Regulate bitcoin

It is high time the regulatory authorities laid down a clear definition and tax norms for the new asset class of virtual currencies. Runaway appreciation in the values of bitcoin, ethereum, and other virtual currencies has turned these into popular speculative vehicles. In January, bitcoin was trading just below $1,000. Last Wednesday, it rocketed above $11,000 before settling at $10,500 on Friday after two of the world’s largest futures exchanges in the US gave the green light to list bitcoin futures, a significant step in allowing mainstream investors to buy and sell the cryptocurrency. This parabolic appreciation has made them vastly popular for traders in India, among other places. The rupee volume of bitcoin trades runs at around Rs 125 crore per day and 1.5 million Indians are active bitcoin traders.

This is clearly a bubble, and such bubbles arise when the market finds it hard to accurately value a new concept. Bitcoin is especially hard to understand. Each coin is a string of encrypted computer codes. The currency is not backed by any central bank and uses an innovative system of peer-to-peer verification to clear transactions. It is accepted as a medium of exchange by a relatively small, though growing, pool of individuals and merchants. The supply is limited by a mathematical formula. There are only 16.7 million coins in circulation. As more money is chasing this limited supply, prices have risen.

Some traders are talking in terms of bitcoin hitting $40,000, or even $100,000. These optimists offer two rationales. One is an expectation that bitcoin will be recognised as a currency by more nations. Right now, only Japan among the G-7 accepts it as a legitimate currency. The second expectation is that more merchants, including e-commerce giants like Amazon and Alibaba, will accept bitcoin. Less optimistic traders believe that such expectations are already factored into the price, while pessimists think a crash is around the corner.

Virtual currencies create multiple regulatory concerns. Bitcoin is convenient for hawala transactions; it can be bought using rupees and sold in euros, dollars, or yen to facilitate capital flight. Such trades may well have occurred post-demonetisation. A non-resident Indian may also do reverse transaction, buying bitcoin in US dollars and selling it in rupees to remit money. Ignoring possible capital gains (or losses), the transaction costs may be lower than fees payable in remittance via conventional banking channels. Virtual currency-denominated Initial Public Offerings, or Initial Coin Offerings as these are called, have been launched by many dubious start-ups, which seek to bypass market regulators.

There is no way to ban trading or usage of such instruments because such bans are impossible to enforce. Somebody can just memorise private keys, retain no physical evidence of ownership, and make bitcoin transactions from any internet connection. One major issue is that most central banks and tax authorities have not even agreed on basic definitions of virtual currencies. They should emulate the Japanese and treat bitcoin as a currency, laying down rules for usage and clarifying tax treatment. Nobel Laureate Joseph Stiglitz has demanded that bitcoin be outlawed, but that could remain just wishful thinking. While the bubble can well deflate, the fact is that virtual currencies are here to stay and regulators need to adopt a pragmatic approach to dealing with this new class of assets.

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