Layman’s Understanding of Bitcoin

Before the public want to respond to the request for the Government of India for an opinion on regulation of Bitcoins/Virtual currencies, there is need for us to understand clearly the nature of Bitcoins and why it is popular and why it is desirable or undesirable.

There are many technical guide to the Bitcoin which is one of the types of what is called a “Crypto Currency”. There are more than 766 other Crypto Currencies in the market and the number is growing by the day. Bitcoin is the most popular and is today quoted at over US$ 2100 and hence attracts special attention.

The Finance Ministry in its communication has also used a term “Virtual Currency”. I prefer to call the Bitcoin more as a Crypto Currency since today “Virtual Currency” can apply to any currency held in virtual form. For example, Rs 100 I have kept in Phone Pe is virtual currency for me. I can use it for a virtual transaction and I may not be able to credit it to my Bank account and withdraw. I may have a mobile recharge balance which I can share with my friend as if I have withdrawn money from my Bank account and paid to my friend. This system works like a currency and hence can be considered as “Virtual Currency”.

Hence the term Virtual Currency is more generic and is inappropriate to the context of Bitcoin regulation. “Crypto Coin” is a better term to use in this context since it represents not only the Bitcoin but also other 765 plus Crypto coins which work on similar technology using the Block Chain technology base without any  regulation from a statutory regulator of a sovereign country.

However, “Crypto Coin” is a “Technology” and it can be used both by the general population without any regulatory control of a sovereign Government as well as under the control of a sovereign Government.

Amongst the available Crypto coins, Bitcoin and a few others have acquired notoriety because they have established themselves as the “Currency of Terrorists”. (COTs) With the current adverse attention, I presume that the terrorists are spreading their Bitcoin wealth by converting it to other currencies also and hence there are many popular Crypto Currencies that can be called “COT”s .

Any ransomware attack (which is to be classified as a Terror activity) in which a particular Crypto Currency is mentioned as the means of payment should be treated as a potential COT.

Additionally we can for the purpose of debate and regulation consider the possibility of a “Currency of Terrorist” being partly rendered as “Sanitized Currency of Terrorists” (SCOT) which can be trusted and used.

The appropriate classification to discuss is

a) “Virtual Currency” (VC) which is a digital form of legacy currency

b) “Crypto Currency” (CC) which is a form of recognized payment system in which an Electronic Coupon is created with the use of a cryptographic use such as hash process or digital signature process

c) Currency of Terrorists (COT) of which  Bitcoin is one

d) Potential Currency of Terrorists (PCOT) which is flagged for being declared as a COT if certain minimum criteria is fulfilled.

e) Sanitized currency of terrorists (SCOT) which is a part of COT that has an established clean track record for which a process can be established.

The Government has raised two important queries namely

  1. Whether Virtual Currencies should be banned, regulated or observed?
  2. If VCs are to be regulated what measures are to be taken for consumer protection, promote orderly development etc

We presume that in this query, Government has used the term VCs as “Crypto Currencies” of the Bitcoin type. In our classification we have used the term VC to current versions of digital currencies for which a regulation is already in place. Hence the term VC used in the Government communication could be applied to the other four categories of Bitcoin like systems namely the CCs, COTs, PCOTs and SCOTs.

We can discuss the need for regulation or banning for all these four types of systems.

In our opinion “Banning” is also part of “Regulation” and “Regulation” includes “Banning”. Hence we shall look at “Regulation of CCs” as inclusive of “Banning of VCs” that the Government has raised.

Also the suggested classification of CCs as COTs, PCOTs and SCOTs is also part of the regulation and hence they are considered together.

Before we proceed, let us also be clear on some basic aspects of Bitcoin which represents a unique technology which is of course fascinating by answering in simple terms some questions. These answers may be technically incomplete but have been so expressed for simplicity. (If any experts consider this as misleading, they may kindly suggest modifications”.

1.What is Bitcoin?

Bitcoin is an electronic document which says that “So and So” is the owner of 1 Bitcoin. It is like a public declaration of ownership. The “So and So” is mentioned not as a name but as a “Hash Value”… a number that identifies Bitcoin wallet of the owner.  The entire electronic document itself is digitally signed and has an identity in the form of a hash value. In effect it is like saying that Hash value X belongs to Hash value Y, where X is the BITCOIN identity and Y is the OWNER identity.

The Bitcoin wallet is held with a service provider just like the other digital wallets and is registered to an email address and/or a mobile. The wallet itself will have an anonymized ID.

2. What is the Mining Process?

A bitcoin transaction when it occurs is broadcast to the public through a network and is recorded by individuals. The individuals then process the transactions on certain rules.

The rules require that the transactions during the immediate past have to be listed showing the seller, buyer and the number of BTC (Or its sub units which may be called centi bits, milli bits etc upto the lowest satoshi which is 10 to the power -8 of 1 BTC or 1 in 100 million parts. It may roughly be 1 in 30 parts of a paise).

The transaction record should include some header information such as the identity of the previous set of records taken on record, the hash identity of the recorder etc and finally a “Random number” (called the nonce).

