Bitcoins and laxmicoins: Legal or not?

The rising ubiquity of the bitcoin, the decentralised digital currency , in online transactions and its trickle into brick-and-mortar commerce has made businesses, investors, banks and regulators across the world sit up and take notice.

Although it has no instrinsic value, speculation is rife, leading to volatility and meteoric rises (one bitcoin was equivalent to US $1,300 in the first week of December).

In India, too, bitcoin usage is gaining traction, with reports stating that there may be close to 50,000 users in the country. With an estimated 70 virtual currencies established across the world and the increasing enthusiasm for bitcoins in India, an Indian virtual currency called Laxmicoin was all set for launch.

But the Reserve Bank of India (RBI) seems to have put a damper on things with its recent press release cautioning against the use of virtual currencies. Since then, a number of bitcoin operators have shut shop. The launch of Laxmicoin has also been postponed, and its makers have sought clarification from the RBI.

Although the central bank has not established any regulatory framework applicable to bitcoins, it has repeatedly stated that it is examining the issue.

The RBI's caution stems from various issues, including security concerns, illicit use, volatility and the lack of a governing authority. The very nature of the the bitcoin itself is a matter of debate.

Laws around virtual currencies are still evolving as the world comes to grips with the digital economy and challenges of taxation, foreign exchange and securities regulation, and cybercrime.

The anonymity and ease of carrying out cross-border transactions appear to enable circumvention of legal restrictions on foreign exchange transactions and money-laundering. Further, advances in technology have even enabled the creation of counterfeit bitcoins and unauthorised bitcoin mining.

Despite all these concerns being widespread across the world, some governments have recognised bitcoins. In the US, virtual currency exchanges and money transmitting businesses are regulated by way of mandating registration and anti-money-laundering compliances. A US court also recently held that bitcoins were currency, and bitcoin-related investments were in the nature of securities. In Europe, an EC directive stating that only banking or regulated entities can issue virtual currency suggests the inference that bitcoins aren't currency.  In the UK, bitcoins have been treated as vouchers and taxed with VAT, though this position is being reviewed. However, stricter positions are also being taken. China has recently banned financial institutions from trading in bitcoins.

Under the current Indian regulatory framework, it is arguable whether the bitcoin falls within the meaning of the term 'currency' or 'security', and therefore may go unregulated by either the RBI or the Securities and Exchange Board of India . This is significant, since transactions that bitcoins enable - transfer of funds abroad, investments (including speculation and Ponzi schemes) and the potential to purchase illegal commodities - are exactly the kinds of activities that India's regulators would seek to restrict. A case could be made that bitcoins are regulated under the Payment and Settlement Systems Act, 2007, but there seem to be no steps for such enforcement.

On the whole, though, bitcoins remain a grey area, and if bitcoin usage continues to ramp up as it has in the past few years, changes will be required to financial, securities, investment and consumer laws. However, regulating the Internet is notoriously difficult and historically, the law has always been outpaced significantly by great leaps in technology.

With uncertainty regarding the legal framework and potential for misuse, it would be wise to temper the enthusiasm for bitcoins and tread carefully, so as not to fall afoul of the law.

Sujjain Talwar is a partner and Aakanksha Joshi is a senior associate at Economic Laws Practice. The above article does not constitute legal advice.