Breaking: Bitcoins legalised in Japan – legal framework and tax treatment

The Japanese have brought into force a new legislation treating digital currency as a legal payment method, from the beginning (1 April 2017) of this fiscal year. Bitcoins are now legal tender in Japan and are at par with other fiat currencies. This has been made possible by the passing of a new law called the Virtual Currency Act by the Diet. The Financial Services Agency announced that it is going to treat cryptocurrencies as legal tender from April 1st, 2017.

 

The Virtual Currency Act

This bill was primarily to revise portions of the Banking Act. The Virtual Currency Act serves to account for changes to the economy. It also strives to keep economy at par with technological developments.

Section 3 of this bill now includes wording on virtual currency and is being tentatively called the “Virtual Currency Act.”

According to global law firm DLA Piper, the amended parts of the Payment Services Act, which is a part of the Banking Act, defines digital currencies as “property of value,” that is useful for payment to unspecified persons, and is purchasable from and sellable to unspecified persons.

Important to note, the law does not require users of bitcoins to reveal the parties they transact with. This provision may be used to deal with ‘unspecified’ and probable criminals. This is in consonance with the legal theory that no one shall be compelled to be a witness against himself.1

The law explicitly finds a distinction between digital currency and electronic money. ‘digital currency’ is not the same as ‘electronic money’ because the former has no issuers and is usable by any accepting individual, whereas the latter has a specific issuer and is only usable by the issuer or authorized persons.

 

Bitcoin exchanges

The new law seeks to regulate bitcoins and bitcoin exchanges by equipping the Financial Services Agency with the authority to conduct on-site inspections and issue administrative orders as and when needed. All bitcoin exchanges shall be required to register with the Financial Services Agency.

The recognition automatically brings in obligations to be fulfilled by banks, financial institutions and cryptocurrency exchange platforms. These institutions would be required to comply with stricter anti-money laundering and additional KYC requirements. The law also provides for annual audits in finance, technology and consumer protection principles.

Digital currency exchanges also have to comply with a few other restrictive regulatory requirements. One of them being the requirement to hold, at minimum, liquid capital of ¥10 million yen, worth approximately US$90,000. Also, exchanges have to prove that they possess requisite technology infrastructure, with measures in place to prevent leakage, identity theft, loss and damage of funds and other information.

Recall The Mt. Gox incident – the largest bitcoin hack ever? This legislation was drafted long back in 2013 and had been in abeyance for the past few years. Although Japan’s large population is technologically adept, and is already used to sending tokens and coupons between their smartphones, most Japanese had still not heard of Bitcoin until the Mt. Gox fiasco. Many were introduced to Bitcoin by seeing Mark Karpeles’ face on TV at courtroom trials.

 

Tax treatment

Any profits arising from trading in cryptocurrencies can be considered “income from business activities or miscellaneous income”. The asset-like nature of bitcoins and other cryptocurrencies means that capital gains tax are applicable upon them in Japan.

Interestingly, the practice of levying 8% consumption tax on sale and purchase of bitcoins and other cryptocurrencies would not be leviable in Japan from 1st of July, 2017. This is due to the efforts of the Japanese government to reform its tax laws.

DLA Piper explains that “the taxation of virtual currencies is undergoing many developments in Japan,” and new accounting standards detailing the treatment of digital currencies for tax purposes are “anticipated in the near future.”

“While bitcoin exchanges would be exempt from consumption tax, the exchange of virtual currency for assets or services (i.e., when someone pays virtual currency to a seller of assets or services) is still subject to consumption tax in the same way as those transactions which are paid in traditional currency.”
-DLA Piper

 

Entry to the bitcoin market

The bill also revises the ‘Act on Prevention of Transfer of Criminal Proceeds’ requiring exchanges to implement a stricter KYC process. Consequently, opening an account at a bitcoin exchange has gotten more difficult.

New users would now need to answer a list of prescribed questions, things like profession and purpose fall within the purview. Users need to submit identification documents and wait a few days during which their profile is vetted. Registered address of new customers shall be verified by sending a postcard with a verification code.

