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WORLD OF BITCOINS
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INTRODUCTION
We live in a world where transactions are made by traditional methods using separate
currencies. This system has been implemented since the dawn of time. But for a more
modern approach, a new form of currency called as crypto currency have been
introduced by various organizations around the world. The first crypto currency to be
introduced is the Bitcoin.
Bitcoin is the creation of a computer programmer named using the pseudonym
Satoshi Nakamoto that made its debut in January 2009. This is an open source, peer-
to-peer, digital currency that has no physical manifestations. Unlike earlier digital
currencies that had some central controlling person or entity, the USP of Bitcoin lies
in its network being completely decentralized, with all parts of transactions performed
by the users of the system. This is similar to the U.S. dollar so, Bitcoin is a fiat
currency in that it is not redeemable for some amount of another commodity i.e.
Bitcoin in itself does not any intrinsic value. But unlike the dollar, a Bitcoin is not
legal tender nor backed by any government or any other legal entity, nor is its supply
determined by a central bank. The Bitcoin system is a separate network, with no
intervention of traditional financial institutions.
In this report we are going to introduce Bitcoin. We will be talking about the different
features of Bitcoin and the process by which bitcoin works. We will then continue to
critically analyze the legal and the social aspect of bitcoin in different countries
around the world. We would then conclude by talking about the possible introductionof Bitcoin in India and the legal aspect attached to it according to the Indian judicial
system.
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FEATURES OF BITCOIN
Are Bitcoin Transactions Anonymous?
Bitcoin transactions are not completely anonymous. An example of an anonymous
transaction is an exchange of cash between two strangers. In this case, no personal
information needs to be revealed nor does there need to be a record of the transaction.
At the other extreme a non-anonymous transaction is a typical online purchase using a
credit card. This transaction requires validation by a third-party intermediary who
knows the identities of buyer and seller and about their financial information and who
maintains a record of the transaction. A Bitcoin transaction falls between these two
extremes.
In a Bitcoin transaction there is no third party intermediary (such as Paypal or Visa in
e-transactions). The buyer and seller interact directly but their identities are encrypted
and no personal information is transferred to one another.
However, unlike a fully anonymous transaction, there is a transaction record. A full
transaction record of every Bitcoin and every Bitcoin users encrypted identity ismaintained on the public ledger. For this reason Bitcoin transactions are thought to be
pseudonymous, not anonymous.
If Bitcoin exchanges (where large transactions are most likely to occur) are to be fully
compliant with anti-money laundering laws for complete safeguard like other
financial intermediaries, then they will be required to collect personal data on their
customers, limiting further the systems ability to maintain the users pseudonymity.
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Reason for Interest in Topic
The interest in topic of Bitcoin arises because of certain concerns about it, which can
be enlisted as follows:
1.
Its use in illegal money transfers and questionable transactions. Its potential
for facilitating money laundering
2. Its effect on the ability of the Federal Reserve to meet its objectives (of stable
prices, maximum employment, and financial stability).
3. The protection of consumers and investors who might use it.
Bitcoin offers users the advantages of lower transaction costs, increased privacy, and
long-term protection of loss of purchasing power from inflation. However, there are
also a number of disadvantages that could hinder wider use. These include sizable
volatility of the price of Bitcoins, uncertain security from theft and fraud, and a long-term deflationary bias that encourages the hoarding of Bitcoins. Bitcoin also raises a
number of legal and regulatory concerns, along with lack of clarity about its status in
the regulation of foreign exchange trading.
How Does the Bitcoin System Work?
Bitcoin is sometimes referred to as a crypto-currency because it relies on theprinciples of cryptography (communication secure from view of third parties) to
validate transactions and for the production of the currency itself. Each Bitcoin as
well as every user is encrypted with a unique identity. Each transaction is recorded on
a public ledger (called a Blockchain) that is visible to all computers on the network,
but does not reveal any personal information about the parties involved. The public
ledger is meant to verify that the buyer has the amount of Bitcoin being spent and has
transferred that amount to the account of the seller.
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The public ledger is a unique attribute of Bitcoin because it solves the so-called
double spending problem (i.e. spending money you do not own by use of forgery or
counterfeiting) and the need for a trusted third party (such as a bank or credit card
company) to verify the integrity of electronic transactions between the transacting
parties.
