Bitcoin

Bitcoin is a piece of digital code which is also used by people as currency. It was started in 2009 by Satoshi Nakamoto, whose real identity is still shrouded in mystery. The maximum number of bitcoins that can be created is limited to ~21 million.

How can one get bitcoins?

  • Mining: Bitcoins are hidden in data blocks created by Satoshi and spread across the internet. They can be mined by solving these data blocks using special computer software. Solving one data block fetches 25 Bitcoins currently.
  • Exchange: If someone doesn’t know how to mine bitcoins, he can buy them from a person/company who has already mined them. They can be bought at the prevailing exchange rate. Special websites called “Bitcoin exchanges” have come up for such buying/selling of bitcoins. One can also get bitcoins by providing goods or services to another person who already has bitcoins and is ready to pay in them.

Where are bitcoins stored?

Bitcoins are stored in digital wallets or e-wallets. These wallets are basically client software installed on computers, mobile phones or other devices. A person can access his digital wallet by typing a unique public address like “Hhfot2191u4810fjkljfk99849” and transfer bitcoins to another person’s digital wallet.

Benefits of bitcoin over fiat money

Fiat money is defined as any money that is declared by government to be legal tender. Rupee, dollar, euro are examples of fiat money. Bitcoins have various benefits as well as disadvantages over fiat money, the disadvantages being mainly because of their negligible recognition and acceptability presently. The various advantages that bitcoins present over fiat money are:

Low transaction costs

There is virtually zero transaction cost of Bitcoins when compared to a transaction over the internet of same amount in foreign currency. Thus, tea growers in Assam are planning to export tea to foreign countries in return for payment in Bitcoins as they currently have to pay a substantial amount in fees to payment intermediaries like PayPal.

High divisibility

The lowest denomination of bitcoin is 0.0000001 (10-8) bitcoin, also called 1 Satoshi. Thus, it is possible to divide bitcoin in many small parts and even if there is a shortage of Bitcoins in future, they can be used as mode of payment if they adjust their value at a lower level than the current bitcoin-dollar exchange rate. For example, if today the rate of 1 laptop = 1 bitcoin, it is possible that in future the rate of laptop may adjust itself to 1 laptop = say 0.00165 bitcoins, if there is shortage of bitcoins.

Smarter contracts

Bitcoins can enable ‘smarter’ contracts because of computer programming. We can have conditional-scripting capabilities. E.g. If Event X happens, pay “Y” an amount of “Z” Bitcoins at a particular “HH:MM:SS” time from the digital wallet.

Account keeping easier and more accurate

Since all transactions are digital in nature, there is no need to manually enter any records in paper account books. Software which automatically calculates income, expenses, tax, assets, liabilities, etc. could be used to keep accounts. Hence, there would be more efficiency in account-keeping, less chances of mistake and less harm to environment due to lesser use of paper.

Durability more than paper currency

Paper currency is less durable as it can be burnt or torn apart. On the other hand, bitcoin being a digital code is infinitely more durable than paper currency, unless someone shuts down the entire internet.

Harder to counterfeit than paper currency

Since bitcoins are created by crypto-currency mathematical algorithm, they are much harder to counterfeit than paper currency.

Disadvantages of bitcoins over fiat money

Very less acceptability

Only a miniscule number of goods and service providers accept payment in Bitcoins currently. Even financial intermediaries do not accept savings or investments in shares, bonds, etc. in bitcoins. Therefore, a person cannot expect to buy his daily necessities like vegetables, milk, or pay his mobile bill, etc. in Bitcoins.

Highly fluctuating value of bitcoins

The value of bitcoin in the first week of Dec was 1 Bitcoin = 1200$, where as in the 3rd week of Dec it came down to 1 Bitcoin = 580$. Thus a person wanting to pay for his daily expenses only in bitcoins can see a substantial portion of his wealth lost in a very small time, unless the prices of all goods and services also decrease with the fall in exchange rate of bitcoin

Less cognizability

Even illiterate people can recognize and differentiate between different currency notes based on their colour, dimension, etc. However, it is virtually impossible for illiterate people to recognize a bitcoin. Even a literate person would need a computer, special software and internet connection to recognize and use bitcoin

Owing to the above limitations of bitcoin, it is a less reliable “medium of exchange” as compared to fiat money. However, in the future with increasing awareness about bitcoins and higher acceptability among governments and goods/service providers, it is possible that it might become a more acceptable and widespread medium of exchange

Potential adverse effects of its use on the economy and security of a nation and world in general

Black markets

News has often come out in recent years that bitcoins are accepted by people selling illegal goods and services like drugs, arms or by online gambling websites. In fact, it has been estimated that in 2013, more than half of all bitcoin transactions were used in the trading of illegal substances. Thus, bitcoins provide terrorists an alternative way of buying arms and weapons thus endangering the security of nations.