Further, from the enactment date all exchanges are required to voluntarily apprise their user base with detailed corporate information, including but not limited to, their trading name and address, registration number, transaction content, as well as disclose all fees and costs to users. They must also keep separate accounts for fiat money and digital currencies, as well as undergo a regular audit. The auditing is to be done by a public certified accountant or audit firm at least once a year.

The Payment Services Act also introduces regulations “for the registration of all virtual currency exchange businesses,” DLA Piper explains, citing how this regulation is “consistent with the declaration made at the 41st G7 Summit at Elmau in 2015.”

“Currently, most Bitcoin-cash exchange services available in Japan are operated by Japanese companies. However, the amendment to the Act could be an opportunity for foreign VC-cash exchange service providers to expand their business into Japan, because the new registration system is also open to foreign entities.”
– DLA Piper Law Firm

 

Conclusion

All in all, a brave government has paved the way for a brave technology to take effect. Wishing more acceptance to blockchain and it’s users.

 


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Value of bitcoins; RBI on bitcoin; legality of bitcoin transactions in India

Bitcoins are numbers you can trade with. People would be ready to exchange goods and services with bitcoins as they value the bitcoin numbers. Compared to currency which is made out of thin air by a central bank, bitcoins and other digital tokens, require massive computational power to generate, and have a base in global energy prices.

This idea of using a set of protocol to transact and create new bitcoins securely was published by an Anonymous author using the pseudonym of Satoshi Nakamoto. The paper was titled: Bitcoin: A Peer-to-Peer Electronic Cash System by Satoshi Nakamoto

The global bitcoin economy is maintained by consensus among its users on who owns how much bitcoins. It relies on a system of decentralised ledger technology and triple entry accounting to prevent fraudulent entries. The bitcoin protocol is used to communicate with each other on the network.

The bitcoin economy has a unique system of rewarding bitcoins to anyone who would maintain the global bitcoin accounts. The rewarding mechanism of bitcoins creates an incentive for people to deploy computational resources to maintain the economy. This requires accounting for bitcoins according to a set protocol. The bitcoin protocol therefore requires ‘proof of work’ from its users in order to reward them with new bitcoins. The ‘proof of work’ is resource intensive and requires huge computational power. To learn more about how it is done, you may read my previous article on what are bitcoins – what is so different than fiat money?

 

Accountability

Humans needed a strong, tamper-proof, irrefutable and immutable method of accounting. An accounting method which no amount of intelligence can influence. It was an awaited concept. People across the world were waiting for a panacea of accounting. And Indians needed it the most. The most corrupted countries needed the most amount of accounting.

On came the blockchain technology. It can be used to create a permanent record of transactions, which are mathematically undeniable. Even people cannot deny the entries, because people would need to digitally sign each and every transaction.

The problem was simple, the solution is complex. And it works. It works so much that the current valuation of transactions of all bitcoins has surpassed USD 16 billion.

NSA of USA is used to say that, “if you have nothing to hide, you have nothing to worry”. Well it is time for the governments to come clean. If governments have nothing to hide, they should accept the blockchain technology for transparent and open accounting.

Read more on this accounting principle: How blockchain is changing the finance industry: Triple Entry Accounting

 

What is ‘proof of work’?

‘Proof of work’ in the bitcoin protocol simply means a proof of expending resources towards maintaining the bitcoin economy. The more resources you expend would mean more seriousness about the accuracy of transactions.

This proof of expending resources requires solving quadrillions (1016) of intricate mathematical calculations. The result of which would be verified by the bitcoin protocol.

The bitcoin protocol maintains a level of difficulty and the reward amount, proportionate to the number of bitcoins in circulation, to treat the proof of work. The difficulty level keeps changing according to the number of bitcoins in circulation. More bitcoins in circulation would mean more numbers of calculations required to claim the reward amount. Along with the difficulty, the reward also keeps changing. More bitcoins in circulation would mean lesser reward and vice versa. In the beginning (~2006) the reward was 50 BTC per solution, as of now it is 12.5 BTC.

