The bitcoin rush: How it all began and what you need to knowCryptocurrencies, the blanket term for digital currencies like bitcoins, have caught the fancy of investors not just globally but also in India, thanks to their rising value.  

Touted as an exotic form of investment till now, cryptocurrencies, which are also known as altcoins (alternative coins), are now fast capturing the popular imagination with investors getting easier access to bitcoin exchanges and wallets to trade in this virtual cash. 

The reason for the sudden rush: the humongous growth in value of bitcoin. One bitcoin traded at about Rs 12.51 lakh on December 12, 2017. Two years ago, it was trading at a mere Rs 17,331. That is a nerve-wracking appreciation. 

So small wonder, according to media reports, some 3,000-5,000 new investors are jumping on the crypto bandwagon in India every day. This is in spite of a lack of regulatory clarity and even after several warnings from Indian monetary regulator Reserve Bank of India.

How it all  began

The first cryptocurrency—bitcoin—emerged during the global economic crisis that emanated out of the sub-prime collapse in the U.S. The period 2007-09 was catastrophic for financial markets all over the world, and it shook public faith in some of the leading financial institutions across the globe.

Amid this chaos, in 2008, a computer engineer or probably a group of developers who went by the nom de plume Satoshi Nakamoto thought upon a “virtual currency” (even now, the world doesn’t know who or which group of people is Satoshi Nakamoto).

They (for convenience, we address Satoshi as they) conceptualised it as a virtual or computer-generated currency that works on a self-regulating system where there is no need for third-party interventions such as banks and exchanges to validate a transaction. Instead, it relied on an inbuilt mathematical logic which ensured there is no discrepancy in the completion of a transaction.

This virtual currency was called “Bitcoin” and Satoshi defined it in a paper written in 2008 as “a purely peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution”.

How it works

Bitcoin or a cryptocurrency is a virtual currency that uses encryption for security. “Cryptic” means “secret” and the transfer of the virtual currency happens anonymously via digital signatures into “wallets” or accounts. A virtual currency can be transferred by use of a “public key” which is like an email address that can be used to send and receive the currency.

Then there is a “private key” which acts as a password and allows you to use your currency and make payments. These transfers happen instantly while the signatures contain the necessary information to transfer the currency.

To ensure a seamless tracking and record-keeping of the circulating virtual currency, Satoshi introduced an accounting mechanism, now known as blockchain or the distributed ledger technology. The blockchain is a tamper-proof, digitised and decentralised ledger that stands as the proof of all transactions on the network. This ledger cannot be manipulated due to coding principles and circumvents the issue of fraud prevention and double counting.

Types of cryptocurrencies

While there are more than a 1,300 cryptocurrencies today, only a handful of them is known to most people. Bitcoin, Ethereum, Ripple and Litecoin are the most popular cryptocurrencies. The total market capitalization of these cryptocurrencies has crossed $430 billion in the international market.

Indians have also taken a fancy to some of these major cryptocurrencies, besides bitcoin. Many crypto-clubs have also come up on social media platforms to discuss and educate people on the nuances of crypto investing.

How is a cryptocurrency different from a normal currency

Although these virtual currencies differ from one another, most of them present the common features of a currency such as a durability, portability, fungibility (interchangeability), scarcity, and divisibility. Most of these cryptocurrencies have a limited supply which adds an incentive to hold them. For example, there are only 21 million bitcoins that will ever come into circulation, enhancing its value.

Traits of Money Gold Fiat

(INR)

Cryptocurrency

(Bitcoin)

Fungible (Interchangeable) High High High
Non-Consumable High High High
Portability Moderate High High
Durable High           Moderate High
Highly Divisible Moderate Moderate High
Secure (Cannot be counterfeited) Moderate Moderate High
Easily Transactable Low High High
Scarce (Predictable Supply) Moderate Low High
Sovereign (Government Issued) Low      High Low         
Decentralized Low        Low High
Smart (Programmable) Low Low High    

 

The peer-to-peer movement over a decentralised network is the strongest feature of cryptocurrencies as it excludes the need for any third-party intervention. Just like one can easily download music and movies from peer-to-peer connections, money can be transferred as easily. It only requires a cryptocurrency wallet address. It eliminates the need for limits, rules and expenses for spending, processing and transmissions.

