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Cryptocurrencies: How it works and why the Government is against it

With the IT department finding out over 6 lakh active cryptocurrency users, the Government is planning to bring in a law to regulate virtual currency.

Reliance Jio Infocomm has announced that it plans to create its own cryptocurrency called JioCoin. According to reports, Mukesh Ambani’s elder son, Akash Ambani, will lead a team of 50 young professionals who will work on the blockchain technology.

A matter of much debate and discussion, the year 2017 saw a rush in the number of people using and investing in cryptocurrency. A survey on trading of cryptocurrencies conducted by the Income Tax department has found out that there are six lakh active cryptocurrency users in the country, and cryptocurrency worth around Rs 17,800 crore has been traded on nine active cryptocurrency exchanges.

What is cryptocurrency:

A cryptocurrency is a form of digital or virtual currency which is exchanged over the internet and uses cryptography as a means of security. There is no central authority governing cryptocurrency, and hence, it is secretive and mostly immune to government interference. The money does not pass through a third party or a middleman and is a completely decentralised peer-to-peer payment system. While transactions and accounts can be traced, the owner accounts are usually not easily traceable.

Cryptocurrencies can be used to make payments, international transfers and transact online. With the value of bitcoin going up in recent years, some people even use it for investment purposes. A large number of individuals and even businesses have started using the digital currency, including retailers, restaurants, and even law firms. Many online websites also accept virtual currencies as payment.

Created by Satoshi Nakamoto on 31 October 2008, Bitcoin is the premier decentralised cryptocurrency. Nakamoto is actually a pseudonym and the real inventor’s or inventors’ identity is still contested. In the absence of a centralised authority, Bitcoin is policed by a large number of users called Bitcoin miners. These miners, who are located worldwide, use special computer programme and resources to solve highly complicated maths problems and get a certain number of bitcoins in exchange. They do this by verifying transactions and adding them to a public ledger, which is known as the blockchain, holding the transaction history of all bitcoins in circulation. These miners secure the network and ensure that everyone’s systems are synchronised together. New coins are released every ten minutes and are given to those miners who help accurately track the transactions and maintain the network.

While there are 1,384 cryptocurrencies apart from Bitcoin, some of the most popular currencies include:

Litecoin: The second cryptocurrency to be launched after Bitcoin, Litecoin was created in October 2011 by MIT graduate Charles Lee. When launched, the cryptocurrency was known as the ‘gold’ to Bitcoin’s ‘silver.’ Like Bitcoin, Litecoin is also generated by mining, however, the main difference is that the Litecoin network takes 2.5 minutes to generate a block, while Bitcoin takes 10 minutes.

Ethereum: Currently the second largest cryptocurrency, is an opensource software which is based on blockchain technology, much like Bitcoin. The cryptocurrency was launched by Russian Canadian programmer and writer, Vitalik Buterin in 2015, and enables users to use it as digital currency with no third party intervention. Following an attack on the decentralized Autonomous Organisation (DAO), an investor directed venture capital fund, Ethereum was split into a new version Ethereum, with the original continuing as Ethereum Classic. Ethereum’s value has jumped from around 10 USD in January 2017 to nearly USD 1,280 this year.

Zcash: Among the newest of the cryptocurrencies, launched in the latter half of 2016. According to the company website, if Bitcoin is the http of cryptocurrency, then Zcash is like the https – a decentralised and open-source cryptocurrency, which promises to provide extra security, much like https.

Ripple: This is both a cryptocurrency and a real-time digital payment network for financial transactions. Ripple’s cryptocurrency is labelled as XRP, while the digital payment platform is an open source, peer-to-peer, decentralised payment system that allows money to be transferred in any form – actual currency or cryptocurrency. XRP acts as a bridge currency between various cryptocurrencies enabling financial institutions to settle cross-border payments faster and cheaper.

Dash: Another open source peer-to-peer cryptocurrency, Dash is even more secretive than Bitcoin. Created and developed by Evan Duffield, DASH, which is a portmanteau for Digital Cash, works on a decentralised mastercode network. It is widely accepted by several web merchants worldwide.

The potential threats:

The Indian government has maintained the position that virtual currencies are not legal and that those who are trading in it are doing so at their own risks. The Government is also awaiting expert’s advice on shutting down cryptocurrency trading.  After the prices of Bitcoin soared in early December 2017, the RBI had also reiterated its warning against “users, holders and traders of Virtual Currencies (VCs) including Bitcoins regarding the potential economic, financial, operational, legal, customer protection and security related risks associated in dealing with such VCs.”

According to the RBI, the potential risks of trading in cryptocurrency such as Bitcoins are

Prone to malware and attacks: Since they are virtual currencies stored in digital/electronic media, they are more prone to attacks and losses that arise out of such attacks.

No centralized authority: Since cryptocurrencies are not governed by any central authority, payments are not regulated nor is there any authority to address any complaints that arise from trading in cryptocurrency.

Value based on speculation: Since there is no underlying asset for virtual currencies, their values are based purely on speculation. With huge volatility in the system, users are susceptible to huge losses.

Multiple jurisdictions with suspect legal status: Cryptocurrencies are being traded on platforms which are located in multiple jurisdictions where the legal status is unclear. This makes them more prone to fraud and trickier to trace.

Illegal activities: In the absence of regulatory authorities, virtual currencies are being used for money laundering and funding illegal activities.

Regulators across the world are becoming increasingly worried about the rising popularity of cryptocurrencies. South Korea’s Justice Minister Park Sang-ki had recently said that the justice ministry is preparing a bill to ban cryptocurrency trading. The announcement hit the cryptocurrency market, with prices of digital currencies, including bitcoin and ripple, dropping by nearly 20 percent between 5-12 January. With the country’s citizens protesting against such a move, the government announced on January 15, that the ban has not been finalised yet. Countries such as Vietnam, Indonesia, China and Russia are already mulling banning cryptocurrencies.