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The RBI advisory of 24th December 2013 has set an agenda for the Bitcoin community as to the future of Bitcoin industry in India.

The advisory was fine as far as the public was concerned since it was the duty of RBI to warn the  individual investors about the FEMA risk and the volatility risk involved in buying or selling Bitcoins.

The advisory was completely silent on the “Miners”.

The advisory was some what negative on the business entities since it hinted at a possible review of the guidelines in future.

When the advisory was followed by the ED action on two of the Ahmedabad based traders, the Advisory assumed a more threatening meaning.

The statement of the Dy.Governor of RBI, Mr K.C.Chakravarthy in Coimbatore in which he has assured that RBI is not having intentions of regulating the Bitcoins at present has eased the situation to some extent.

However, if any businessman wants to invest a couple of lakhs or more on setting up a high end mining facility or for developing a trading platform or for a VC to consider financing such ventures, the current vagueness in the RBI’s policy is not acceptable. They would like to have a more categorical statement from RBI that they consider Bitcoins as outside the laws applicable to the currencies in India either under the RBI act or Indian coinage act or Payment and Settlement act. Similarly SEBI needs to clarify that trading of Bitcoins and other crypto coins is outside its regulatory area.

At this point of time if a clarification is sought, it is unlikely that either RBI or SEBI will commit on either the acceptability or non acceptability of the cryptocoin system or its exchange platforms.

Also the industry need to always keep a watch on “Retrospective Legislation” and other players like the Income Tax authorities suddenly springing a surprise and pushing a business to the brink of a collapse.

The industry should therefore pursue its efforts to extract a clear mandatory guideline from RBI, SEBI and Income Tax authorities on how they would deal with Cryptocoins in the future.

If the guideline is considered unfair it would be necessary for the industry to approach the appropriate courts in India to seek a clarification on

a) whether the guidelines are within the powers of RBI,

b)Whether they are not an infringement of the Constitutional rights of Indians and

c) Whether they infringe on the Human Rights in general.

Such a judicial clarification is essential for the industry to raise necessary finance and  would also be good for RBI and other institutions to resolve the issue without executive responsibility.

Even while the process of getting such clarification is on, the industry can move proactively to cause the setting up of  a “Regulatory Body” and start addressing the issues raised by RBI in its advisory. This will pave the way for a favourable response from RBI when it considers responding to any query on clarifications.

If we analyse the RBI advisory then the following action points may be required.

1. Security Concerns: The web platforms that provide services for wallets and trading etc need to ensue that they adopt the best information security practices on the lines adopted by Banks and other organizations. This will require policies and procedures to be established for the purpose. It will have to meet the laws such as ITA 2000/8. It will be on the lines of the  Total Information Assurance program suggested by Naavi in the past for Banks.

2. Grievance Redressal Mechanism: Being a peer to peer system the grievances also have to be resolved by the same system. It is possible to device a means by which an “Ombudsman” can be appointed for the purpose of interacting with the public and resolving the conflicts. He can be supported by an appropriate back end support system to ensure that disputes will be resolved within the provisions available int he protocol.

3.Financial Risk due to volatility: This is the inherent nature of the commodity and will get resolved over a time. What needs to be ensured now is only following of ethical practices by operators so that public donot get mislead by tall claims. This is a public education issue and can be effectively met by an appropriate overreach program.

4. Legal Jurisdiction Issue of foreign trading platforms: At present users in India may tend to trade on foreign exchanges like MtGox or BTCChina etc because there are no such exchanges in India. Once a sophisticated exchange based in India becomes operational, the issue would be resolved. Until then just as we deal with foreign E-Commerce sites such as Amazon or E Bay, we need to manage the situation under the existing laws. By linking the approved grievance redressal mechanism to such services it is possible to address the issue.

