A BIT of A crypto Crisis

It’s as easy as setting up an e-mail address or operating a bank ATM, anyone can do it — this is what you may often hear from Bitcoin advocates. But here’s the catch: more than 50 per cent of the world’s largest cryptocurrency is owned only by about 2,000 users, most of them are connected and the trade is synchronised. The recent boom and bust of Bitcoin prices has proved this. “These heavyweight first movers, also known as whales, are working in collusion. Some of them are working on behalf of the super-rich and politicians,” said a source who worked with a cryptocurrency exchange in India.

Risky business

Whales want you to rely on their ‘Papa John’s pizzas’ story: On May 22, 2010, a web developer purchased two $23 Papa John’s pizzas using 10,000 units of Bitcoin. Crypto lobbyists claimed that it was the first known cryptocurrency transaction. By 2017, the $23 starting stake was worth more than $145.2 million. This story is still selling like hotcakes among ordinary investors in India and worldwide. Cryptocoin exchanges have been adding over 3,500 users a day and now have reached eight lakh downloads, said a source.

But after 16 booms in a year, there is panic. In December 2017, Bitcoin lost one-fourth of its value in just a day. This volatility could be an indication of ‘pump and dump’ manipulations and frauds. Manipulators ganged up like any other assets class to spike or shrink the cryptocurrency market at the cost of ordinary investors. Governments and regulators have rarely declared any clear-cut directions. There have only been advisories on Bitcoin — a form of digital payment maintained by an independent network of computers on the Internet‚ using cryptography to verify transactions. 

On November 13, a Supreme Court bench of Chief Justice Dipak Misra and justices AM Khanwilkar and DY Chandrachud said: “The emerging trend of crypto money, if unchecked and unregulated, is a threat to exchequer’s money and financial sovereignty of the country.” Finance Minister Arun Jaitley said: “Recommendations are being worked on. The government’s position is clear; we don’t recognise this as legal currency as of now.” After the apex court observation, all regulatory agencies became active.  The Income Tax department has sent notices to the offices of top nine Bitcoin exchanges.

The Union Finance Ministry cautioned people on December 29 against risks in trading in virtual currencies such as Bitcoin that lack government fiat and are not legal tender, comparing them with Ponzi swindles that offer unusually high returns, with early investors paid off with money from later ones. It, however, stopped short of announcing an outright ban or imposing any curbs. 

The caution follows a crackdown by the South Korean government on trading in cryptocurrencies which led to an 8 per cent drop in its value. Regulators in Hong Kong and Singapore have also warned against initial coin offerings, citing concerns about fraud, money laundering and terrorist financing.

Need for a parallel currency 

The September 2008 financial crisis almost brought the world economic activity to a halt. At that point, a group of technologists, who believed that the crisis was an organised scam, established Bitcoin. Satoshi Nakamoto, a name used by the unknown person or people, released Bitcoin in 2009, as an open-source software project. Litecoin was the first cryptocurrency which used Satoshi open source program in 2011. Currently, about 1,374 parallel currency have been created which are known as ‘altcoins’. According to Quandl, a leading provider of alternative data for financial services, there are currently 16,764,750 Bitcoins in circulation, and 6,05,853 Bitcoin users (unique addresses). Since Bitcoin’s inception in 2009 there have been a total of 28,62,14,316 Bitcoin transactions.

Currently, the value of Bitcoin is around $14,000 (Rs 9 lakh approximately). But Bitcoin is neither a currency nor a coin. It does not have any intrinsic value and is not backed by any kind of assets. The price is entirely a matter of mere speculation resulting in volatility. The Department of Economic Affairs has constituted an inter-disciplinary committee to examine global regulatory and legal structures governing Bitcoin and suggest a framework for regulation. The committee has submitted its report which is under consideration of the government.

Regulating volatility

Bittrex, the third-largest cryptocurrency exchange in the world, recently took steps to prevent price manipulation. In an e-mail to its members, Bittrex said: “Within the next two weeks, the minimum allowable trade value for orders will go from 50,000 Satoshi to 1,00,000 Satoshi (1 Satoshi =1/10,00,00,000 BTC).  We will also require a minimum trade quantity on a per market basis”. It further added: “Bittrex actively discourages any market manipulation, including pump groups.  Consistent with our terms of service, we will suspend and close any accounts engaging in this type of activity and notify the appropriate authorities.” John McAfee, the first anti-virus maker, has overlooked such collusions and is still bullish on Bitcoin’s future. He believes that the recent crackdown is the main reason for the latest volatility and Bitcoin’s price will go up again.

Cryptocurrency expert Dr Sanjay Sharma said that the general impression conveyed was that authorities could spoil the party, and the limitations of the governments in actually exerting control were underplayed in the mass and social media. “It would be interesting to see how the cryptocurrency markets are going to react when the limitations of governments in controlling and unearthing cryptocurrencies are better recognised.”

