RBI warns against use of virtual currencies like Bitcoins

The Reserve Bank of India has cautioned the users, holders and traders of virtual currencies (including Bitcoins), about the potential financial, operational, legal, customer protection and security related risks.

In this regard, RBI has been looking at the developments relating to certain electronic records claimed to be 'decentralised digital currency' or 'virtual currency' like Bitcoins, litecoins, bbqcoins, dogecoins etc., their usage or trading in the country.

It said that it is examining the issues associated with the usage, holding and trading of such virtual currencies under the existing legal and regulatory framework of the country, including foreign exchange and payment systems laws and regulations.

The price of Bitcoin has been fairly volatile this year rising over five times in less than two months to cross $1,000 last month only to see its value shrink by a third since then.

RBI noted that the creation, trading or usage of virtual currencies including Bitcoins, as a medium for payment are not authorised by any central bank or monetary authority.  "No regulatory approval, registration or authorisation is stated to have been obtained by the entities concerned for carrying on such activities. As such, they may pose several risks to their users," according to RBI.

For those who don't already know, Bitcoin is an internet-based virtual currency that came into existence in 2009. It is an open-source protocol, its design is public, and nobody owns or controls it. Bitcoin also boasts of certain unique properties that are not found in other payment systems. Note that as far as Bitcoin is concerned, there is no central authority. It is like email or internet, in the sense that no one owns email protocol or internet protocol.

Also, it is the demand and supply that decides it's pricing, so, depending on the supply/demand and adoption of Bitcoin, people buy or sell at various prices. Most of the time, the exchange that has a maximum volume is used as reference point to determine its prices. It is like how gold prices are being determined. The fluctuations are based on speculation only. If there are positive news about Bitcoin and its adoption, more people invest in it and drive prices up, whereas if there is any bad news, people who have already invested sell it to lower their risk. Read here for more.

RBI also specified several risks that the use of virtual currencies poses, including the following:

Prone to losses: Since virtual currencies are stored in digital/electronic media that are called electronic wallets, they are prone to losses arising out of hacking, loss of password, compromise of access credentials, malware attack, etc. Also, since they are not created by or traded through any authorised central registry or agency, the loss of the e-wallet could result in the permanent loss of the virtual currencies held in them.

No regulation of payments: Payments by virtual currencies, take place on a peer-to-peer basis without an authorised central agency that regulates such payments. As such, there is no established framework for recourse to customer problems/ disputes/charge backs, etc.

Volatility in value: There is no underlying or backing of any asset for virtual currencies. As such, their value seems to be a matter of speculation. Huge volatility in the value of virtual currencies has been noticed in the recent past, exposing its users to potential losses on account of such volatility.

Trading of virtual currencies: Virtual currencies are being traded on exchange platforms set up in various jurisdictions whose legal status is also unclear. Hence, the traders of virtual currencies on such platforms are exposed to legal as well as financial risks.

"There have been several media reports of the usage of virtual currencies, including Bitcoins, for illicit and illegal activities in several jurisdictions. The absence of information of counterparties in such peer-to-peer anonymous/pseudonymous systems could subject the users to unintentional breaches of anti-money laundering and combating the financing of terrorism (AML/CFT) laws," according to RBI.

Globally, there are some companies, including BTCChina in China, MtGox in Japan and Bitstamp in Europe that buy/sell Bitcoins. In India, too, there is a startup called Seven Digital Cash LLP based out of Gandhinagar (Gujarat) that buys and sells this digital currency through its platform Buysellbitco.in.

Just last week, we had reported that Gaurav Burman, managing partner of Elephant Capital, had invested in his personal capacity an undisclosed amount in itBit Pte Ltd, a Singapore-based Bitcoin exchange. Prior to this, itBit had raised $3.25 million co-led by Canaan Partners and RRE Venture, with participation from Liberty City Ventures and a few individual investors.

Burman, who picked a minority stake in itBit, is now planning to bring the platform to India. As per the latest estimates, there are over 11 million Bitcoin users worldwide, of which around 50,000 are in India.

(Edited by Joby Puthuparampil Johnson)