Bitcoin (Cryptocurrency) is dangerous Investment option

A cryptocurrency is basically a virtual currency (VC). It is based on a cryptic algorithm / code (hence, the name cryptocurrency) which makes counterfeiting very difficult. The most important part about a VC is that no Government has issued it and hence it is not Fiat Money. It is a privately-issued currency which is entirely digital in nature. There are no paper notes or coins. Everything about it is digital. Further, it is based on blockchain technology, meaning that it is stored over a network of servers. Hence, it becomes difficult to say where exactly it is located. This also makes it very complicated for any Government to regulate VCs. This has been one of the sore points for the Indian Government. The fear that VCs would lead to money-laundering and financing of illegal activities is one of the key concerns associated with cryptocurrencies.

While dealing with VCs one should also know about Non-Fungible Tokens (NFTs). These are units of data stored on a blockchain ledger and certify a digital asset. NFTs are useful in establishing fractional ownership over assets such as digital art, fashion, movies, songs, photos, collectibles, gaming assets, etc. Each NFT has a unique identity which helps establish ownership over the asset. NFTs have even entered the contractual space. These NFTs could then be traded on a virtual exchange. These tokens carry an interest coupon and the amount raised from the token is given to the person creating the token, e.g., the basketball player. At the end of the maturity period, the token would be redeemed and they may or may not carry a profit-sharing in the revenues earned by the token creator. The payments for buying these tokens can also be made by using cryptocurrencies.

Why Do Bitcoins Have Value?

Any discussion about the value of Bitcoin must address the nature of currency. Gold was useful as currency due to its inherent physical attributes, but it was also cumbersome to extract from mines. Paper money was an improvement, but it requires manufacturing and storage and lacks the mobility of digital currencies. The digital evolution of money has moved away from physical attributes, and towards more functional characteristics.

Bitcoin does not have the backing of government authorities, nor does it have a system of intermediary banks to propagate its use. A decentralized network consisting of independent nodes is responsible for approving consensus-based transactions in the Bitcoin network. There is no fiat authority in the form of a government or other monetary authority to act as a counterparty risk and make lenders whole, so to speak, if a transaction goes awry. The main source of value for Bitcoin is its scarcity. The argument for Bitcoin's value is similar to that of gold, a commodity that shares characteristics with the cryptocurrency. The cryptocurrency is limited to a quantity of 21 million. Bitcoin's value is a function of this scarcity. As the supply diminishes, demand for cryptocurrency has increased. Investors are clamoring for a slice of the ever-increasing profit pie that results from trading its limited supply. Bitcoin also has limited utility like gold, the applications for which are mainly industrial. Another theory is that Bitcoin has intrinsic value based on the marginal cost of producing one bitcoin. Mining for bitcoins involves a great deal of electricity, and this imposes a real cost on miners. According to economic theory, in a competitive market among producers all making the same product, the selling price of that product will tend towards its marginal cost of production. Empirical evidence has shown that the price of a bitcoin tends to follow the cost of production. Bitcoin's utility as a store of value depends on how well it works as a medium of exchange. If Bitcoin does not achieve success as a medium of exchange, it will not be useful as a store of value. Throughout much of its history, speculative interest has been the primary driver of Bitcoin's value. Bitcoin has exhibited the characteristics of a bubble with drastic price run-ups and a craze of media attention. This is likely to decline as Bitcoin continues to see greater mainstream adoption, but the future is uncertain.

In recent times, there has been a great euphoria about investing in cryptocurrencies. Cryptocurrencies are neither a currency nor an investment. They need to be scrutinized.

Cryptocurrency basics

Ø Cryptocurrencies are virtual or digital exchanged by private individuals or groups.

Ø More than 2,000 cryptocurrencies are said to be existing; Bitcoin is the first and pre-eminent cryptocurrency to be used widely.

Ø Bitcoin was created by Satoshi Nakamoto, presumed pseudonym, in 2008 and released as open-source software in early 2009. The first Bitcoin transaction took place between him and an early adopter in January 2009.

Ø In 2010, the first sale of an item using Bitcoins took place when a customer used 10,000 Bitcoins to buy two pizzas.

Ø The years between 2012 and 2017 saw the Indian cryptocurrency market gaining a strong footing.

Ø India now has 15 homegrown cryptocurrency exchange platforms that enable trading and selling, with more than 1.5 crore users. At 10.07 crore, India also has the highest number of crypto owners in the world.