Why Would One Want to Use Bitcoins?
Lower Transaction Costs
In absence of any third-party intermediary, Bitcoin transactions are intended to be
substantially less expensive for users than those using traditional payments systems
such as Paypal and credit cards, which charge merchants significant fees for their role
as trusted intermediary to validate e-transactions. Additionally, Bitcoin sales are non-
reversible, which removes the possibility of consumer charge-backs, which merchants
find costly. Merchants would presumably pass at least some of these savings on to the
customer. While there is a lot of apparent evidence that this is true, there is no
comprehensive data on the size of Bitcoins effective transaction cost advantage.
Increased Privacy
Those who seek a higher degree of privacy may feel more comfortable using Bitcoins
for their (legal) commercial and financial transactions. The risk of identity theft can
also be less, and some even may find the removal of government from a monetary
system attractive. However, as discussed, Bitcoin transactions do not have theanonymity afforded by cash transactions, as there is a complete historical record of
Bitcoin amounts and permanent encrypted data of all transactions on the Bitcoin
system that is potentially traceable.
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No Erosion of Purchasing Power by Inflation
Inflation is broadly defined as an increase in the prices of goods and services. This is
equivalent to saying that there is a fall in the real value of the currency. It is
commonly believed to be a monetary phenomenon in which the supply of the
currency outpaces the demand for the currency causing its value (in terms of what it
can buy) to fall.
Most often the central bank of an economy regulates the supply of money and credit
and quite often some degree of mismanagement of this government function is at the
root of a persistent high inflation problem. In the case of Bitcoin, however, there is nogovernment or central bank regulating the supply of Bitcoins. The supply of Bitcoins
is programmed to grow at a steady rate regulated by the degree of mining activity and
then is capped at a fixed amount.
Inflation could occur if the demand for Bitcoin decreases relative to the fixed supply.
If these digital banks move to a situation where held reserves stabilize, this source of
inflation would diminish.
What Factors Might Deter Widespread Bitcoin Use?
Slow Transaction Confirmation
Some of the transaction cost advantage could be offset by the slow speed at which
Bitcoin transactions are processed confirmed, which, depending on the size of the
transaction, can take a minimum of 5 minutes or as long as 20 minutes.
Not Legal Tender
Rupee is legal tender and by law can be used to extinguish public or private debts. Acreditor is required to accept legal tender for the settlement of a debt. At a minimum,
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the payment of taxes forces Indian citizens to hold rupee. Arguably, for many, such a
government endorsement is comforting and creates a strong underlying demand for
the rupee. By contrast, a currency like Bitcoin that is linked to a complex computer
program that many do not understand and that operates without accountability to any
controlling entity could be an unattractive vehicle for holding wealth for many people.
Price Volatility Discourages Its Use as Medium of Exchange
Bitcoins price has been volatile since its creation in 2009, subject to sharp
appreciations and precipitous depreciations in value. However, 2013 has seen a much
higher level of price fluctuation than ever before. During March and April of 2013,
Bitcoins dollar exchange rate moved from about $50 up to $350, and back to near
$70. Bitcoins price has moved up evenmore sharply later during 2013, rising from
near $50 in September to above $1,100 by early December, and down to near $800 by
mid-December. This is a price pattern more typical of a commodity than a currency to
be used as a medium of exchange, and suggests that the market for Bitcoin is
currently being driven by speculative investors and not by a greater demand for
Bitcoin due to increased transactions by merchants and consumers.
A rising dollar price of Bitcoin is likely to deter potential buyers who would expect to
see their purchasing power be greater in the future. A falling Bitcoin price is likely to
deter potential sellers who would expect to see their potential sales receipts be greater
in the future.
The Systems Long-Term Deflationary Bias Will Deter Its Use as
Currency
Because the supply is capped in the long run, widespread use of Bitcoin would mean
that the demand for Bitcoin would likely outstrip supply, causing Bitcoins price to
steadily increase. The implication of that increase is that the Bitcoin price of goods
and services would steadily fall causing deflation. Faced with deflation, there is a
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strong incentive to hoard Bitcoins and not spend them, causing the current level of
transactions to fall.