5. AML and FEMA Issues: It is necessary to ensure compliance of available laws on AML or FEMA by the traders through appropriate policies and procedures. This is part of the Total Information Assurance program. A suitable customized techno legal information security framework for Bitcoin community (On the lines of Indian Information Security Framework- IISF proposed by Naavi earlier) can address this issue.

Thus every one of the concerns expressed by the RBI can be addressed if there is a willingness of the Bitcoin community.

Naavi’s proposition is to create a private  voluntary society to which all the Bitcoin members will get themselves accredited under a commitment of a common ethical commitment and to seek the support of RBI/SEBI/IT authorities to recognize such a body as a trustworthy ally of the regulators.

If such a program has to succeed, the body has to be insulated from vested business interests.

The business interests can however be represented by a separate agency of the business entities while the regulatory issues can be handled by the independent voluntary society.

The model is similar tot he Indian Banking system where RBI is the regulator but IBA is the industry representative. IBA takes up business interests with RBI and problems are resolved by mutual discussion.

Similarly the current business groups associated with Bitcon can be the industry representative body while the voluntary society can be formed now to take care of the regulatory concerns.

However the industry players have to whole heartedly support and participate in such a voluntary endeavour as if it is a “Self Regulating Body” of the industry. If this bottoms up approach is not initiated, there may be a possibility of a similar regulatory body being hoisted by the regulators on the industry.

In such an endeavour there will be issues that we normally see in any organization such as jockeying for power, fighting for resources, individual egos etc. If the Bitcoin community in India can effectively address all these issues and come together, then regulators would be happy to come up with an industry friendly policies at the national level.

Let’s start a debate on this idea. Suggestions from interested persons are  welcome.

Naavi

Dr K.C.Chakaravarthy, Dy Governor of RBI has always been pragmatic when it comes to security issues in the Bank. He has also been always pro-customer minded when dealing with Banking issues.

True to his reputation, he has come up with an honest admission that at this point of time RBI has no plans to come up with a regulatory framework for Bitcoins. He says that RBI is neither supporting the system or coming up with any adverse regulation. He is candid to admit ..”Whether it is legal or illegal, we don’t know”.

See details here

We hope the ED shows the same pragmatism in dealing with the raids they have already conducted.

Naavi

Related Report in domainb.com

On the 24th of December 2013, RBI gave an advisory  on Bitcoins.

Copy of the advisory can be found here.

The caution was meant for the users, holders and traders of Virtual Coins (VCs) including Bitcoins, about the potential financial, operational, legal, customer protection and security related risks that they are exposing themselves to.

The advisory refers to the virtual currencies as “Electronic records claimed to be decentralized digital currency or virtual currency”.

The advisory goes on to state that “trading or usage of VCs including Bitcoins, as a medium for payment are not authorised by any central bank or monetary authority.

It adds “No regulatory approvals, registration or authorisation is stated to have been obtained by the entities concerned for carrying on such activities”.

It is in the light of the above that the Advisory states that they may pose several risks to the users.

The advisory recognizes the following risks:

1.Loss of VCs may arise due to hacking, loss of password, compromise of access credentials, malware etc.

2.There is no established framework for redressal of customer problems, disputes, charge backs etc.

3.Losses may arise on account of volatility of value.

4.Trading of VCs on platforms on websites operating in different jurisdictions poses legal and financial risks.

5.Absence of information on counter parties could subject users to unintentional breaches of anti- money laundering laws.

The advisory also states that RBI is presently examining the issues associated with the usage, holding and trading of VCs under the extant legal and regulatory framework of the country, including Foreign Exchange and Payment Systems laws and regulations.

It is clear from the above that RBI has been extremely careful in releasing the advisory. It has not provided any mandate but has done its duty to the public by highlighting the risks inherent in the use of VCs. These risks are known to an informed VC user but were required from the point of view of the ordinary man on the street.

Hence the Bitcoin community need not be unduly worried about the advisory.

However RBI has indicated that it is still examining the issue. This could mean that at some point of time in future RBI may come out with a more detailed mandatory guideline if it deems fit.