Ø Cryptocurrency investments in India increased from $923 million in April 2020 to a whopping $6.6 billion by May 2021, a growth of 400 per cent in one year.

In this day and age of unrelenting hype around cryptocurrency, it is easy to lose sight of some basic facts.

Cryptocurrencies is not a “currency” in any realistic sense of the word. For any instrument to classify as a currency, it must have the following features: (1) it is a promissory note wherein the issuer is promising the bearer or the holder a value. (2) It is backed by a sovereign nation and, therefore, there is never a question of any default in executing the promise and (3) the printing of currency in either physical or digital form is always based on some tangible asset, like gold or a basket of goods. Thus, it’s clear that cryptocurrency can never be a currency. Supreme Court noted that the word ‘currency’ is defined in section 2(h) of the Foreign Exchange Management Act, 1999 to include ‘all currency notes, postal notes, postal orders, money orders, cheques, drafts, travellers’ cheques, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments as may be notified by the RBI. The expression ‘currency notes’ was also defined in FEMA to mean and include cash in the form of coins and banknotes. Again, FEMA defined ‘Indian currency’ to mean currency which was expressed or drawn in Indian rupees. It also observed that the RBI had taken a stand that VCs did not fit into the definition of the expression ‘currency’ under section 2(h) of FEMA, despite the fact that the Financial Action Task Force (FATF) in its Report defined virtual currency to mean a ‘digital representation of value that can be digitally traded and functions as (1) a medium of exchange; and / or (2) a unit of account; and / or (3) a store of value, but does not have legal tender status.’ According to this Report, legal tender status is acquired only when it is accepted as a valid and legal offer of payment when tendered to a creditor. Government does not consider cryptocurrencies legal tender or coin and will take all measures to eliminate use of these crypto-assets in financing illegitimate activities or as part of the payment system.

Cryptocurrencies is not even an asset. An asset is something that has a tangible value. Even if its immediate utility is intangible, an asset should have some tangible benefits. The cryptocurrencies being promoted currently bitcoin, Litecoin, Ethereum etc. are nothing but gaming points. Whenever a discussion on crypto takes place, promoters talk of blockchain technology. This technology is just a technique to account for transactions and has nothing to do with cryptocurrencies, except that the cryptocurrencies’ digital exchange is being maintained in blockchain format. Hence, the points which are earned through a gaming application are stored and transferred through blockchain technology. However absurd it may seem, even the points earned in a game of ludo can be presented as cryptocurrency if they are stored and sold by blockchain technology by the person monetising these points. Thus, cryptocurrencies have absolutely no value and cannot be considered an asset.

Much of what passes for crypto is actually criminal activity. These are frauds like multi-marketing schemes, chit funds or deposit frauds. These schemes were disguised as timeshare schemes, gold and land investments, and promised hefty returns. These pyramid schemes were carried out over a long period to evade the law as fraud could still be established, the trail of funds could be traced and the perpetrators identified.

Did RBI have power to regulate VCs?

The Apex Court observed that once it was accepted that some institutions accept virtual currencies as valid payments for the purchase of goods and services, there was no escape from the conclusion that the users and traders of virtual currencies carried on an activity that fell squarely within the purview of the Reserve Bank of India. The statutory obligations that the RBI had, as a central bank, were (i) to operate the currency and credit system, (ii) to regulate the financial system, and (iii) to ensure the payment system of the country to be on track, and would compel them naturally to address all issues that are perceived as potential risks to the monetary, currency, payment, credit and financial systems of the country. If an intangible property could act under certain circumstances as money then RBI could definitely take note of it and deal with it. Hence, it was not possible to accept the contention that cryptocurrency was an activity over which RBI had no power statutorily. Hence, the Apex Court held that the RBI has the requisite power to regulate or prohibit an activity of this nature. The contention that the RBI was conferred only with the power to regulate, but not to prohibit, did not appeal to the Court and thus, the RBI had the power to regulate and prohibit VCs.

Can LRS be used for investing in Cryptocurrencies?

