Abstract

Cryptocurrencies are digital tokens or digital currencies typically issued by non-governmental agencies. They are classified as a special type of asset in which payments are made directly through an online network without the interference of any Central authority. They are not a legal tender. They are anonymous in nature or rather pseudonymous, meaning that the identities of users are not revealed. As of today there are above ten thousand cryptocurrencies worldwide.^[1] It was first discovered by ‘Satoshi Nakamoto’ (pseudonymous) in 2008. In the past few years, the demand for cryptocurrency trading has increased significantly. The reason attributed to it is that these are profitable in nature like assets. Of late, cryptocurrencies have become a cause of concern for various governments due to their anonymous nature and many have banned these currencies. The article discusses the technology behind cryptocurrency, the regulatory challenges in the country and worldwide, the cyber-security challenges and the future predictions.

Cryptocurrency

A cryptocurrency is a digital currency typically issued by a non-government entity, which uses ‘cryptography’- an encryptiontechniquefor maintaining and securing monetary transactions. Cryptocurrency transactions are restricted to a digital network only; they mostly do not exist in a physical form (like a paper currency or a credit/debit card) and have a distinct classification of their own which is different from securities, commodities, or even currencies.^[2] In the last few years the number of cryptocurrencies has grown over a ten thousand different types, the most common ones are Bitcoin, Ethereum, Tether, Ripple, Dogecoin, Binance coin, etc.^[3] Cypto-currencies are different from Central Bank Digital Currencies (CBDC)^[4]; they are legal tenders and are mostly the electronic form of the already existent paper form of national currencies. Whereas cryptocurrencies are independent currencies, with no centralised backup; they are simply a medium of trading with no intrinsic value, their value is determined by the demand and supply market much like other assets.

Bitcoin was the first cryptocurrency to be released as open-source software a year after the report in the name of Satoshi Nakamoto was released that described this electronic payment system.^[5] The main characteristic of the system was to allow direct monetary transactions between users without revealing their identity and without intervention from any central authority. Due to this reason, often a high volatility in the rates has been one of the constant characteristics of cryptocurrencies. And regulating the currency has been a major challenge as the Central authorities have very little control over it. The underlying technology of the cryptocurrencies is based upon a distributed ledger technology (DLT), mostly the Blockchain technology that uses an encryption technique, making it anonymous.

The Underlying Technology

A distributed ledger technology (DLT) like the blockchain, as the name suggests, is a series of blocks, each of which contains the data of the cryptocurrency transaction that have taken place up to that block in an encrypted form.^[6] This data on the blockchain can be accessed by anyone on the network. ^[7] A cryptographic hashing function (a mathematical algorithm) is used to generate the linkbetween two consecutive blocks in the chain containing the database history. In case there is a change in the database history, the link is broken indicating the presence of a corrupt block which eventually is replaced by the network. This indicates that blockchain records transactions in a verifiable way, protected from tampering or being corrupt.^[8] There are also other applications of the blockchain technology apart from cryptocurrencies.

Crypto Mining and crypto wallets

The transactions that take place on a blockchain get stored in the blocks of this distributed ledger as a database which needs to be updated with every transaction. Crypto mining is referred to as the process of verifying thesetransactions by solving the complex cryptographic codes by “crypto miners”and compiling them on the blockchain after confirming them.^[9] The solutions are also cross examined by other miners or users on the same network before they enter the block. Crypto miners provide the computing power required for the mining process and therefore are rewarded with new bitcoins for solving codes per block.^[10] Crypto mining in recent years has turned into a profit making business due to its bitcoin rewarding model.

Trading in cryptocurrency requires a digital wallet for storing the cryptocurrency just like a digital wallet. There are several (exact number is not known as they are not regulated) cryptocurrency exchanges around the world which provide this service. Binance, Coinbase, Kraken, Bitstamp, are some major ones. A user might also choose to self-host their cryptocurrency instead of using a third party (cryptocurrency exchange)^[11] as the later might require sharing personal information with the exchange. However, self-hosting also has other cyber-security risks since the user is solely responsible for her wallet security.

