EXAMINING THE LEGAL CHALLENGES POSED BY CRYPTOCURRENCY AND BLOCKCHAIN TECHNOLOGY

The first cryptocurrency was Bitcoin, which was first released as open-source software in 2009 created by pseudonymous developer Satoshi Nakamoto. As of March 2022, there were more than 9,000 other cryptocurrencies in the marketplace, of which more than 70 had a market capitalization exceeding $1 billion[2].

What is blockchain technology?

Blockchain technology records and confirms cryptocurrency trades, much like a digital ledger. A blockchain collects and stores the information when you buy, sell, or exchange cryptocurrency. This information stays in a secure location that’s not under a centralized government overseeing or controlling the cryptocurrency market.[3]

What are the risks to using cryptocurrency?

Since they are still a relatively new concept, the market for cryptocurrencies is quite unstable. Since cryptocurrencies are not governed by banks or any other third parties, they are frequently uninsured and challenging to convert into a type of fiat currency (such US dollars or euros). Additionally, because cryptocurrencies are intangible assets based on technology, they can be hacked just like any other intangible technology asset. Finally, because you keep your cryptocurrency investments in a digital wallet, you stand to lose all of them if you lose that wallet (or access to it or to backup wallets).

Cryptocurrency and blockchain technology have indeed brought about several legal challenges. While the technology itself has the potential to revolutionize various industries, its decentralized and borderless nature presents unique legal considerations. Here are some key legal challenges posed by cryptocurrency and blockchain technology:

Regulatory Uncertainty

[4]Regulatory Uncertainty means legal, regulatory, and political developments and uncertainty, including such uncertainty arising out of:

(1) changing rules, regulations, and interpretations of federal and state agencies and other government entities;

(2) litigation brought by public authorities and private parties associated with the vision and managed care industries; and

(3) any regulatory procedures, approvals, and similar matters associated with the transactions and matters contemplated by the terms of this Agreement.

Cryptocurrencies and blockchain technology often operate in a regulatory gray area. Governments and regulatory bodies worldwide are still grappling with how to classify and regulate cryptocurrencies, initial coin offerings (ICOs), and other related activities. Uncertainty about government policies causes investors to lose confidence in their fiduciary currency which led to these policy uncertainty forces investors to re-examine their portfolios and cut back on future losses.[5] This uncertainty can create challenges for businesses and individuals operating in the crypto space, as compliance requirements can vary significantly from one jurisdiction to another.

Anti-Money Laundering (AML) and Know Your Customer (KYC) Compliance

Cryptocurrencies have been associated with illicit activities due to their pseudonymous nature. Many jurisdictions now require cryptocurrency exchanges and other service providers to implement AML and KYC measures to prevent money laundering, terrorist financing, and other illegal activities. These compliance obligations can be complex and resource-intensive, particularly for decentralized platforms and projects that aim to preserve user privacy.

Anonymity signifies that your true identity is hidden from the outer world. However, your online activity is still visible—it cannot be traced back to you, either pseudonymous or otherwise. In the context of blockchain, anonymity can be achieved by using pseudonymous addresses, which are unique strings of characters representing a user’s identity on the blockchain. These addresses are generated through a cryptographic process and are not directly linked to a person’s real-world identity. As a result, it is difficult to trace the activities of a particular user on the blockchain back to their real-world identity. With pseudonymity, you can create and use a fictional persona to represent yourself, allowing you to interact with others without revealing your true identity. In the blockchain world, this idea takes even more significance, as pseudonymity can be used to protect identity while still allowing you to conduct transactions and engage in other activities on the blockchain[6].

Investor Protection

The decentralized and unregulated nature of cryptocurrencies can expose investors to significant risks, such as fraud, hacking, and market manipulation. Initial coin offerings, which involve the sale of tokens as investment opportunities, have faced scrutiny due to cases of fraudulent projects. Regulators in various countries are increasingly focusing on protecting investors in the crypto space through enhanced disclosure requirements, investor education, and enforcement actions against fraudulent activities.

Taxation Challenges

Cryptocurrency transactions can pose challenges for tax authorities. Determining the tax treatment of cryptocurrencies, such as capital gains tax on the sale of tokens, can be complex due to their unique characteristics. Additionally, the cross-border nature of cryptocurrency transactions makes it challenging for tax authorities to track and monitor taxable events accurately. Transactions that occur between individuals in different countries using blockchain technology. These transactions can include sending money to friends or family members, paying for goods or services, or other financial transactions.[7]The most fundamental difficulty in taxing crypto assets is that they are “pseudonymous”. That is, transactions use public addresses that are extremely difficult to link with individuals or firms. This can make tax evasion easier[8].