This possible outcome highlights the importance of the economys principal currency
being elastic, its supply increasing and decreasing to meet the changing needs of the
economy, and of the important role of the central bank in implementing such a
monetary policy.
Uncertainty of Bitcoin Networks Security
While counterfeiting is supposedly not possible, Bitcoin exchanges and walletservices have at times struggled with security. Undoubtedly, cash and traditional e-
payment systems also have periodic security problems, but a high degree of security
problems on a system trying to establish itself and gain customer confidence could be
more damaging. Some notable examples of security breaches on the Bitcoin network
have included the following:
In September 2012, Bitfloor, a Bitcoin exchange, reported being hacked, with
24,000 Bitcoins (roughly equivalent to 250,000 USD) stolen. As a result, Bitfloor
temporarily suspended operations.
On April 3 2013, Instawallet, a web-based wallet provider, was hacked, resulting in
the theft of over 35,000 Bitcoins. With a price of 129.90 USD per Bitcoin at the time,
or nearly 4.6 million USD in total, Instawallet suspended operations.
On August 11 2013, the Bitcoin Foundation announced that a bug in software within
the Android operating system had been exploited to steal from users wallets.
On October 23 and 26 2013, a Bitcoin bank, operated from Australia but stored on
servers in the USA, was hacked, with a loss of 4,100 Bitcoins, or over 1 million AUD.
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BITCOIN MINING
The word mining is used in analogy to gold mining that follows a curve like
logarithmic function.
Bitcoin transactions are happening all over the world/network but unless someone
keeps a record of this no one will be able to know who paid what. Mining is the
process of assembling the latest transactions from up to ten minutes ago so that they
become permanent in the history of chained transactions. The bitcoin network deals
with this by collecting all the transactions made during the 10 minutes into a list that
is called a block.
Miners receive these blocks. It contains all the transactions made between two bitcoin
addresses at a given point of time. The blocks contain cryptographic hashes i.e.
encrypted transactions. Miners use their computers to decipher the transactions. By
deciphering the block they are verifying the transactions within it. They validate the
transactions and do not allow conflicting ones.
When such a block of assembled transactions is compiled and added to history, the
ones that devoted computer resources i.e. the miners are rewarded. Miner is rewarded
to his designated bitcoin address, but usually miners work in mining pools and share
the rewards collectively. Bitcoins only exist as balances associated with a bitcoin
address. What you actually keep is the private key of the address. A private key is like
a password that enables you to spend from the corresponding bitcoin address, and is
made of 256 bits, a string of 256 zeros and ones. It is usually expressed in more
compact formats using hexadecimal numbering.
Mining Tools
a) Hardware
To perform mining you need high spec computers. This is required to churn
through and decipher the available bitcoin blocks. As value of currency appreciates,
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more and more people are building server farms. This makes financial sense due to
current value of Bitcoin to the cost of CPU grunt.
a)
Software
To interface to the bitcoin marketplace you need software and a relevant
bitcoin account. This includes having your own wallet. Many mining applications are
available online. You can even join a mining pool and work with other miners to
share in their rewards.
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LEGALITIES OF BITCOIN IN DIFFERENT COUNTRIES
There has been a different point of view of different Countries towards crypto-
currencies but the most popular among them is Bitcoin. More than 25 countries in the
world have accepted Bitcoin in one or the other way, but it is still restricted and
declared illegal by many others. Legality of Bitcoins in some of the major Nations is
briefed as follows:
United States of America
United States has accepted Bitcoin and its completely legal to trade and mine Bitcoin
in USA. According to the declaration of Internal Revenue Service on March 25, 2014
Bitcoin is treated as a property rather than a currency. General tax principles that
apply to property transactions apply to the transactions using Bitcoin. However, they
have also put restrictions on certain use of Bitcoins, like they cant be used as
donations to political parties for their campaign. Also there are discussions going on
about Bitcoin being a potential threat to the Nation, as it can increase illegal activities
like drug, child pornography, etc.
Instead of the ambiguity about authenticity of the complete process, there are many
business tycoons who are investing in the field. Like recently, Richard Branson
(founder of Virgin Group) along with Jerry Yang (Co-founder and former CEO of
Yahoo Inc.) invested more than $30 million in BitPay (Leading payment processor
company of Bitcoins).