Cyber-security risks involving cryptocurrencies

Lack of a central regulatory authority naturally makes cryptocurrencies prone to cyber-security risks. Cybercrimes involving cryptocurrencies mainly target crypto-wallets and the crypto-mining process. Fake crypto trading platforms (both apps and websites) imitating original crypto wallets are on the rise. Users who fail to differentiate between the original and fake platforms often end up sharing their security and financial details and become victims of phishing attacks.^[12] Other cyber-security threats involving cryptocurrencies include scams like selling non-existent cryptocurrencies to customers with little knowledge about crypto trading. A prominent cybercrime related to cryptocurrency is “crypto-jacking”, in which a victim’s device is used to mine cryptocurrency without her knowledge. As mentioned previously, crypto mining is an energy intensive process, incurring huge costs; which is why, “crypto-jacking” is a common type of cybercrime which targets a user’s device and uses its energy resources to mine cryptocurrency.^[13]

Apart from crypto-jacking, initial coin offering (ICO) exit scams are increasing day by day in which fake companies offer ICOs to customers. An ICO is a way for crypto companies to raise money in which customers are promised a discount on the new crypto coins in exchange for active and popular cryptocurrencies like bitcoin. These companies often rent fake offices to deceive customers only to disappear later.^[14] Other serious cybercrimes involve demanding ransoms from ransomware attacks in cryptocurrency and dark web criminal activities like money laundering, drug trafficking, terrorism financing making transactions in cryptocurrencies. Use of cryptocurrency for such activities make it highly difficult for law enforcement agencies in tracking the money trail (due to the anonymous nature of cryptocurrencies) in order to gather evidence of the crime.^[15]

In some successful crackdowns by law enforcement agencies, the Securities and Exchange Commission (SEC) in August 2022 charged several people involved in a crypto-related Ponzi scheme called Forsage, which had raised around 300 million dollars from various investors across the world including the US.^[16] A few weeks before, in July 2022, the crypto exchange Kraken was reportedly under investigation by the U.S. Treasury Department for violation of federal sanctions against Iran.^[17] In the same month, three people in the US, one of whom was a Coinbase employee, were charged with wire fraud conspiracy by a US district attorney in New York and the Federal Bureau of Investigation (FBI), for committing insider trading in cryptocurrency assets of Coinbase.^[18] Earlier in March 2019, the ‘Coinhive’ service was shutdown, as it was responsible for crypto-jacking. ^[19] Coinhive provided the code which allowed websites to use their visitors’ computers to mine Monero, a cryptocurrency. Despite the cyber threats involving cryptocurrencies, this financial technology (FinTech) has grown rapidly in recent years, making financial transactions easier and providing an edge to investors across the world.

Opportunities and Obstacles

Cryptocurrencies use advanced FinTech which makes fund transfer easier as well as secured. Creation of a crypto wallet is quick and easy and it can be done online from anywhere in the world. Crypto transactions are mostly anonymous as the crypto-wallet information is hidden. Crypto coins are difficult to be faked, copied or spent twice. The operation cost is quite low as compared tothe charges levied upon by banks for financial transactions.

The absence of a Central regulatory authority grants equal control to all participants in the network, making it a decentralized one. A failure in any part of the network does not stop the functioning of the system, it still continues to operate since every computer in the system shares the responsibility for mining cryptocurrency. Cryptocurrency companies can create as many numbers of addresses without disclosing any personal information of users. At the same time, the history of every transaction that has taken place is stored in the sequential blocks making it transparent as well as anonymous at the same time.

Apart from that, crypto transactions are quite fast. As compared to credit cards, which require data like card number, and other details to be provided for transactions, thus making them less reliable, cryptocurrencies are completely secure since no data needs to be disclosed during transactions. Cryptocurrency wallets mostly operate on two keys - one of which is public and available to all (the wallet address) and the other is private which is only known to the owner.^[20] The transactions occur only when the owner of the cryptocurrency applies the private keys and a mathematical function.

However, in the nascent cryptocurrency market, volatility is a huge disadvantage. Cryptocurrencies are highly unstable; their value hugely depends upon the statements made by various governments. Cryptocurrency prices also depend on the perceived value and demand and supply just like other financial instruments. Also the ever increasing number of cryptocurrencies and little or no regulation increase the competition and price discrepancies as compared to other financial markets like stock exchanges. Also in case of bankruptcy and frauds, there would be no legal authority to look after it causing a natural hesitation for investors.

Apart from that, crypto mining is anenergy and resource-intensive process, often allowing only large firms to be able to operate in this domain. Another rising concern involving cryptocurrencies is the anonymous nature of transactions, which encourages nefarious actors to carry on illegal activities like those on the dark web and several other serious cybercrimes. Given the wide opportunities and obstacles both, the stand on cryptocurrencies is not uniform across countries; many have banned them, while only a few are on their way tolegalise or regulate them.