This possibility will hang on the heads of all Bitcoin operators as the proverbial Sword of Damocles.

If Bitcoin operators need to commit on any investments on Bitcoin, then there is need for better clarity since business cannot thrive on a future full of uncertainty.

The problem is complicated by the fact that the RBI advisory has already been mis-interpreted by most people including some of the Bitcoin operators themselves. All the major news papers highlighted the fact that “Bitcoins operators shut shop after RBI advisory”. This automatically implied that RBI’s advise was to “Shut shop”. It is ironic that the panic actually spread because some of the Bitcoin operators stated that they are “Suspending” their operations following the RBI’s advisory. This was interpreted by the public as “Admission that there was some thing wrong”.

During the last Bitcoin Conference on December 15th at Bangalore, I had clearly made out that RBI advisory was expected and the advisory was on the lines then indicated. From 15th December to 24th December there was ample time for the operators to take stock of their operations. In fact if there was  a need to temporarily shut shop, it was immediately after the conference.

As one can see, RBI advisory did not warrant closure of business. At best it warranted the operators to review their business policies to make their operations compliant with the expectations.

When the Bitcoin operators revealed a nervousness and responded with their own knee jerk reaction to the RBI advisory, it was natural for the Enforcement Directorate to presume that there must be some thing wrong and they need to move in before it is too late. In a way the hasty closures actually must have prompted the ED to act immediately.

Anyway the bygones are bygones and the clock cannot be turned back. It is now time to look to the future and both RBI and ED on one side and the Bitcoin operators on the other side should sit and discuss how Bitcoin (and all other VCs) as a system need to be looked at. If  the risks of money laundering in Bitcoins is not different from the use of printed notes, RBI need to consider if at all there is a need to throttle what is essentially freedom of the citizen to create and use his own system of payment settlement.

If  a citizen decides to give his friend Idlies and Dosas so that he purchases a film ticket for him, why should the regulator be concerned about this barter system?  Bitcoin after all is a community arrangement to use a “Specified Electronic Record” as the basis for settlement of payment.

If Bitcoin is being perceived as a “Currency” , then Government should think … What is  there in Bitcoin which is not there in Indian Rupees or US Dollars?

If the public are voluntarily giving it a status of a “Peer to Peer Currency”, then

Is it right for the regulator to infringe on his freedom of choice of a payment system?

.. It is time to ponder

Naavi

Bitcoin is a unique concept of an instrument that can be used for settlement of consideration between persons who form part of a digital community. It was developed as a peer to peer payment settlement system in the Internet world. The community of Netizens who participate in the Bitcoin transactions decide on who gets how much of Bitcoins and which transaction is to be added to the approved chain of transactions.The community itself determines the value of the Bitcoin by simply a process of demand and supply.

The Government or the Central Bank of any country have no role either in the production of Bitcoins or in the maintainance of the system.

Hence Bitcoin is a system that belongs to the community which is part of the digital world. The Government authorities which have a role in managing the society of Citizens have no real role to play in regulating the Bitcoins which operate only in the Netizen world.

There are some transactions where the Bitcoin is being exchanged for the currencies of the physical world. This inter society transactions are the transactions that create problems of jurisdiction. The physical society Governments need to restrict their regulatory concern only in managing the inter society conversion of Bitcoins to fiat currencies and no more.

It is to be noted that Bitcoin system is governed by the “Protocol”. This is the “Master Governance System”.  It is an open source document that the constitution of the Bitcoin governance is known to all. Any changes or refinements to the protocol are done by the users themselves as defined by the protocol itself.

All decisions on Bitcoins are taken democratically by the community participants.

Being a system developed only by Netizens for the Netizens by a community of the Netizens, Bitcoin is actually a matter of right of these Netizens. The restrictions that some regulatory authorities are trying to impose on the community is therefore to be treated as a curb on the democratic rights of Netizens.