Mining is the act of solving mathematical calculations in order to receive bitcoins as reward. A hash is one of these mathematical calculations (read about hashing). You need 2,107,420,200 trillion hashes 1 to earn the bitcoin reward of 12.5 BTC as of today: 13th March ’17.

 

The value of bitcoins

Very sophisticated equipment are required to perform these mathematical calculations. The best equipment I would recommend for mining as of now is the Antminer S9 it costs USD 2400. The S9 runs on a 1.4 KWh electrical input. It can solve thirteen trillion hashes in a second. It would take 162109246 seconds or ~45000 hours to get the promised reward.

So, to earn 12.5 bitcoins you will need to expend about 63,000 KW as of now. The price of 1 KW in Ahmedabad on a High Tension Maximum Demand line as of now is 260 INR.2 63000 KW would therefore set you off by ~INR 1.64 crores.

Include the component of the cost of the mining hardware, and it would not make business sense for an Indian. However consider INR 5 to 20 per KW of hydroelectricity in northern China.

Therefore if we ever have to, we can only buy bitcoins from those who produce it cheaply. You can buy one bitcoin at INR 93,519 from Unocoin today.3

This global disparity in energy prices is driving energy advantaged nations to own more bitcoins than they should have. And although the makers of bitcoins sought decentralisation of economic power, it is nonetheless the way it is.

The disparity thus creates relative acceptance of bitcoins across the globe. Some countries are better placed to accept bitcoins than others. Not surprisingly Chinese people own 58% of the current global bitcoin circulation.4

 

Hacking, fraud and crimes with bitcoins

Although there has been a spurt in usage of bitcoin for criminal activity, it was more pronounced at a time when mining bitcoin was fairly easier, and the price of bitcoin averaged below 100 USD a piece. It happened that people could mine their own bitcoins, and once you have that capability you are answerable to no one. The scenario changed soon after.

 

Government intervention

Fortunately, or unfortunately, the circulation of bitcoins rose, and the per bitcoin value increased due to increase in difficulty to generate one bitcoin. While this might sound unwelcoming, but yeah INR/BTC touched the 1 lakh mark.

Interesting things happened due to the massive success. The difficulty of mining increased, not everyone can generate bitcoins now, it has narrowed down to only huge bitcoin farms, having investments of millions of dollars. When someone invests so much on a technology, they actively lobby for government attention and for legal sanctions.

SO, as of now, all those who mine bitcoins also seek legal sanctions and they put in all possible efforts to get the government to recognise bitcoins as legitimate currency.

Bitcoin companies also wanted the government to restrict mining of bitcoins, by restricting entry to the market. Governments came up with KYC norms for bitcoin users, and all over the world bitcoin usage got some sense of legitimacy. KYC puts in a legitimate but difficult hurdle for new bitcoin companies who do not have market reach.

As of now, you are free, and it is perfectly legal to buy, sell and transact in bitcoins in India if you are ready to furnish your identification documents. Just search ‘buy bitcoin India’ on Google.

And as bitcoins are permanently and publicly trackable, KYC binds your bitcoins to your legal identity, exposing you to legal troubles if you abuse BTC. It is getting fairly difficult to abuse BTC everyday.

 

Blockchain analysis firms

As I told you earlier, that the technology gives us an irrefutable new method of accountancy. The blockchain technology which we use to trade in BTCs, is nothing but a permanent publicly available ledger. So anyone and everyone can go through the ledger to find out transactions which ever happened on the platform.

So this new set of fintech firms arrived, who built softwares to go through the BTC ledger and find out bitcoins which have been used for illegal purpose. They coined the term ‘dirty bitcoins’ and ‘dirty accounts’ to refer to bitcoins which have at least once been used for illegal purposes.

These firms track down criminals and their bitcoin accounts5 and sell the data to law enforcement agencies who were not so equipped to handle BTC abuse6. So we have to be careful that the BTC we use is not a dirty BTC, otherwise we might get into trouble.