India’s Stand on Cryptocurrency

Cryptocurrency in India is neither a digital legal tender nor is considered legal as per the government announcement on Virtual Digital Assets on February 1, 2022.^[21] However, it was decided to tax cryptocurrencies and other digital assets and non-fungible tokens (NFT) - a 30 percent tax on any income generated from their transactions as well as a 1 percent tax deduction at source (TDS) on all transactions.^[22] Earlier in 2010, there was a complete ban on all crypto-related activities like mining, buying or selling. The Reserve Bank of India has also time and again shown strong reluctance regarding legalising cryptocurrencies implying that they pose serious threat to the macroeconomic stability of the country.^[23]

The status of cryptocurrencies in India has therefore changed in the recent years, from a complete ban to taxation; taxing however has not made it necessarily legal either. “The Cryptocurrency and Regulation of Official Digital Currency Bill of 2021”, is now under way, which would clarify the actual status of cryptocurrency, once it becomes a law. As per latest reports, the Indian government is in consultation with the International Monetary Fund (IMF), the World Bank and some Indian stakeholders discussing valuable inputs to be incorporated in the country’s crypto policy.^[24] However an important announcement made in the Union Budget was creation of the Central Bank Digital Currency (CBDC) or the digital rupee by 2023, which would be a legal tender, backed by the RBI.^[25]

Cryptocurrency Worldwide and the Way Forward

A few countries are on their way to legalise cryptocurrencies and some are coming up with regulations to control their use. El Salvador in September 2021 was the first country to make the use of bitcoins legal for all transactions, alongside the US dollar.^[26] Binance, the crypto exchange has been granted approval to operate in France where the company can offer trading services as it has been registered with AMF, the French Stock market watchdog.^[27] However, some countries like China have declared all cryptocurrency related transactions illegal and introduced their own CBDC instead.^[28] Indonesia, Singapore, Japan are also making progress towards adopting their CBDCs at the earliest.^[29]

Cryptocurrency is an innovation in financial technology which was inevitable much like any other technological innovation. The world is witnessing a FinTech revolution with digital currencies and block chain technology applications in various sectors of the economy. But cryptocurrencies being decentralised have created a “trustless” system eliminating the need for organisations like banks, which in turn can lead to power and wealth accumulation by some and loss of integrity of financial transactions. According to some cryptocurrency promoters, the market for cryptocurrency has already become so large that banning it would be too costly for any country. However, with many countries establishing their own Central Bank Digital Currencies as an alternative to cryptocurrencies and some placing proper regulations on cryptocurrencies instead of banning them, a balanced approach can be witnessed that would allow the underlying technology to help investors, strengthen entrepreneurship, promote financial inclusion and open new doors in digital economy for every section of the society.

Endnotes :