China
China is the country where they had the biggest Bitcoin market initially. It was the
best time for Bitcoin industry when the price of a single Bitcoin reached about $1000.
But in December 2013, Central Bank of China, Peoples Bank of China and many
other financial institutions and banks rejected Bitcoin and said that no transactions
can be done using Bitcoins. Thereafter, the price of Bitcoin fell to almost $500 in one
day.
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China has not rejected Bitcoin but they state Bitcoin as Highly speculative digital
virtual good. China has not banned the use of Bitcoin official but they have issued
instruction for their citizen to be careful about the use of Bitcoin. Some of the
instructions are as follows:
1.
Not to use it as a real currency,
2. It must be treated as special Virtual goods.
3.
Beware of theft of your electronic wallet.
Canada
Use of Bitcoins in Canada was illegal initially; there was this statement by an official
of Canadas finance department that stated as Only Canadian bank notes and coins
are recognized as legal tender in Canada. Bitcoin digital currency is not legal tender
in Canada.
Earlier, on 5th November 2014, Canadian Government released tax regulation for the
use of Bitcoins; it said that the rules of barter transactions would be applied whenever
its used for payment of goods and services. When two or more people exchange
goods and services, it termed as Barter Transaction.
According to Canadian Tax system, the value of the goods or services that are used
for barter transaction should be specified in the details of taxpayers income and
according appropriate tax will be deducted from his/ her income.
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PROS AND CONS OF RECENT DEVELOPMENTS OF BITCOINS
PROS:
The advent of Bitcoin is clearly made visible with the increasing reach and
acceptance by many major companies such as Zynga, PayPal, Tesla, not-for-
profit organizations like Wikipedia, and educational institution like University
of Nicosia, to name a few.
Recently Expedia, one of the worlds largest online travel agencies has
become the latest company to accept Bitcoins as form of payments, limited
only to hotel bookings, and restricted to its US site. This has been one of the
biggest moves for the benefit of this organization as Bitcoins become more
and more widely accepted. However certain conditions have been levied over
processing of these transactions, namely that Bitcoins would not be held by
the company, but would be converted to US Dollars after every 24 hours.
Denmarks Tax Board recently held a discussion where they concluded that
any gains (taxed) and losses (deductible) made through Bitcoin trading should
be exempt from taxation, as Bitcoins are a virtual currency, and not real
money. Exception to this is the ruling, would be for the Businesses whose
primary focus is in digital currencies, who are obliged to declare their
winnings and losses to the government.
Bitcoin seem to be the most viable candidate to become a possibly universal
virtual currency, as they cover over 76% of total alternate virtual coin market
cap.
CONS:
The major negative aspect of Bitcoins is the question on its legality across
different nations, and lack of a central authority to overlook/maintain the
sanctity/security of the entire system. Theoretical research [5] has been done
to understand the weak points of the Bitcoin currency network, and one
possible defect in the system, has been unearthed, is known as the 51per
center. This research talks about how, if a single entity were able to control
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more than 50% of the mining sources, would potentially be able to forge
transactions in the public ledger, as a transaction deemed to be correct and
verified by more than half the miners, is classified to be true. However,
although such instances of a single consortium or entitycontrolling over
half of the worlds total mining haveoccurred earlier (by the group GHash.io),
no incidents of fudging of the public ledger have been reported.
Also the security of the computers, mobile phones and servers storing the
wallets and passwords will become of paramount importance, which is
contrary to the recent trend of rise of cloud based services, where every app is
given permissions to access to the locally data stored. This need is clearly
demonstrated by the recent cases of Mt. Gox Bitcoin Exchange and an
Australian Bitcoin Bank, who were collectively hacked and in the process
looted of 654,100 BTC (valued at $406,800,000 as on 14-July-2014).
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make jihadist donation untraceable. As per Sky news, ISIS is keen to employ bitcoin
as a mode to finance their terrorist activities. Unlike traditional currency Bitcoins do
not have central controlling authority and do not require banks and other
intermediaries for money transfer. So it can be used for evading tax, as bitcoin is not
so easy to trace. There are numerous ways through which bitcoin transactions can be
made anonymous. It can become mean to pay for criminal activities because of its
higher degree of anonymity. It can be used for money laundering, as the source of
money is secret to some extent.
