Decrypting Cryptocurrency

By Anmol Kaur Bawa, Symbiosis Law College, Pune.

Virtual Currency: the How and What

The modernistic approach to virtual currency often called “crypto”currency is the evolution of digital, intangible and computational currency which individuals can use for online purchases and in  a plethora of digital transactions. The flabbergasting concept as such has thrived,  on the notion of “trust” and “transparency”. Cryptocurrency embodies an electronic payment system based on “cryptographic proof” that shall encrypt the detailed history of all the transactions of a user, allowing the two parties in a random transaction to gain enough trust to transact directly without the need for the involvement of a third financial institute.

The main engine of this system is firstly the decentralized, peer-to-peer technology and secondly, the computationally stored data of irreversible transactions that has been the bone of contention between the supporters and critics of cryptocurrency. Peer to peer technology herein, refers to independent two-party movement of currencies from one account to another without going through a state recognised financial institution. Instead of the records of a Central Bank, the data of transactions and creation of new currency is stored in a network of computers not under the surveillance of the government but rather under the control of a private collective.

Cryptocurrency works on the basis of an anonymous Public Key and a Private Key. The public can see the amount that someone is sending to someone else, but under the garb of code numbers.

Anonymity: a boon or a burden?

The basic premise on which cryptocurrency has gained due popularity is the enticing feature of privacy from the government and the world at large. However, what the users of virtual currency overlook, are the multiple risks involved in such uncertain investments. Firstly, the researcher shall reiterate cryptocurrency to be an “uncertain” investment due to lack of centralised control and recognition as a legal tender.

Secondly, the special provisions of pseudonyms serves as a vulnerable platform for not only the old but the new investors as well, to be trapped in cases of money laundering, tax evasion and terrorist funded transactions.

Without State interference, the digital accounts of the users can easily fall prey to hackers committing theft involving several ways ,including hacking the hard drive of one’s computer, getting access to the user private key and by breaking the user private access key.

The third risk is stashing away of black money on the one hand and the failure to bring the digital wallets under tax-advantage retirement accounts on the other. The online transactions become a perfect medium to invest black money and since the government doesn’t keep any record of the assets, the State is unable to tax such hidden assets and the count of municipal bonds, partnerships and annuities remains unknown, in the anonymous currency exchanges. Thus, in such circumstances, the users lose out on the benefit of securing their retirement accounts from being taxed. While in the former case, the national treasury of a State is affected as huge amounts of assets remain unlevied.

Governments’ Approach: Who is Accountable?

The global response to the cryptographic payment system has been two-sided. The contention of not recognising cryptocurrency as a legal tender and the over-estimation of Initial Coin Offerings (ICO) leading to misrepresentation and cyber frauds has led to the banning of the virtual currency in China, Indonesia and Bangladesh. While in most of the European States, the question of accountability is upon the users, the only statement given out most of the times indicates “buyer beware”.

The U.S. approach to deal with cryptocurrency, however seems to bring the question of surveillance to a boil. The U.S. Security Exchange Commision has attempted to bring the Decentralised Authority Organisations (DAO) which provide the virtual  currency services under an experimental structure of regulation. This regulatory initiative is “simple agreements for future tokens” (SAFT). The proposed plan attempts to identify the cryptocurrency as a security by putting the Initial Coin offerings of a DAO under the Howey’s test.

In SEC v. Howey, the Supreme Court determined the elements constituting an investment contract, thereby recognising the assets invested as a “security”. According to which an “investment contract” shall consist of (1) investment of money (2) expectation of profits from the investment (3) investment of money in a common enterprise (4) any profit coming from a promoter or third party.

SEC, through SAFT, tries to put the agreement between the investor and the DAO under the legal framework of an “investment contract”, provided the nature of agreement complies with the essential of Howey’s test. If the ICO agreement passes the test, it shall be considered as an investment contract and the digital assets involved as a “security”. Thereafter, such “securities” shall easily be subject to certain disclosure and registration requirement under the Securities Act of 1933 and the Securities Exchange Act of 1934.

The researcher on this point shall applause the creative interpretation and implementation of the statutory laws to provide a solution to the decentralised digital transactions and increase accountability of the DAO (service providers). Further, the DAO is required to produce an “offering memorandum” which help retain crucial information about the DAO and the investor.

India’s Stance: Is there scope for adaptation?

The legal position of Cryptocurrency in India is under deliberation. The recent statement given by the Finance Minister, Arun Jaitley, in his budget speech, has given only a partial insight into the government’s approach.

However, the Reserve Bank of India is looking for an alternative to the unregulated “non-fiat” cryptocurrencies, especially with the daunting presence of Bitcoin in the digital market. A Cryptocurrency policy drafting is underway, as the government wants to use the blockchain technology but in a centralised and monitored fashion. The present scenario of deregulated digital currency transactions involves foreign exchanges, owing to the reason that the same provides global anonymity and the RBI currently doesn’t recognise cryptocurrency under its jurisdiction.

However, the Indian approach to the issue at hand is by way of policy regulations rather than an attempt to put DAOs under a statutory obligation as seen in the case of U.S. Till now, most of the DAOs have been following the Know Your Customer (KYC) guidelines so that they are soon recognised by the States. Several DAOs feel that confidentiality is instrumental in crowdfunding the currency. Regulatory collection of users information may lead to a repulsion to the initial coin offerings.

The Securities Contract (Regulation) Act, 1956 provides the definition of “securities” as shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate. There’s scope for broad interpretation here, as the nature of transaction between the DAO and the investors is on the lines of investment contract. The government should not find it unreasonable to consider the investment in virtual currency as an asset.

Moreover, the currently working Blockchain and Cryptocurrency Committee of India (BACC) is in talks with the investors for coming out with a course and certifications which help them comprehend whether the customer (investor) understands the concept and the investment product in its entirety.

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