If some of the Non Netizens are also adopting the use of Bitcons for settlement of payments in the physical world, they are doing so at their own financial risk. They are aware that if the value of Bitcoins fall down, they cannot go to any regulatory authority to compensate them for the loss. Despite this lack of assurance if people adopt Bitcoins as a currency of their choice, it is necessary for the regulators to respect this choice of the people.

If necessary the Government can consider regulations to ensure that the citizens of the physical world are not adversely affected by the use of Bitcoins.

However, in any democratic set up it is essential for the Government to respect the right of Bitcoin community to mine, use and trade in Bitcoins as an essential human right.

Naavi

According to wikipedia, the total black money of Indians in the Swiss Banks is around US $ 1.2 Trillion.

Seen in this context, the Enforcement Directorate accusing the Bitcoin system as a tool of hawala appears a joke.

At present the total Bitcoin stock ever mined is valued at around US $ 10 billion. The stock of bitcoins in India is a fraction of a fraction of a fraction of the total bitcoin population.

The ED recently unearthed a hawala network in Punjab worth over Rs 1000 crores involving bogus invoicing of exports. The amount of black money used in Indian elections is of the order of thousands of crores. The amount of bribes that our politicians take each year is of the order of several lakh crores.

If US $ 1400 billion (Rs 70 lakh crores) has gone out of India and reached Swiss Banks, it indicates that the ED has failed miserably in controlling the illegal movement of funds from India to foreign countries whether in the form of cash or otherwise. According to one estimate, the amount of cash moving out each year is itself of the order of Rs 4 lakh crores.

Hence the possibility of bitcoins being used as a major tool of hawala transactions requiring the ED to conduct raids on two bitcoin operators in Ahmedabad is not a credible argument.

In the light of such information, the enforcement Directorate needs to answer the Bitcoin community about why the department considers Bitcoin a threat more than the other known forms of hawala.

Probably the ED was excited about the prospect of  identifing some Bitcoin trading to Narendra Modi or Amit Shah so that they can raise another hue and cry against the BJP’s prime ministerial candidate.

Naavi

The Enforcement Directorate officials who have raided on two Bitcoin traders in Ahmedabad have tried to justify their action by stating that “Bitcoin may be used by hawala traders”.  A senior official of the ED is reported to have stated that the “arrested traders will be charged under section 3 of the Foreign Exchange Management Act (FEMA)”

It is sad that the ED officials have been using their draconian powers to terrorize the small entrepreneurs who have been early adopters to the global phenomenon of a “Peer to Peer” crypto currency system.

Now that the ED has made the move, they may be reasonably expected  to go to any extent to twist the law to justify their arguments. In these circumstances, let’s see what are the provisions of FEMA which are being invoked.

Section 3 of FEMA states

” 3. Dealing in foreign exchange, etc.- Save as otherwise provided in this Act, rules or regulations made thereunder, or with the general or special permission of the Reserve Bank, no person shall-

(a) deal in or transfer any foreign exchange or foreign security to any person not being an authorized person;
(b) make any payment to or for the credit of any person resident outside India in any manner;
(c) receive otherwise through an authorized person, any payment by order or on behalf of any person resident outside India in any manner.

Explanation.- For the purpose of this clause, where any person in, or resident in, India receives any payment by order or on behalf of any person resident outside India through any other person (including an authorized person) without a corresponding inwa d remittance from any place outside India, then, such person shall be deemed to have received such payment otherwise than through an authorized person;

(d) enter into any financial transaction in India as consideration for or in association with acquisition or creation or transfer of a right to acquire, any asset outside India by any person.

Explanation.- For the purpose of this clause,” financial transaction” means making any payment to, or for the credit of any person, or receiving any payment for, by order or on behalf of any person, or drawing, issuing or negotiating any bill of exchange or promissory note, or transferring any security or acknowledging any debt.“

 The above section applies to dealing with a “Foreign Exchange” or “Foreign Security”, “Making or receiving to or from a person resident outside India”, “acquiring any asset outside India”, which can be done only as per the provisions of the Act.