^[1]Raynor de Best, “Quantity of cryptocurrencies as of February 3, 2022”, Statista, March 22, 2022 athttps://www.statista.com/statistics/863917/number-crypto-coins-tokens/
^[2] “What is cryptocurrency and how does it work?”, Kaspersky, at
https://www.kaspersky.com/resource-center/definitions/what-is-cryptocurrency
^[3]Adam Hayes,“10 Important Cryptocurrencies Other Than Bitcoin”, Investopedia, July 8, 2022 at
https://www.investopedia.com/tech/most-important-cryptocurrencies-other-than-bitcoin/
^[4] “Cryptocurrencies”, Reserve Bank of Australia, at https://www.rba.gov.au/education/resources/explainers/pdf/cryptocurrencies.pdf
^[5]Satoshi Nakamoto,“Bitcoin: A Peer-to-Peer Electronic Cash System”, bitcoin.org, October 31, 2008 at https://bitcoin.org/bitcoin.pdf
^[6]Wolfgang Karl Härdle, Campbell R. Harvey and Raphael C. G. Reule, “Understanding Cryptocurrencies”, International Research Training Group 1792, March 26, 2019 at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3360304
^[7]Ibid
^[8]Marco Iansiti and Karim R. Lakhani, “The Truth About Blockchain”, Harvard Business Review, January-Februray 2017 Magazine at https://hbr.org/2017/01/the-truth-about-blockchain
^[9]IttayEyal and EminG¨unSirer, “Majority is not Enough: Bitcoin Mining is Vulnerable”, Department of Computer Science, Cornell University at https://www.cs.cornell.edu/~ie53/publications/btcProcFC.pdf
^[10]Ibid
^[11]Wolfgang Karl Härdle, Campbell R. Harvey and Raphael C. G. Reule, “Understanding Cryptocurrencies”, International Research Training Group 1792, March 26, 2019 at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3360304
^[12] “Common cryptocurrency scams and how to avoid them”, Kaspersky, at
https://www.kaspersky.com/resource-center/definitions/cryptocurrency-scams
^[13] “What is Cryptojacking? – Definition and Explanation”, Kaspersky, at
https://www.kaspersky.com/resource-center/definitions/what-is-cryptojacking
^[14]Nick Chong, “Consumers have lost almost $100 million to ICO Exit Scams”, EWN, August 14, 2018
https://ethereumworldnews.com/consumers-lose-100-million-ico-exit-scams/
^[15]Debopama Bhattacharya, “The Dark Web and Regulatory Challenges”, MP-IDSA, July 23, 2021 at
https://www.idsa.in/issuebrief/the-dark-web-and-regulatory-challenges-dbhattacharya-230721
^[16]US Securities and Exchange Commission, “SEC Charges Eleven Individuals in $300 Million Crypto Pyramid Scheme”, August 1, 2022 at https://www.sec.gov/news/press-release/2022-134
^[17]Ryan Mac and David Yaffe Bellany, “Kraken, a U.S. Crypto Exchange, Is Suspected of Violating Sanctions”, The New York Times, July 26, 2022 at https://www.nytimes.com/2022/07/26/technology/kraken-crypto-iran.html
^[18]Department of Justice,U.S. Attorney’s Office, Southern District of New York,“Three Charged In First Ever Cryptocurrency Insider Trading Tipping Scheme” July 21, 2022 athttps://www.justice.gov/usao-sdny/pr/three-charged-first-ever-cryptocurrency-insider-trading-tipping-scheme
^[19]John Porter, “Popular ‘cryptojacking’ service Coinhive will shut down next week”, The Verge, February 28, 2019 athttps://www.theverge.com/2019/2/28/18244636/coinhive-cryptojacking-cryptocurrency-mining-shut-down-monero-date
^[20] “Cryptocurrencies: A Guide to Getting Started”, World Economic Forum, June 2021 at https://www3.weforum.org/docs/WEF_Getting_Started_Cryptocurrency_2021.pdf
^[21] “Budget 2022-2023 Speech of Nirmala Sitharaman, Minister of Finance”, Government of India, February 1, 2022, at https://www.indiabudget.gov.in/doc/budget_speech.pdf
^[22] Ibid
^[23] Keynote address by Shri T Rabi Sankar, Deputy Governor, Reserve Bank of India, “Cryptocurrencies – An assessment”, Reserve Bank of India, February 14, 2022 at https://rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1196
^[24] PBNS, “Consultation paper on cryptocurrency soon: Economic Affairs Secretary Ajay Seth”, NewsOnAIR, May 31, 2022 athttps://newsonair.com/2022/05/31/consultation-paper-on-cryptocurrency-soon-economic-affairs-secretary-ajay-seth/
^[25] “Budget 2022-2023 Speech of Nirmala Sitharaman Minister of Finance”, Government of India, February 1, 2022, athttps://www.indiabudget.gov.in/doc/budget_speech.pdf
^[26] Robert Hart, “El Salvador Makes History As World’s First Country To Make Bitcoin Legal Tender”, Forbes, June 9, 2021 at https://www.forbes.com/sites/roberthart/2021/06/09/el-salvador-makes-history-as-worlds-first-country-to-make-bitcoin-legal-tender/?sh=38142d14eaa3
^[27] “List of DASPs registered with the AMF”, AMF, July 20, 2022 at
https://www.amf-france.org/en/professionals/fintech/my-relations-amf/obtain-dasp-authorisation#List_of_DASPs_licensed_by_the_AMF
^[28] Francis Shin, “What's behind China’s cryptocurrency ban?”, World Economic Forum, January 31, 2022 at
https://www.weforum.org/agenda/2022/01/what-s-behind-china-s-cryptocurrency-ban/
^[29] Debopama Bhattacharya, ”Digital Yuan (e-CNY): China’s Official Digital Currency”, March 12, 2022 at https://www.tandfonline.com/doi/abs/10.1080/09700161.2022.2039582

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