regulatory framework. The government has remained unresponsive to it. Even so no clear conclusions can be drawn given that the government reports and judicial decisions are still awaited.
The global attitude towards VCs is also patchy. Many countries have adopted a friendly approach towards VCs by putting appropriate regulations in place. For instance Japan has ordered all cryptocurrency exchanges to submit a report on their system risk management. South Korea permits trading of cryptocurrencies only from real-name bank accounts to ensure compliance of Know-Your Customer [“KYC”] and Anti-Money Laundering [“AML”] laws. On the other hand, countries like China have banned VCs in all shapes and forms. European Union has also expressed its concern against VCs from time to-time. Similarly private players like Facebook, Google and Twitter have disallowed any cryptocurrencies and initial coin offerings advertisements on their respective platforms.
In the light of such behavior, it becomes difficult to measure the viability of cryptocurrencies. However, the world community at large has agreed that cryptocurrencies have its own downsides which need to be tackled. International Monetary Fund has called for greater international discussion and cooperation on cryptocurrencies. At the G-20 meet this year, the member-nations consented to monitor cryptocurrencies.
Conclusion. A November, 2017 report released by RBI, has called regulation of VCs as “a complicated issue”. VCs have enabled cheap and speedy processing of financial transactions by eliminating the need for any middleman/bank/central authority. However, the absence of any central authority has lead to series a scandals involving VCs. In such a scenario it is best to adopt a “study-and-watch approach”, as suggested by the United Nations Commission on International Trade Law. The approach adopted by India seems to be in consonance with this suggestion.
Even though an order banning VCs is passed by RBI, several government bodies are studying and exploring the potential of VC and its underlying technology. Before forming any regulatory response, India can take guidance from the principles laid down by International Monetary Fund for national authorities. Any regulatory response should not stifle innovation, should be adaptive to future landscape, should regulate both the VC market and its participants, and should effectively integrate the conventional financial system and the new VC system. The Institute for Development and Research in Banking Technology, a body established by RBI, has suggested that the blockchain technology can be adopted for maintaining centralized KYC database, making cross-border payments and even digitizing Indian Rupee.
The Financial Action Task Force, responsible for setting global AML policies, has promised to present its revised AML countermeasures for cryptocurrencies at the upcoming G20 meeting of finance minister. More such government recommendations are expected this year. Further, RBI’s ban should be imposed only for a temporary period. VCs have brought forth some breakthrough aspects of technology which cannot be disregarded. India should keep its doors open to future developments and should take a policy stance accordingly.