Core Technical Concepts / Synopsis of the Industry : Crypto Currency (as at Jan 2021, India)
1. Prior to understanding what cryptocurrency (“cryptos”) are it is imperative to know the underlying technology that powers these cryptos – Blockchain Technology or the Distributed Ledger Technology (DLT)
2. Blockchain or DLT is a mechanism of storage data records in a manner that there is no central authority that controls it. Thereby all the nodes in the systems are responsible for storing some part of the data, which is an ingenious way of saving of data since owing to no central authority, there is no chance of central level corruption or distortion of data records at the central level. Such a system of data records has been considered by tech experts as immutable, non editable, non corruptible on which various use cases can be built. Example – supply chain systems, voting systems, educational records. Such records can then be verified by using a public private key encryption similar to what is currently used in India for digital signatures.
3. The records on a blockchain are maintained publicly on an explorer which is visible to all. Thereby a public blockchain system is visible publicly, however for masking of transaction the transaction details or transactions parties data may be hashed by using an algorithm called SHA256, which is nothing but a mechanism to convert any data whatsoever to a alphanumeric code, which throws same result each time the same input is inserted. No two results are identical.
4. As a use case for transfer of value from person to another, blockchain can be used to create crypto currencies, which are technically not currency, however they can be used in the tech world for acknowledgement of certain work done. Example – If A (person or a computer) does some work for B, then instead of paying in INR or any fiat currency, a value in terms of a token may be given, which is generally of use within a certain ecosystem. Say a bank may charge all bank fees in a token called XYZ and bank customers have to buy XYZ to settle bank charges fees, however such XYZ may also be used in receiving some credit card cash backs. So the XYZ token is a valid “value” that can be used within the ecosystem of a bank and thereby derives some value based on volume of transactions. Such token is then a crypto token, since it is backed by mathematical algorithm that no two token can have same id number, yet each token is of same value, just like the Rupee note.
5. Cryptos or crypto tokens are of two types : Utility and Security. Security Tokens are such which give the users a partial ownership right and Utility tokens are such which give the users just an access to the ecosystem. In loose terms, security tokens are like shares of a company, whereas utility token may give non ownership rights to use or trade an asset.
6. In 2009 a white paper appeared in the tech circle which gave birth to such a token called – Bitcoin. Which is not backed by any asset however could be used a value transfer from one person to another and each transaction could be recorded publicly on a explorer (a public ledger) in a hashed manner.
7. People started trading and using these tokens, and over time the value increased. Primarily as a hedge tool / store of value / non fiat transactions over internet especially for techies. From 2009 till 2014 there was marginal growth in value. Till another crypto coin called Ethereum was launched by a Russian Canadian tech developer called Vitalik Buterin. Ethereum is like google play store or apple store, which provided infrastructural solutions for tech developers to build their own decentralized apps within Ethereum ecosystem. The concept was a massive hit and prices of Ethereum soared in a matter of months, making Vitalik one of the youngest millionaires of the world.
8. There were no legal regulations about how to trade and use these tokens till now. And most of such tokens that were build on Ethereum were either self governed or were not transparent. Many failed, many are still doing well. However this caught the eye of the government around the world and some of them acted to bring in some notifications. Like RBI in India stated (notification still available on their website) that dealing in crypto currencies ( they called it virtual currencies) are risky and users shall be responsible for their own loss. Similarly other countries like US UK China Australia issued similar notifications.
9. Use cases of cryptos – However each crypto coin is made is through a mathematical process called ‘mining’ which is a process where computers compete with each other and whoever solves the problem first is able to win a reward in way of a new token which is minted or created. Each new token is then added to the existing chain of blocks of such tokens, creating the blockchain. Wherein each next block has a reference of the previous block, so no random person can edit or add to the chain. Obviously the longest chain is also the most trustworthy chain and all transactions are recorded in a public ledger called explorer. Each coin like Bitcoin or Ethereum have their own explorer and they are publicly verifiable.
10. Challenges to the government – By 2017 / 18 Government realized that people are able to exchange values or transfer value from one country to another by circumventing FEMA laws. In addition the biggest criticism of Cryptos is that they are not backed by any underlying asset, though in theory the value of the 'mining' cost is the underlying value. the Example – a person in Dubai is able to pay a person in HK in Bitcoins which is validly recorded over the explorer however it circumvents the Foreign exchange laws and there was no clarity on taxation as well. China then took initiative and realized that Chinese are able to ‘mine’ cryptos and sell it off in global market for gains. The government initially encouraged it but later when the people were not traceable they banned ‘mining’. Business slowly shifted to Hong Kong and from there to offshore countries like Malta / Estonia. Malta president rather welcomed crypto entities to their country but with a change in government things changed. He had promised regulation licenses but post the change in government not much has happened on ground. Estonia also offered such registration but there was not much from the government thereafter.
11. In India, in 2017 / 18 we observed the existing law and realized that there was no clear law that supported or opposed the use of cryptos. We then wrote 5 Right to Information application to know more about the government stance on the same. We have copies of RTI to MCA, Tax Department, GST Department, SEBI, RBI. Only RBi replied and stated that virtual currencies are not currencies and no one can issue currency other than government, however interestingly they stated that FEMA laws don’t apply to cryptos as such (