The major action taken by the Indian government is the advisory issued by the
Reserve bank of India on 24th of December 2013. In the advisory the RBI warned the
users of bitcoin against financial, legal, and security risks and losses due to hacking,
price volatility and lack of a central controlling authority to address consumer
complaints. On 27th December 2013, the Enforcement Directorate raided the bitcoin
exchange buysellbitco.in in Ahmedabad.
WAYS TO BRING BITCOIN IN THE AMBIT OF INDIAS LAW:
Theft Of Bitcoins By Unauthorized Access:
Bitcoin is a form of crypto-currency and it is based on the principles of cryptography.
As cryptography comes under the provision of IT Act, 2000; bitcoin can also be
brought under this act after some research and amendments. In this way we can stop
unauthorized access and hacking, and prevent theft of Bitcoins from virtual wallets.
THE INFORMATION TECHNOLOGY ACT, 2000
An Act to provide legal recognition for transactions carried out by means of
electronic data interchange and other means of electronic communication, commonly
referred to as "electronic commerce", which involve the use of alternatives to paper-
based methods of communication and storage of information, to facilitate electronic
filing of documents with the Government agencies and further to amend the Indian
Penal Code, the Indian Evidence Act, 1872, the Bankers' Books Evidence Act, 1891
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and the Reserve Bank of India Act, 1934 and for matters connected therewith or
incidental thereto
Money Laundering:
Bitcoins can be used for money laundering. The goal of a large number of criminal
activities is to generate profit for an individual or a group. Money laundering is the
processing of these criminal proceeds to disguise their illegal origin
The following point has the relevant provision of the prevention of money laundering
Act, 2002, which can be applied to crypto-currencies - Section 3 of the Act explains
the offence of money laundering as under: " Whosoever directly or indirectly attempts
to indulge or knowingly assists or knowingly is a party or is actually involved in any
process or activity connected with the proceeds of crime and projecting it as
untainted property shall be guilty of offence of money laundering." Here it talks about
proceeds of crime and not only money
PREVENTION OF MONEY LAUNDERING ACTS, 2002
An act to prevent money-laundering and to provide for confiscation of property
derived from, or involved in, money laundering and for matters connected there with
or incidental theyreto.
Tax Evasion:
Bitcoins are perfect for tax evasion. Unlike real currency, they are not controlled by a
central bank and they do not require banks and intermediaries for money transfer. So
it is very difficult for tax authorities to track such money. There are numerous ways to
make bitcoin transactions completely anonymous. This makes them suitable for the
purpose of tax evasion. There is no mechanism to make transactions in bitcoin report
the income to tax authorities.Charging tax for income made through Bitcoins can
solve this. If someone sells Bitcoins after keeping them for long period of time then he
should be charged capital gain tax. If anyone charges bitcoin for any service
rendered then he should pay income tax after converting them in Rupees.
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You cannot export goods from India and get paid in Bitcoin and keep your money
outside India. Payment of exports must repatriate in India in foreign exchange
through normal banking channels. The Foreign Exchange Management Act can place
this regulation.
THE FOREIGN EXCHANGE MANAGEMENT ACT, 1999
An Act to consolidate and amend the law relating to foreign exchange with the
objective of facilitating external trade and payments and for promoting the orderly
development and maintenance of foreign exchange market in India.
CONCLUSION
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Bitcoin has the potential to make a significant impact on the market only through
widespread acceptance. This may seem like an unlikely scenario because all the
countries use a non-digital form of currency. It would also have to depend on 3 main
significant factors:
Stability
Acceptance
Trust
Bitcoin has the potential to become a universally accepted virtual currency. Its about
high time, the countries start taking the use of Bitcoins seriously. This can only be
achieved by creating widespread awareness among the masses. The countries need to
introduce the use of digital currency in their legal and economic systems.
In conclusion we would like to state that Bitcoin offers a huge window of opportunity
for the evolution of financial systems in this Internet era, and act as a catalyst to
reshape the way businesses and individuals make transactions worldwide. To adopt
bitcoin or not is still open for debate.
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UnitedStates/Local%20Assets/Documents/FSI/us_fsi_BitcointheNewGoldRus
h_031814.pdf.Last accessed 21st July 2014.
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