Mining virtual coins

Indian cryptocurrency geeks have been offered to set up mining centres after the Chinese government ordered closing down of Bitcoin mining in the country. Indian crypto players are accepting such offers albeit on a rider: there won’t be any deviation from the government of India’s guidelines on cryptocurrency. More than three quarters of mining computers have been installed in China alone, and they produced 80 per cent of the world’s Bitcoin supply while India operations account for just two per cent, after the Czech Republic and other Scandinavian countries. Bitcoin mining consumes large quantities of energy because it uses computers to solve complex maths puzzles to validate transactions written to the blockchain, or digital ledger. 

There are technical constraints, too. The blockchain technology platform is the backbone of cryptocurrencies, including Bitcoin. In 2008, when the Bitcoin technology was designed, each block was fixed at 1MB, and after nine years, this capacity is exhausting in handling the growing traffic. The current upper limit is approximately seven transactions per second, as against thousands by popular payment options like Visa or MasterCard.

Julian Hosp, co-founder and president of Singapore-based blockchain company TenX, which makes multiple virtual currencies instantly spendable in the real world, reportedly said “I don’t think it’s going to be a bubble that’s just going to burst and everyone is going to lose their money, but I think it’s going to be that all the coins and all the assets with very little use or value are going to get sorted out.”

CRYPTO TRADE

1,374 Parallel currency called altcoins

16,764,750 Bitcoins in circulation currently

6,05,853 Bitcoin users (unique addresses)

28,62,14,316 Bitcoin transactions since its inception in 2009

WHAT IT IS AND HOW IT WORKS

It is a virtual token money which does not have any physical backing like other currencies. Records of Bitcoin transactions and balances are stored on thousands of computers across the globe. Bitcoin prices depend on demand and supply of users. You can exchange it on the Internet with a unique code. It’s decentralised so no need of any central clearing house like banks to complete transactions. It’s unregulated and without a reverse transaction.

If you want to buy something through Bitcoin, you have to just transfer a symbolic code to the seller’s wallet account through the Internet. Each currency can be split into a different fraction to ease transactions. If you have a Bitcoin, it does not mean that you have a coin. You have only a Bitcoin address (numbers) and a key (password). The Bitcoin address is mentioned in transactions ledger book known as blockchain. If you want to send Bitcoins from your address to others, you have to create another block on blockchain. Once the transaction is complete it appears on the blockchain and anyone can see it on the Internet.

Bitcoins are not unlimited. A group of people known as Bitcoin miners generate one Bitcoin every 12.5 minutes. So far 16 million Bitcoins have been mined. Once it reaches 22 million by 2147, its mining will be stopped.

TERMINOLOGY

BLOCKCHAIN: 
All cryptocurrency, including Bitcoin, transactions are grouped into blocks. Each block has created a hash, a digital number like the last digit of credit or debit card numbers. Since each block is also hashed with the chain of previous blocks, the entire chain of blocks or ledger book is fully secured and tamper proof.

WALLET: 
A digital file where you can keep your key. A kind of program which creates and manages your address.

ICO: 
Initial coin offering in which you are buying stocks in a company bypassing all capital market regulator (SEBI) checks. These are business plans for companies that are themselves selling ‘shares’ via coins, which will then be traded on some crypto exchanges. According to Autonomous Research, in 2017 companies have raised $400 crore through ICO, up sharply from $22.5 crore in 2016.

KEY CHECKS

1. Who is promoting or marketing the product, what are their backgrounds, and are they licensed to sell the product?
    
2. Have they been paid to promote the product?
    
3. If a digital wallet is involved, what happens if I lose the key? Will I still have access to my investment?
    
4. Is the blockchain public? Has the code been published, has there been an independent cybersecurity audit?
    
5. Availability of legal protections in the event of fraud, hack, malware, or downturn in business prospects?

‘Different from a Ponzi scheme’

Manu Prashant Wig, Director, Blue Fox Motion Pictures says plans are afoot to seek legal approval to crypto BFXC and pay tax on it. DNA talks to him about his cryptocurrency and its market dynamics.

The BFX coin business model seems to be a Ponzi scheme as there are no pledged assets to support the price.

Not at all. We only use referrals to promote the business. In a Ponzi scheme, the top level earns, whereas the lower ones are at loss, plus the only way someone earns is through referring others.

But in our referral system, there is no such thing. Anyone at any level can earn more than their sponsor or inviter. Plus, there is no compulsion to refer people to the system. Mining incomes are generated for all as per the mining pool deliveries.

Your group has said that BFX coin has raised more than Rs 300 crore. Where is the investors’ money going and what will it be used for?

This is not fully true. We have sold 33 per cent ICO through the referral system and held back 66 per cent for corporate buying and other marketing and mining activities to be funded at a later stage.

The ICO funds will be used for various projects being undertaken by Blue Fox abroad and even in India.