The Cosmos of Cryptocurrency

One of the recent fincial phenome being discussed at the highest level of policymaking across the globe is cryptocurrency. While many have already experienced it, majority are still curious to know what is cryptocurrency and how it functions. Cryptocurrency is a digital, decentralized currency system with no regulatory authority as opposed to the normal banking system. In this system, digital assets are transacted through cryptography. Transaction in cryptocurrency is encrypted and transferred between peers, and confirmed in a public digital ledger through a validation process, known as mining. In the cryptocurrency system, the digitized ledger or database is known as blockchain. 

Cryptocurrency consists of a network of peers. Every peer has a record of the complete history of all transactions and knows the balance of every account operating in the network. A transaction made between two entities is signed with a private encrypted key. Such transaction is verified and confirmed through the process of cryptography and broadcast in the network. Once it is broadcast in the network, it becomes a part of the blockchain and visible to all members of the peer group. This process is known as mining.   

Mining is open to all in the network and anyone can confirm the transaction. In cryptocurrency, coins are generated or produced by miners. The miner has to solve a complex mathematical puzzle to add the transaction in the ledger. This mathematical puzzle is based on a high-security SHA 256 Hash algorithm. The process of confirmation of the transaction is done in such a manner that no one individual in isolation can add or alter in the database of the blockchain. Once a block is added to the ledger, it becomes a permanent transaction and no alteration can be made to it. For completing the process, the miner receives a fee that is added to its digital wallet. Such digital wallet in cryptocurrency stores the public and private keys that can be used to receive or spend the cryptocurrency. The mining process is known as proof-of–work in the language of cryptography and it gives value to the currency. The participants in crypto-currencies are not known by their identities, rather they are known by the encrypted wallet key.   

Although cryptocurrencies have global presence, many people, institutions and organizations are yet left unexposed to the concept of cryptocurrency. Bitcoin was the first and still the most important cryptocurrency. In January 2009, while announcing the invention of the currency, Bitcoin inventor Satoshi kamoto said, “Bitcoin is a new electronic cash system that uses a peer-to-peer network to prevent double-spending. It’s completely decentralized with no server or central authority.” A Cambridge University research estimates that in 2017, 2.9 to 5.8 million unique users were making transactions in cryptocurrencies and most of them were using Bitcoin.

To start trading in cryptocurrenc,y one needs to choose a cryptocurrency wallet and an exchange to trade on.  Cryptocurrency exchange is like a stock exchange but not in any way part of regular stock exchanges. Due to the decentralized and unregulated ture, various apprehensions on the operation of cryptocurrencies have been raised. Serious observations have been made on the transaction pattern and legality of cryptocurrency all over the world. The legality of cryptocurrencies is not defined and legal status of cryptocurrencies varies from country to country.  While some countries have explicitly allowed their use and trade, others have banned or restricted it.

Concerns have been raised for possible cyber crime due to unregulated person-to-person global platform that is offered by cryptocurrencies. Since users seek decentralized and unregulated exchange for transaction, possibilities of tax evasion and money laundering are also arising.   

Transactions that take place in cryptocurrency exchanges are independent of the control of formal banking systems, and, therefore, it is difficult to charge actual taxable income arising out of cryptocurrency transactions. Since the mode of transaction is very complex and in encrypted form, it further makes it difficult to account the transactions. Again, as most of cryptocurrencies offer system of anonymity to their users by protecting their identities through an encrypted private key, it may become easier to launder money through anonymous transactions in cryptocurrencies. 

Cryptocurrencies have been compared to ponzi schemes, and economic bubbles. Investment and transaction risks associated with cryptocurrencies have alarmed various governments and tiol regulators. GBL, a Chinese bitcoin trading platform, was suddenly shut down on October 26, 2013 and caused a loss up to $5 million worth of bitcoin. In February 2014, the world’s largest bitcoin exchange, Mt Gox, was declared bankrupt due to theft. It caused an estimated loss of $473 million to the bitcoin customer. On November 21, 2017, the crypto-currency med Tether announced that they were hacked, causing a loss of $31 million USD from their primary wallet. On December 6, 2017, more than $60 million worth of bitcoin was stolen after a cyber attack hit the cryptocurrency mining platform Nice Hash. Such incidents have made many governments adopt a cautious approach to cryptocurrencies, and they have realized the effects that cryptocurrencies could have on the fincial security of a country. 

The Securities and Exchange Commission (SEC) of the United States has warned investors of cryptocurrency investing risks and hinted at the need for greater regulation. Caution was raised in the World Economic Forum held in January 2018 to make sure that cryptocurrencies are not used for illicit activities.  Chi has been taking vigorous actions to crack down on cryptocurrency. It has issued instruction for freezing of bank accounts associated with cryptocurrency exchanges and ordered a tionwide ban on internet and mobile access to all things related to cryptocurrency trading. The United Kingdom (UK) and the European Union (EU) are also planning to regulate cryptocurrencies. On Dec 4, 2017, The Guardian reported that the UK Treasury and EU both had made plans to make an end to anonymity available to cryptocurrency traders, citing it an anti-money laundering and tax-evasion crackdown. However, countries such as Japan, Singapore, Switzerland and Venezuela are offering favourable atmosphere to cryptocurrency trading. While Japan is trying to attract the cryptocurrency market of Asia as Chi and South Korea are coming with regulatory mechanisms, Venezuela is trying to come out of the economic sanction imposed on it by announcing its own oil-based cryptocurrency called “petro”. 

India, earlier viewed as having friendly environment for cryptocurrencies, has decided to clamp down on trading of such digital currencies. Fince Minister Arun Jaitley said that the government will do everything in its capacity to clamp down on the use of bitcoin and other cryptocurrencies in India. In his last budget speech, Jaitley said, “The government does not consider cryptocurrencies legal tender or coin and will take all measures to elimite use of these crypto-assets in fincing illegitimate activities or as part of the payment system.” India has similar concerns for possible money laundering, tax evasion, terror funding and illegal activity proliferation such as that of the US, EU, UK and Chi in regard to trading in cryptocurrencies. 

Very recently, the Cabinet Committee on Economic Affairs (CCEA), has given approval to the Unregulated Deposit Schemes Bill, 2018 that seeks to ban all unregulated deposit schemes. A Fince Ministry statement said that the bill is aimed at tackling the mece of illicit deposit-taking activities in the country. It is a largely accepted fact that institutions running cryptocurrency schemes exploit the existing regulatory gaps and lack of strict administrative measures to dupe poor and to take away their hard-earned savings. Regulatory measures would certainly curb such activities. But along with such mechanism, awareness and sensitization among investors and traders in cryptocurrencies are highly required. 

(The writer, an IRS officer, is Deputy Commissioner of Income Tax, Guwahati. Views expressed are persol. He may be reached at kpbasom@gmail.com)