Chainalysis is one firm which is doing good in this business. They have a tool through which if you have a specific customer that you are interested in, or a ransom note with a Bitcoin address, the tool will automatically find connected dirty bitcoins and bitcoin wallets.

 

Did/Can bitcoins replace fiat money?

No not yet, governments have legitimised bitcoin transactions, that does not mean it is a legal tender which the central bank needs to respect. To understand why BTC cannot even replace fiat money, we have to find out why the RBI respects the INR and not any other currency on earth.

There are so many better and stronger currencies lying around, say the USD or JPY, or even the GBP. Much less prone to demonetisation 😀 However, they are also not legal tender because the law does not say so.

But what is legal tender? We may decide to settle our transactions with anything as we please. I might offer you 34kgs of carrot for your smartphone. And it is recorded in Indian History that we have used spices and seashells as currency.

It is in this perspective that we distinguish between currencies of different types with legal tender. ‘Legal tender’ is a status accorded to any currency by the law of the land. Acceptance of legal tender for discharge of debt is the mandate by law. By the power of the law no one can deny acceptance of the new pinky 2000 INR notes.

The RBI Act of 1934, which gives the Reserve Bank of India the sole right to issue bank notes, states that “Every bank note shall be legal tender at any place in India in payment for the amount expressed therein”.

The Finance Act and the other relevant laws of India accord legal status of currency to INR only.

To get BTC recognised at par with INR, we have to first make sure that the interests of all BTC users are aligned with the Indian economic and political interests. Is that possible? The answer is no, unless we as Indians are cool with the global order of things.

INR gives us a personalised and customised sense of security, we know if anything goes wrong we still have the power to correct it via the RBI. That is missing with the BTC, USD, JPY and other currencies.

We need to be cool with the fact that BTC is only for international transactions, and the high volatility of the BTC is not what we want our economy to go through.

 

Future/s in BTC

We have been trading in futures for a long time now, futures of every currency is available. Mt. Gox started out as a future trading platform for BTC with other currencies.

The future of BTC is supposedly much neater. Irrespective of all sensational media reports India is never going to criminalise BTC.7 It would only harm us when other nations use it. It is a game among all heads of states, of who gets to get the most out of BTC.

Although taxes, and other hurdles may get put in place depending on how smart our lawmakers are.

 

The Mt. Gox incident – the largest bitcoin hack ever

An American software developer named Jed McCaleb founded a platform in 2006 named Magic: The Gathering Online eXchange. He set up the platform for secure exchange of trading cards used in a video game by the same name, using the domain name mtgox.com. This platform allowed cards to be bought and sold like stocks.

Some quarters say that it was this underlying technology of trading imaginary cards securely that formed the basis of bitcoins. Although McCaleb never released the original code written by him for Mt. Gox, it is true that the bitcoin technology is similar to such card exchange technology. It is also in popular notion that the anonymous author of the Bitcoin paper,1 Nakamoto, is probably McCaleb himself.

It is important at this juncture to understand how the bitcoin and blockchain works. I would recommend you to go through my earlier post on What are bitcoins / cryptocurrency / blockchain – what is so different than fiat money?

While China as of now, owns 58% of the global bitcoin circulation, it was not so until 2013 when the Japanese were leading the bitcoin race and Mt. Gox owned 70% of all bitcoins.

 

The origin

Mining is the act of maintaining and validating global bitcoin transactions by solving mathematical calculations. New bitcoins are created to reward the miners. Mining is the only way for creating new bitcoins.

Whoever, may be the author of the idea behind bitcoins, people found value and confidence in the literature, and joined in. People developed independent networks based on the paper and it grew at a time when mining was comparatively easy.

By 2008, people had bitcoins and they did not know what to do with it, just like money and stocks lying around. When money lies idle, you would need a banking system where you can put your money in return of an interest or for putting money to any use. And when shares of companies are idle you would want to trade them through an exchange.

