Crypto a Digital Asset: A Legal Perspective

October 11, 2022by Chitwandeep Kaur0

Author – By Chitwandeep Kaur & Naman Jain (Intern)

 

INTRODUCTION

In the present time Crypto currencies has emerged as a person-to-person electronic payment system that allows online payments to be sent directly from one party to another, without the need for a financial institution. In traditional currencies, a central authority issues a currency that all parties are required by law to accept as payment. This makes the issued currency legal tender. Most of the cryptocurrencies are not backed by a sovereign guarantee and are therefore not considered a legal tender. For legal tender, transaction records are generally held centrally at financial institutions like Reserve Bank Of India; rather, cryptocurrency transactions are recorded and shared with all users on the network. Cryptocurrencies are used for payment if the recipient is willing to accept them, because their value fluctuates against other currencies, such as the US dollar, they are also traded. They are also used as utility tokens that grant their holder access to goods and services of a company.

 

CRYPTO A CURRENCY OR AN ASSET?

Money has three main characteristics: it is used as a unit of account, as an accepted medium of exchange, and as a store of value. In most countries, the money is issued by a government-backed authority (like RBI in India) and has a sovereign guarantee[1]. Entities authorized to hold funds and facilitate payments (such as banks, credit cards, and payment wallets) which are licensed by a government agency. This means that there is a centralized system regulated by the government to validate transactions and track the flow of money and keep the record of the same.

Crypto differs from this system in several aspects.  There are four basic characteristics of a crypto like bitcoin, they are only in digital format. Second, there is no central authority to validate and guarantee transactions. Instead, transactions are validated by other users and then securely stored.  Crypto is a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes[2].

Unlike a physical currency, a digital item is easy to copy, steal and transfer. Therefore, a digital currency has the inherent challenge of ensuring that there is no double payment with the same currency. Cryptocurrencies address this problem with the help of “blockchains”. All users of the system have access to the account balances of all other users (code names may be used to protect confidentiality). When a series of payments are made, they are grouped into a “block”. Other users verify the block by verifying that the person who made the payment had sufficient funds. The block is considered valid if all the transactions it contains are validated by the majority of users. At this point, the block is connected to the previous block using cryptography and is released into the system. A chain of such transaction blocks is called a blockchain.

Since this ledger is available and validated by all users, it is a form of distributed ledger technology (DLT). The cryptography method used makes it very difficult to modify transactions in a validated block. Furthermore, a change to one block will require changes to all subsequent blocks, an almost impossible task. Also, since multiple copies of the records are kept, it would be very difficult to manipulate them at the same time. These properties help maintain trust in the system.

INDIAN LAWS AND CRYPTO

Now as the law in India currently stands, a new provision (47A) is inserted into Section 2 of the Income Tax Act of 1961 to define the term “Virtual Digital Asset.” According to Section 2(47A), Virtual Digital Asset (VDA)[3] means––

(a) any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;

(b) a non-fungible token or any other token of similar nature, by whatever name called;

 

 

CRYPTO AS A SECURITY

Further in India virtual currencies like Bitcoin and Ether are unlikely to be subject to securities regulation as they cannot be called ‘security[4]’. The Securities Contracts (Regulation) Act of 1956 (SCRA) provides a non-exhaustive definition of securities and there is currently no regulatory guidance for its application in the context of virtual currencies. Virtual currencies are not included in the listed elements of the definition. Additionally, items covered by the definition derive their value from an underlying asset. However, virtual crypto like Bitcoin and Ether have no underlying assets. Instead, the value is determined solely on the basis of supply and demand. Furthermore, virtual currencies such as Bitcoin often do not have an identifiable issuer, contrary to elements of the definition of security under Indian law. Even taking into account the common meaning of the word “value”, the word is defined in Black’s Law Dictionary as an instrument that demonstrates a proprietor’s property rights in a business.

Virtual currencies, including Bitcoin and Ether, have no such ownership rights, credit relationships, or joint venture investments. Therefore, these virtual crypto are unlikely to be included in the definition of securities. However, some (but not all) tokens issued through Initial Coin Offerings (ICOs) may fall within the scope of SCRA if they are issued by an Indian entity and meet the above tests[5]. This is likely to be the case if they are issued by an identifiable issuer and backed by the issuer’s underlying assets. These tokens must be subject to regulation under the Companies Act 2013 (the Companies Act) (in relation to requirements surrounding the issuance and transfer of securities) and the SCRA (in relation to securities that cannot be listed only on recognized stock exchanges)

 

CONCLUSION

Crypto today do not do a good job at fulfilling the main functions of money or currency, they may be favored by some for ideological, technological or monetary policy reasons. Crypto may have some attributes in common with what we commonly refer to as money, but differ in many important aspects. While Crypto can be exchanged for items of value, they are not a commonly used means of exchange. They are accepted by some but not by all merchants or service providers, with such volatility they have a limited ability to act as a store of value, another important attribute of money, hence crypto assets will be taxed at 30 per cent and over and above that, there is a 1 per cent tax deduction at source which is also imposed on every transaction as crypto are no currency. Crypto has a long way to go before it is equivalent of money or security.

 

[1] https://main.sci.gov.in/supremecourt/2018/19230/19230_2018_4_1501_21151_Judgement_04-Mar-2020.pdf

[2] Glossary of the FATF Recommendations (updated on October 2018) available at https://www.fatf-gafi.org/glossary/u-z/ (Last accessed on 27-07-2022

[3] BILL No. 18 OF 2022 THE FINANCE BILL, 2022 (AS INTRODUCED IN LOK SABHA)  https://www.indiabudget.gov.in/doc/Finance_Bill.pdf accessed on, 29-07-20222

[4] Cryptocurrencies – An assessment (Keynote address delivered by Shri T Rabi Sankar, Deputy Governor, Reserve Bank of India – February 14th, 2022 – at the Indian Banks Association 17th Annual Banking Technology Conference and Awards) https://rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1196

[5] Writ Petition (Civil) No.528 of 2018 INTERNET AND MOBILE ASSOCIATION OF INDIA Versus Reserve Bank Of India https://main.sci.gov.in/supremecourt/2018/19230/19230_2018_4_1501_21151_Judgement_04-Mar-2020.pdf, accessed on 29-07-2022

 

 

Chitwandeep Kaur

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