The Liberalised Remittance Scheme or LRS is a Scheme of the RBI under which any individual resident in India can remit abroad up to US $250,000 per financial year for permissible capital and current account transactions. The million-dollar question is can the LRS be used for buying foreign crypto assets such as Bitcoins, Dogecoins? Alternatively, can a resident carry out a crypto arbitrage, i.e., buy cryptocurrencies from abroad and sell them in India? This is an issue on which there is no express prohibition under the LRS and there is more confusion than clarity. In May, 2007, the RBI clarified that remittances under the LRS were allowed only in respect of permissible current or capital account transactions. However, in June, 2015 the RBI introduced a novel concept of defining the permissible capital account transactions for an individual under the LRS. One may consider whether VCs can be considered to be securities and, hence, permissible under the LRS as an investment in securities. FEMA defines a security to mean shares, stocks, bonds and debentures. VCs are not shares, stocks, bonds, debentures, Government securities, savings certificates, deposit receipts in respect of deposits of securities or units of any mutual fund. Hence, it is not possible to contend that purchase of VCs from abroad tantamounts to an investment in securities.

Crypto promoters have taken fraud to another level with a little scope of their getting caught as there is nothing that anyone is promising as persons releasing the game or the equation from which bitcoins or cryptocurrencies are to be mined and the exchanges through which these points (cryptocurrencies) are traded. These so-called cryptocurrencies have acceptability only as long as they are linked to the normal currency of a country. Unfortunately, millions are falling for this fraud globally. Criminals, particularly drug syndicates, will simply use the garb of crypto to siphon and launder their illegal proceeds.

RBI has flagged of the issue and the government is bringing out a bill to ban and regulate transactions in cryptocurrencies.

The recent aggressive promotion of cryptocurrencies on print and visual media would perhaps prove to be the undoing of their promoters. It is only a matter of time before financial fraud prevention enforcement agencies like the CBI and ED catch up with them. However, millions may lose their hard-earned money by then. If substantial profits fall within the realm of possibility, so are the chances of huge losses and fraud in cryptocurrency trading — and there is no regulatory authority the investor can turn to, for now. The risk is entirely his or hers. A capital gains tax of 30 %, however, will be levied on the profits made.

Driving the robust growth are young Indians; those aged below 35, in fact, form the core of the investors in popular cryptocurrency exchanges.

In spite of the above regulatory heat, the popularity of VCs and crypto exchanges is growing by the day and a crypto exchange has now even entered the Unicorn club.

It’s the lure of fast money that attracted many youths in to this dangerous game. Dogecoin, which started with barely a few cents, rose 300 to 400 %. Bitcoin, too, reached levels hitherto unheard of. Since in this open market trading takes place 24x7, there have been times when these youth would get up in the middle of the night to check out the developments and they would have incurred substantial losses during weekend when normal financial markets are closed. It is a very volatile market which depends entirely on demand and supply, he points out. At present, there is a bull run. This is likely to continue over the next few months, but correction will come. Fascinated by huge profits and looking for ways to beat pandemic boredom, youngsters are buying cryptocurrency and quickly getting acquainted with market ups and downs.

Social media has also played a big role in creating hype around blockchain technologies and cryptocurrencies. In fact, concepts like blockchain technology and cryptocurrency are not easy to understand, there are YouTube videos, blogging sites, webinars, chat rooms and slack channels educating potential customers. Then there are social community groups on WhatsApp, Facebook, Twitter and Telegram, offering tips on research and investment. Serial tech entrepreneurs and angel investors who has been observing the market for the past five years, feels that getting celebrities to promote it gives credibility and legitimacy to this risky venture and youngsters feel it is cool to invest in it. Recently, tweets by powerful people are changing the coin value. The made-for-fun token coin Shiba Inu increased by more than 55 % within 24 hours of a tweet by Tesla CEO Elon Musk. As of now, the market is going in one direction, but we’ll know the actual figures only after the correction comes. Since very little is yet known about this market, chances of people falling prey to illegal transactions and frauds is quite high. Investors should be cautious of the blanket of risks that come clad in the speculative crypto market, which is less than a decade old. They should not invest what they cannot afford to lose.

Risks factors

1. Absence of government regulations: A Bill on cryptocurrency has already been submitted before the Union Cabinet. RBI has issued formal warnings.

2. Virtual theft: Despite a highly safe alphanumeric number that changes with each transaction, cryptocurrencies run the risk of virtual theft from hackers.

3. High volatility: Cryptocurrencies are highly rewarding investments, but there can be extreme price changes due to the fluctuating demand and supply.

Conclusions: The world of cryptocurrencies is of high reward but carries high regulatory risk. This is due to the fact that there are a lot of uncertainties and unknown factors coupled with the apparently hostile attitude of the RBI and the Government towards VCs. People transacting in them should do so with full knowledge of the underlying issues that could arise. The famous Latin maxim ‘Caveat Emptor’ or ‘Buyer Beware’ squarely applies to all transactions involving virtual currencies!

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