Money laundering

Some regulators and law enforcement agencies have raised apprehensions of bitcoins being used for money laundering.

Unauthorized mining

In 2011, cases of botnets engaged in covert mining of bitcoins were detected. E-Sports Entertainment in USA was accused of hijacking 14000 computers to mine bitcoins. The case was settled later with the company penalized heftily for the crime

Jobs in bitcoin mining companies and bitcoin exchanges

Companies which mine bitcoins can create more jobs for software professionals, but this creation of jobs is very small at present as there are very few bitcoin mining companies and exchanges.

Thus, at present, the macro effect on the economy of using bitcoins as a form of money is negligible as their use is extremely negligible now. However, as seen above, the anonymity it renders to a transaction has the potential to encourage illegal activities which also pose threats to security of nations, such as illegal trade in arms, money laundering, etc.

Current status of Bitcoins in India and legal and regulatory issues surrounding it

There are several bitcoin exchanges that have opened up in India and bitcoins are gaining rapid acceptability within India as a form of payment for buying goods and services. However, even then the recognition and acceptance of bitcoins in absolute terms is still very small.

According to international legal and taxation expert Nishith Desai, bitcoins per se are not illegal in India, but how one deals with them may be a matter of legality.

  • For goods exported from India, payment cannot be received in bitcoins if they are parked outside.
  • Proceeds of exports must be repatriated to India in terms of foreign exchange through normal banking channels.
  • Also, if Bitcoins are sold for a price in terms of ‘money’, the Sale of Goods Act would apply but accepting Bitcoins against goods should not attract the provisions of Sale of Goods Act. Also, provisions of Foreign Exchange Management Act (FEMA) would not be triggered if the transaction is intra-India.
  • Apart from this, if someone buys bitcoins and keeps them for a long time, then sells them and gets a profit, he should pay capital gains tax. If someone accepts Bitcoins for service rendered, he should pay the applicable income tax after converting Bitcoins into rupees.

However, RBI recently issued a public advisory against the use of bitcoins. It said that creation, trading or usage of virtual currencies like Bitcoins as a medium of payment is not authorized by any central bank or monetary authority.  And since no regulatory approvals, registration and authorization is stated to have been obtained by such entities for carrying on their activities, they may pose several risks to their users.

The Enforcement Directorate also raided a few bitcoin trading platforms recently. Besides, Income Tax officials visited a Karnataka based bitcoin mining company to look for possible cases of tax evasion and collect information on how the anti-money laundering  and income tax laws could be applied to the digital currency community at large.

These actions taken by RBI and ED have sent tremors down the spine of Bitcoin community in India. Their primary fear is that there are still no official regulations on how companies engaged in dealing with virtual currencies like Bitcoin should comply with anti-money laundering and financial laws. Also, such actions by the government has prompted the bitcoin community to form a trade and lobbying association called Bitcoin Alliance India (BAI), that will attempt to be the voice of bitcoin in India.

Current legal status of bitcoins in various jurisdictions

Possessing bitcoins is not illegal in most jurisdictions in the world, including India and USA. However, recently the People’s Bank of China issued a notice stating that “bitcoin does not have the same legal status as that of currency and cannot and should not be used as currency in circulation in the market.” Thus Chinese financial intermediaries and businessmen are officially prohibited from accepting bitcoins.

Future of Bitcoins

The future of bitcoins, as regards its wide spread use as a form of money, is still very uncertain. There are chances that it would gain recognition and acceptability in developed countries much faster than in developing or Least Developed Countries (LDCs) as there is a high penetration of computer and internet in advanced countries. Also, for businesses to accept bitcoins as payment for the goods and services they render, the value of bitcoins would have to be stable as opposed to its highly fluctuating nature now. Also, a majority of consumers and businesses would start transacting in bitcoins only when their respective governments or central banks come out with laws and regulatory procedures guiding the use of bitcoins.

Also, since the total number of bitcoins that can be created is limited to ~21 million at present, it is difficult to see how they could completely replace fiat money. Thus, a more realistic scenario in future could be where both bitcoins and fiat money are used side by side, with bitcoins used mainly to pay people or businesses who can afford to have digital wallet to accept bitcoins in the first place, and fiat money used to pay for basic goods and services such as vegetables, milk, fruits, labourers, etc.

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