Privacy and Data Protection

While blockchain technology provides transparency and immutability, it also raises concerns regarding privacy and data protection. Public blockchains, such as Bitcoin, store all transaction data on the ledger, potentially compromising user privacy. A blockchain is a distributed ledger that records all transactions or data exchanges across a network of computers. This ledger is transparent, meaning that it is accessible to all participants in the network. Anyone can view the entire transaction history, including details such as transaction amounts, timestamps, and wallet addresses, depending on the specific blockchain implementation. Privacy, on the other hand, refers to the ability to keep certain information hidden or confidential through different mechanisms like zero-knowledge proofs, public and private blockchain and pseudonymity. Privacy-focused cryptocurrencies and blockchain projects aim to address these concerns, but striking a balance between transparency and privacy remains a challenge. Although blockchain technology enables users to control their own data without necessarily relying on third parties, certain characteristics may infringe on user privacy. Public blockchains are decentralized and allow any node to access transactions, events and actions of users[9]. The challenge lies in striking a balance between transparency and privacy in blockchain technology. While transparency provides benefits like trust and accountability, it can also expose sensitive information that individuals or organizations might prefer to keep private.

Intellectual Property (IP) Issues

Blockchain technology’s open-source nature and the ease of forking existing projects can lead to IP-related challenges. Protecting intellectual property rights and ensuring fair compensation for developers and innovators in the blockchain space can be complex. Additionally, disputes can arise regarding ownership of blockchain-based assets and smart contract code. Intellectual Property (IP) issues in the context of cryptocurrencies can pose several challenges and complexities. Here are some key problems related to IP in the cryptocurrency space:

Copyright Infringement: Cryptocurrencies, particularly those that are open-source, rely heavily on software code. Issues of copyright infringement may arise if individuals or projects copy and use code without appropriate permission or attribution.

Trademark Infringement: Unauthorized use of these trademarks by other projects or entities can lead to confusion, dilution of brand value, or misrepresentation.

Patent Issues: Patents related to blockchain technology and cryptocurrencies can be both valuable and controversial. Some entities have filed patents for various aspects of blockchain, such as consensus algorithms, smart contracts, or privacy-enhancing techniques. The existence of patents may hinder innovation, limit interoperability, or result in patent trolls asserting their rights.

Jurisdictional Issues

Cryptocurrencies and blockchain operate across borders, making it difficult to determine jurisdiction and apply traditional legal frameworks. Conflicts between different legal systems can arise, leading to challenges in enforcement, cross-border transactions, and resolving disputes. While complete harmonization remains a work in progress, there are several initiatives and organizations focused on fostering collaboration among countries. Here are some examples:

Financial Action Task Force (FATF): FATF is an intergovernmental organization that sets global standards for combating money laundering, terrorist financing, and other threats to the international financial system. FATF has provided guidance on how its recommendations apply to virtual assets and virtual asset service providers (VASPs), encouraging countries to implement AML and KYC measures for cryptocurrency-related activities.

G20 and G7: The Group of Twenty (G20) and Group of Seven (G7) are international forums that bring together major economies to discuss global economic issues. Cryptocurrencies and digital assets have been topics of discussion in these forums, with efforts to foster international cooperation, share information, and promote dialogue on regulatory approaches and best practices.

Basel Committee on Banking Supervision (BCBS): The BCBS is a global committee of banking supervisors that sets standards and guidelines for the regulation and supervision of banks. It has issued statements on the prudential treatment of crypto-assets, emphasizing the need for banks to effectively manage the risks associated with crypto-assets and align their exposure with their risk appetite.

India’s stance on cryptocurrency

At present, India neither prohibits nor allows investment in the cryptocurrency market. The Reserve Bank of India’s ban on cryptocurrencies was repealed by the Supreme Court of India in 2020. Since then, an investment in cryptocurrency is considered legitimate, although there is still uncertainty surrounding the concerns of extent and payment of tax on the income accrued therefrom as well as its regulatory framework. But it is being contemplated that the Indian Parliament will soon pass a specific law to either ban or regulate the cryptocurrency market in India[10]. However, there are no specific sections in Indian law that exclusively deal with cryptocurrencies. But, information on certain relevant authorities and sections of existing laws that are often referred to in the context of cryptocurrencies and related activities in India are listed below:

Reserve Bank of India (RBI) Act, 1934: The RBI Act is the primary legislation governing the functioning and powers of the Reserve Bank of India. While it does not specifically mention cryptocurrencies, the RBI has relied on its broad regulatory powers under this Act to issue circulars and guidelines related to cryptocurrencies and their usage in India.