So in 2010, to fuel the bitcoin economy through transactional exchanges and bring in new entrants, McCaleb used the domain mtgox.com to create a bitcoin trading exchange named Mt. Gox and incorporated it in Tokyo by the name MtGox Co., Ltd. It quickly found acceptance among Japanese bitcoin users. Mt. Gox was the first entity to hold bitcoins in large scale.

 

The Hack

On 19 June 2011, an account of an official auditor at Mt. Gox was compromised. His password was stolen by a hacker who manipulated the system and illegally transferred a large number of bitcoins to himself. He then went on to sell all these bitcoins at a very low rate using the exchange’s software, creating a massive “ask” order at any price. People globally bought these bitcoins at very cheap rates (some were sold at as low as 1 cent).

Although the price of bitcoins stabilised in minutes to its earlier rate, this hack resulted in loss of around 850,000 (750,000 of investors and 100,000 of its own) bitcoins to Mt. Gox, worth USD 473 million at that time. Compared to the global circulation of ~6,850,000 bitcoins at that time.

A lot of bitcoins were randomly dispersed by the hacker. He sent thousands of bitcoins to accounts which did not exist. These bitcoins can never be withdrawn or transacted with, as it is impossible to access without a password. The bitcoins were permanently lost from the global economy. This opened up a lot of flaws in the system. One of them being the inherent flaw in failing to check existence of accounts before transferring value.

Interesting to note that the hacker could not compromise the bitcoin technology, however, he could steal the password of an official auditor.

 

The cover-up

No one acknowledged the hack for years. It was only on 28 February, 2014, Mt. Gox finally acknowledged the three-year old hack. The company would not have revealed it had there been no need to file for bankruptcy.

Even after the 2011 hacking event bitcoin trading went on at Mt. Gox and in 2013 Mt. Gox came to own almost 70% of all global bitcoin circulation. However, the loss still needed to be accounted for.

Mt. Gox in the meantime kept looking for the missing bitcoins and could track and recover about 200,000 of the 850,000 bitcoins.

 

Aftermath

The company supplanted the loss of bitcoins by using its own store of bitcoins and the recovered amount. This costed the company about USD 473 million and it finally led the company to fail its payments to its creditors. CoinLab which was servicing the Mt. Gox investors in the North America region filed a lawsuit of USD 75 million. The lawsuit demanded Mt. Gox to transfer the accounts of its North American investors from Mt. Gox to CoinLab as per a contract they had entered earlier.

Neither did Mt. Gox have the money to transfer the accounts nor did it have the money to pay for the lawsuit. That is when it finally filed for bankruptcy protection in Tokyo on 28th February, and later in USA on 10th March.

On 16th April, 2014 Mt. Gox finally gave up its plan of restructuration and applied for liquidation.

Out of all this mess the CEO of Mt. Gox, Mark Karpelès, who bought 88% of the Mt. Gox business from McCaleb in 2011, was prosecuted in 2014. He was tried on the grounds of fraud, perpetration of fraud, manipulation of public data, and stealing of over USD 1 million from Mt. Gox. He had been arrested in Tokyo on a different set of allegations and was granted a bail in 2016. He is not allowed to move out of Japan as of now.

While the investigation on every aspect of the hack is still going on.

 

Lessons Learnt

Government regulations

People globally filed a lot of lawsuits, protests and demonstrations took place in Tokyo and the public conscience did get a jolt from the seemingly revolutionary technology.

Governments across the world realised that it was high time they need to interfere and regulate bitcoins.

 

Currency is irreplaceable

It was clear that no amount of technological innovation could render the responsibility a government or a central bank can assume in terms of human losses. A trusted middle man who can insure, validate and take legal action on a transaction is a requirement of any stable economy.

 

Failure of anarchy

In all types of anarchies, society somehow coagulates around the smartest or the strongest. The socio-legal and political fabric of such a system needs to be highly developed. A strong state machinery is therefore required in order to contain the exigencies of such systems.

 

So that’s how it ended. The largest bitcoin exchange which could have owned 60% of all bitcoins in circulation today, ended. Consequently, the concentration of bitcoins then changed hands from the Japanese to the Chinese due to their huge mining farms.


 

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