This section is broad enough to cover several aspects of genuine business transactions. As people often say, if you take your foreign friend to a tea shop and pay the bill for his tea, there can be a deemed violation of FEMA. However we must appreciate that most laws are draconian by nature since they are drafted to “Empower” the law enforcement to act without inhibition for the good of the society. The discretion to use the law properly vests with the officials and if they exceed their authority the Courts can step in and censure the officials.

We cannot therefore question the authority of the ED to take action if there is a “reasonable suspicion” of a violation of law. However we need to ponder over the fact if ED had reasonable suspicion in the instant case particularly to call a citizen “Absconder” the movement he is not present in his office when there is a surprise raid by the officials. The officials need to explain to the public if this is how they are expected to behave with common citizens.

We suppose that the objection of the ED in this case is not that the traders were engaged in the trading of Bitcoins since “Bitcoin” is not yet declared as a “Currency” by the Indian Government or RBI. “Bitcoin trading” per-se is therefore not “Foreign Exchange Trading” and it is not possible for ED to launch any action under FEMA.

If however ED wants to launch action under Section 3 of FEMA on “Bitcoin trading”, then it should be deemed that they have accepted the status of “Bitcoin” as a “Foreign Currency”. In that case if some body applies to RBI for an Authorized Dealer’s license, RBI has to grant the same. Also all existing Authorized Money Changers and Authorized dealers may be deemed to be also authorized to deal in Bitcoins.

I therefore request ED to clarify in public if they have deemed Bitcoins as “Foreign Exchange”  as per the definition clause in FEMA. If ED remains silent on this subject, the silence should be construed as acceptance. I suggest that after waiting for the next 48 hours for a positive confirmation or denial, some body should approach a Court with a reference

1.”Whether the invocation of Section 3 of FEMA by ED to arrest two entrepreneurs engaged in Bitcoin Trading can be deemed as a recognition that Bitcoin is a currency and more particularly, foreign currency under FEMA?”

2.”Whether such recognition extend by implication to all other systems referred to as crypto coins?

3. “Whether any existing Authorized Dealer or Authorized Money Exchanger licensed by RBI can accept Bitcoin and other Crypto coins just as they accept US $, Euros and other foreign currencies without any further reference to RBI?”

I invite main stream media to query ED officials and RBI on this “Deemed Recognition”.

There is however a possibility that ED may change its tune and say that what they are objecting is not for “Bitcoin Tradng Per-se” but for exchange of bitcoins for foreign currencies such as US $ and not for Indian rupees.

In that case the “Reasonable Suspicion” warranting the surprise raid  need to be justified with appropriate documentation on suspected dealings in foreign exchange by the traders. If not, ED officials may be acting on the basis of press reports about Bitcoins and not on solid proof.

The possibility of Bitcoins being used for hawala operations cannot be denied. however this is not restricted to Bitcoins alone. Hawala has been in existence before the advent of Bitcoins and is continuing despite all the efforts of the ED. If ED had been effective then it would not have been possible for our politicians and others to build a fortune in Swiss Banks. The black money circulation in India is also huge and ED has not been able to control such circulation. To single out Bitcoin as a possible tool of hawala is therefore not very fair to the Bitcoin community. Instead ED should state what it wants the community to do to prevent Bitcoins being used for Hawala operations.

In the long term interest of the Bitcoin concept which is part of the Crypto Currency system, there is a need for a serious dialogue with the regulators on whether the action of ED was justified when there are no guidelines available to the community on how to deal with this entity called “Bitcoin” or more generally the “Crypto Currency.

Naavi is interested in developing a “Crypto Currency Foundation of India” that can develop self regulatory guidelines for all Crypto Currency stake holders in India which can also in due course be a starting point for more formal regulations. Interested persons or organizations who would like to promote such a concept may contact Naavi through email naavi@vsnl.com.

Naavi