‘In the recent budget speech by Nirmala Sitharaman for the 2023-24 fiscal year, the finance minister did not discuss any changes or policies regarding crypto and virtual digital assets. However, the 2023 Economic Survey highlighted the need for a unified approach to regulating the crypto space due to its growing popularity. The Governor of the Reserve Bank of India (RBI), Shaktikanta Das, has repeatedly advocated for a ban on crypto and has called for regulation to prevent their use. He has expressed worry that the RBI may lose its ability to monitor transactions if crypto becomes legalized in India’.[11]

Foreign Exchange Management Act (FEMA), 1999: FEMA is a key law that regulates foreign exchange transactions in India. Under FEMA, the RBI has issued regulations that impact the buying, selling, and remittance of foreign currencies, including cryptocurrencies. The circular issued by the RBI in April 2018, which directed regulated entities to cease providing services to individuals or businesses dealing with cryptocurrencies, relied on FEMA provisions.

Further, as per Section 2(n) of FEMA15, “foreign exchange” includes foreign currency and various instruments payable in foreign currency. Therefore, since it has been established that cryptocurrency is not “foreign currency”, by extension, cryptocurrency is also not “foreign exchange”.[12]

Prevention of Money Laundering Act (PMLA), 2002: PMLA is an important legislation that aims to prevent money laundering and the financing of terrorism. In 2019, the PMLA was amended to include cryptocurrency transactions as “proceeds of crime” and brought cryptocurrency exchanges and businesses under the ambit of anti-money laundering regulations. This means that cryptocurrency exchanges in India are required to comply with AML and KYC norms.

Income Tax Act, 1961: The Income Tax Act governs the taxation of various incomes in India. Income generated through cryptocurrency transactions, such as profits from buying and selling or mining activities, is subject to taxation under existing income tax provisions. The Income Tax Department has issued notices to cryptocurrency investors and traders, seeking information and potential tax liabilities.

Is crypto taxed in India?

Yes, the virtual digital assets, or crypto assets, are taxed in India after the Union Budget 2022, where the Hon’ble Finance Minister, Mrs. Nirmala Sitharaman, had announced revolutionary changes to the virtual asset class. For the first time, the government officially termed digital assets, including crypto assets, under “Virtual Digital Assets”. These comprise of all the cryptos such as Bitcoin, Ethereum, etc., and other digital assets such as Non-fungible tokens (NFTs).[13]

In the case of Internet and Mobile Association of India v. Reserve Bank of India[14], wherein the hon’ble Supreme Court quashed RBI’s circular banning the dealings in cryptocurrency. The Court observed that when the consistent stand of RBI is that they have not banned virtual currencies (VCs) and when the Government of India is unable to take a call despite several committees coming up with several proposals including two draft Bills, both of which advocated exactly opposite positions, it is not possible for us to hold that the impugned measure is proportionate and thus the circular banning the entities from dealing in cryptocurrencies was set aside.

Conclusion

It is important to note that the legal landscape surrounding cryptocurrencies and blockchain technology is evolving rapidly. Governments and regulatory bodies are actively working to address these challenges, develop appropriate regulations, and provide clarity for businesses and individuals involved in the crypto space. Also, International cooperation and harmonization efforts in jurisdictional issues related to cryptocurrencies are crucial for establishing consistent regulatory frameworks and addressing challenges that transcend national boundaries. These initiatives and organizations play important roles in fostering dialogue, sharing information, and harmonizing approaches to address jurisdictional issues related to cryptocurrencies. However, achieving complete harmonization remains a complex task due to the diverse legal, regulatory, and cultural contexts across countries. Efforts toward international cooperation and coordination are ongoing to establish greater consistency and clarity in the regulatory landscape for cryptocurrencies. Some countries have entered into bilateral or multilateral agreements to foster cooperation on cryptocurrency-related matters. For example, the European Union has implemented the Fifth Anti-Money Laundering Directive (5AMLD), which requires member states to adopt regulations for cryptocurrency exchanges and custodian wallet providers. Additionally, countries like Japan and Switzerland have bilateral agreements to facilitate information sharing and cooperation in the area of fintech, including cryptocurrencies.

REFERENCES

1. Blockchain in Cryptocurrency: Beginner Guide and Career Outlook

Written by Coursera • Updated on Jun 16, 2023

https://www.coursera.org/articles/blockchain-cryptocurrency

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[14] Internet and Mobile Association of India v. Reserve Bank of India, (2020) 10 SCC 274.