After creating the record a hash value of the entire record is calculated. This hash value has to be lower than a present minimum value. If not, the Nonce value has to be changed and hash value re-calculated. When this exercise is successfully completed, the set of recorded transactions constitute a “Block” and is broadcast as a successful block creation and is added to the previous block chain. The successful creator of the block is rewarded with free Bitcoins and this process is called “Mining”.

The creation of a successful block chain is therefore considered as “Solving a mathematical puzzle” and it requires millions of random attempts using the computer resource of adding a nonce value and calculating the hash, changing the nonce value and recalculating the hash value until the right hash value is arrived at for the block and broadcast. The new Bitcoins issued is a reward for being the first in the crowd to solve the puzzle. Currently 12.5 new Bitcoins are issued for every successful block creation that gets added to the Chain and confirmed by others.

Thus “Mining” is creating “bitcoins” through the use of computers and has no illegality in it.

3. What is a Bitcoin Exchange:

Currently the resources required to create these Bitcoins is considered too high and hence there is a large secondary market of buying and selling of Bitcoins through an Exchange. The prices may vary like any other stock price. Sellers and Buyers may come from different unidentified locations and the transaction may be settled in foreign exchange. Sellers or buyers may be criminals and the transaction may be a money laundering transaction.

The illegality of Bitcoins come through this process.

Since under law except “Negotiable Instruments” no other commodity or instrument can be transferred from one person to another free of defects in the title of the transferor, once a Bitcoin stock gets tainted, it remains tainted for .life. This is the essential difference between Bitcoin as a document and Cheques, Promissory notes, Bill of Exchange.

4. Why is Bitcoin called a “Currency”

Bitcoins can be mined and bought in an exchange and held as an investment. It can also be used for buying some other services or products if the service provider or the seller of the product is prepared to accept payment in Bitcoins instead of Rupees, Dollars or any other form. If more and more persons are freely willing to accept Bitcoins, then it becomes very much like a currency.

However, in the case of a conventional currency there is a Government which says that it guarantees its value. In the case of Bitcoins, there is no such guarantee.

5. Is Bitcoin Buying a Profitable Investment?

The value of Bitcoins is today around US$ 2000 plus in exchanges and it has given good investment returns to those who invested in it earlier. But will it continue in future?… No Body can answer. In a Ponzi Scheme, the early entrants make money at the expense of late comers. The same thing can happen in Bitcoins.

The reason the value of Bitcoins appreciate naturally is because the total stock of Bitcoins in the world is limited by the mining algorithm and progressively, the effort required for mining keeps increasing. Hence the “Cost of Mining” keeps increasing and makes the future value higher and higher apart from other speculative reasons.

If the demand for Bitcoins increase because WannaCry ransomware wants the victims to buy and pay by Bitcoins, then the value has to jump up. If Indian Government tomorrow announces that Indian Citizens cannot hold Bitcoins legally, then the value may drop.

Bitcoin is therefore a highly speculative proposition. If tomorrow the system is banned in most countries, the value will vanish into thin air.

6. What sustains Bitcoins

The general rule in the society is that majority of people often decide what is accepted as a law unless an authority comes in to change it.

The belief that Bitcoin cannot be banned is that there is a very large holding of Bitcoins in the world as of now, and hence it would be difficult to ban the Bitcoin.

Many Governments including China and Probably Japan have themselves mined and otherwise bought Bitcoins at low prices and are therefore supportive of retaining the global recognition of Bitcoins so that they can exercise a higher influence on global economy. (This is like insider trading in Stocks).

Indian Government may not currently have a stock of Bitcoins and if it accepts the system now, it will start with a very low market share of the total Bitcoin wealth in the globe.

Hence any regulatory measure should keep in mind that there is an economic consideration to either legalizing it or not.

An easy to understand example is that If a large number of people in Kashmir support terrorism and indiscriminate killing of Non Muslims,  then terrorism gets redefined as “Freedom Struggle”. The difference is thin and guided by the majority opinion. If the Kashmir Hindu population is slowly eliminated, then the balance can only tilt in favour of today’s terrorists.

Similarly, if a large number of population want to use Bitcoins for transactions which is anonymous because they can keep their black money in the form of Bitcoins, then there will be value to Bitcoin as a “Currency” and there will be popular support. There are a large number of such Black money supporters in the Government, Politician Circles and even among the public. Many of them might have converted their Black money after November 8, 2016 into Bitcoins. Even now, if the Bitcoin exchanges in India distribute one Bitcoin each to all our politicians and bureaucrats of relevance, then there will be so much support for Bitcoins that it will be legalized.

Hence Bitcoin popularity may be sustained by various illegal means and this itself is a cause of worry for honest citizens. When Citizens express their opinion on the regulation, they have to keep this in mind.

(…Discussions will continue… send me your comments or queries)

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About Vijayashankar Na

Naavi is a veteran Cyber Law specialist in India and is presently working from Bangalore as an Information Assurance Consultant. Pioneered concepts such as ITA 2008 compliance, Naavi is also the founder of Cyber Law College, a virtual Cyber Law Education institution. He now has been focusing on the projects such as Secure Digital India and Cyber Insurance
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