Bit of a regulatory dilemma

A few years ago, an oil trader in London placed an order for a few billion tonnes of oil, sending the entire industry into a tizzy. Prices started skyrocketing.

Well, the only issue was that the order was placed when the trader was extremely tipsy. Next day, he came back to reality and reversed the order, and the prices went back to normal. Something similarly intoxicating seems to be happening with bitcoins.

To the uninitiated, bitcoins are digital currencies that data hunters mine out of a complex computer programme. Nobody prints them.

No central bank such as India’s RBI backs these crypto-currencies. But that doesn’t mean people don’t trust bitcoins. They do. And they trade with it. A beauty salon in Chandigarh accepts bitocns for their services. Bangalore, India’s ‘e’ capital, hosted a global conference on the virtual currency, which many expect to have its own exchange in India by next March. Digital payment makes buying a smooth process, especially for international purchases, as exchange rate risks are fewer and cumbersome bank rules or fees are mostly absent. It also enables people to make payments in areas without banking access or where carrying cash can be dangerous.

Pros and cons Bitcoin is one of the latest additions to electronic payments. These, at times, all but substitute the use of the legal currency. Millions of Africans, particularly in Kenya, make payments simply by texting one another. Some even use mobile minutes as a form of currency. In the bitcoin world, transactions do not require names but digital wallet IDs, which make them more private than credit cards.

That said, quite a few factors seem to be going against bitcoins. The first is, of course, their legality. As things stand now, they do not enjoy a legal tender status — a medium of payment that law allows or a legal system admits to be valid for meeting a financial obligation.

All major currencies such as the rupee or the dollar sport this tag. One can use the rupee to buy bitcoins and use them in turn to procure goods and services.

Despite its short history — bitcoins were created only in 2009 by an unknown geek, Satoshi Nakamoto — bitcoins bear some bad reputation. Law enforcement agencies in the US and a few other countries recently busted gangs that use bitcoins to support drug peddling. Many allege bitcoins are widely used for money laundering as well.

To top it all, the electronic currency has seen huge fluctuations in its value. For instance, in January 2013, one bitcoin was valued at just about $50; by December it hit $1,200 before softening to about $800. This shows speculators are at work.

The price levels also indicate bitcoins are used as an investment option to counter inflation and low returns in other investments caused by a gloomy economic environment.

Regulators are only beginning to notice bitcoins and, as always, most of the action is in the US. In March 2013, the US Financial Crimes Enforcement Network formed regulatory guidelines for decentralised virtual currencies such as bitcoins, classifying US bitcoin miners who sell their virtual currencies as Money Service Businesses or MSBs.

Legal Issues These MSBs may be subject to registration and other legal obligations. The New York State Department of Financial Services, citing its authority to regulate money transmissions and its concern with criminal activity, announced an inquiry in late 2013 into possible regulations and guidelines for bitcoin. Back home, the RBI says it is adopting a “wait and watch” policy towards bitcoins and would probably step in when it gets the first sniff of abuse.

Recently, China, home to the largest bitcoin exchange in the world, banned transactions between bitcoin exchanges and third-party payment firms.

According to Bloomberg , “Chinese central bank officials (on December 17) told third-party payment service providers to stop offering clearing services to online Bitcoin exchanges.”

The People's Bank of China said while individuals are permitted to freely trade and exchange bitcoins as a commodity, Chinese financial banks are not allowed to operate using bitcoins, and entities dealing with bitcoins must track and report suspicious activity. Soon, Baidu, China’s biggest search engine, stopped accepting bitcoins, causing a 20 per cent drop in their value.

Apart from the regulatory chaos, what could probably be the biggest worry is the cap on the number of bitcoins that can be mined — 21 million coins. And many believe that half the mark has already been crossed. But one should not be too surprised if this limit is reached faster than expected and no more bitcoins will be made.

Of course, if the cap ceases to exist, due to a security breach, then all hell may break loose!

(The author is Director, Finance, Ellucian.)

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