In a nutshell, cryptocurrencies are based on the properties of mathematics rather than relying on physical properties (like gold and silver) or trust in central authorities (like central banks).

Investing in cryptos

Indians have been investing heavily in bitcoins and the Indian rupee now accounts for approximately an 11% of the volume of trading by currency. There are various wallets and exchanges which need a simple KYC verification and allow you to open an account.

The KYC will entail a simple upload of scanned copies of PAN card, Aadhar card and a most recent photograph. The verification process usually takes two to three days to complete.

You can use your regular payment methods (credit/debit cards, net banking, NEFT, RTGS, Wallet payments such as Paytm, PayuMoney and others) to transact in these altcoins. Most of these exchanges also allow you to convert one altcoin into another.

Choosing the right platform

The differentiating factor is that the same cryptocurrency will not cost the same on each platform as they also purchase at a premium from international exchanges. Factors like international prices, market volatility, demand and supply in India and an exchange’s own internal order book will determine its buy-sell rate.

Since this market is still developing, some exchanges will have higher transaction volumes than other and can offer a better rate. Also, there is no one international price of a bitcoin. It can differ across countries and exchanges. There is usually a 5-10% premium that Indian exchanges have to pay for purchasing cryptocurrencies. As one can see in the chart below, the weekly price of bitcoin varies from one exchange to another and even within the same country.

 

Where do you trade and store your money? There are wallets to hold your money and there are exchanges where you can trade across currencies. The most common and popular wallets in India are – Zebpay and Unocoin. They also allow buying and selling of up to 30 popular crypto-currencies. There are charges for trading, while you can hold these currencies without any charge.

There are exchanges like Coinsecure and BTCXIndia that allow trading with features like limit orders and bid and ask price, as per your choice. The fees are also generally less than a wallet. Unocoin charges a 1% transaction fees plus 18% GST on a transaction whereas a Coinsecure transaction takes 0.4% transaction fees and GST. Hence a frequent trader will benefit from an exchange.

Click here to get an idea of the order book of an exchange along with the current highs and lows of a bitcoin. You can similarly look for various currencies on an exchange.

Regulatory stance in India

Besides giving three risk warnings till now, India’s central bank RBI has resisted so far from taking an official stance on the regulation or functioning of the cryptocurrencies. On December 5, RBI issued its third warning, reiterating its two earlier statements (on December  24, 2013, and  February 1,  2017) cautioning the investors about the risks in investing in virtual currencies.

In February, RBI had said it had not “given any licence/authorisation to any entity/company to operate such schemes or deal with Bitcoin or any VC (virtual currencies)”.

India is not alone in this quandary. Various developed countries are at different stages of acknowledging the presence of cryptocurrencies as an asset class and there is confusion among investors whether and how to report cryptocurrency gains. 

In India recently income tax department conducted surveys across various bitcoin exchanges in order to ascertain the identity of investors and examine the books of accounts. IT department is worried about unaccounted transactions and if the bitcoins gains are escaping the tax net. So it’s clear if one has profited from cryptocurrency trading, it will have to be reported in their income tax filing.

Till the government comes up with detailed instructions on tax treatment, investors are advised to treat the bitcoin profits as capital gains. A Scroll article quotes tax experts as saying: “If these are held as an investment for three years or more, the gains will be considered as long-term capital gains. The investor will need to pay 20% tax after considering indexation benefit. If an individual sells it within a shorter time period (less than three years), the gains will be treated as short-term capital gains. The profit will be clubbed with the investor’s income and he will have to pay tax depending on his income tax slab.”

And if one is investing through international exchanges, they also need to be aware of the Foreign Exchange and Management Act (FEMA) rules.

What is in store

It’s true regulations and government oversight will catch up with cryptocurrencies soon. One needs to understand there are risks in trading in these digital currencies with massive fluctuations in prices. And it’s no comfort that what is causing the massive spurt in value is not because of an underlying economic value, but because of a massive demand outstripping the supply, and with the hope that one day these currencies will emerge as dominant means for transacting goods and services. But like any new invention, there would be teething troubles at the start, and at the end, these virtual currencies are likely to prove its naysayers wrong. For now, enjoy the party as long as it lasts.

Author
Ankita Awasthi

Ankita Awasthi is a personal finance writer. Feedback to this article may be sent to contact@rupeeiq.com