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What is a Bitcoin?
Bitcoin is a digital currency. It is decentralized and there is no government, institution (like a bank) or other authority that controls it. Owners are anonymous; instead of using names, tax IDs, or social security numbers, they use wallets with specific addresses. Bitcoin connects buyers and sellers through encryption keys. Bitcoins are not issued from the top down like traditional currency; rather, they are "mined" by powerful computers connected to the internet.

It was invented in 2009 by a person (or group) who called himself Satoshi Nakamoto. His stated goal was to create "a new electronic cash system" that was "completely decentralized with no server or central authority." After cultivating the concept and technology, in 2011, Nakamoto turned over the source code and domains to others in the Bitcoin community, and subsequently vanished. 

What is mining?
Bitcoin mining is the process by which transactions are verified and added to the public ledger, known as the block chain, and also the means through which new bitcoins are released.  Anyone with access to the internet and suitable hardware can participate in mining.  The mining process involves compiling recent transactions into blocks and trying to solve a computationally difficult puzzle.  The participant who first solves the puzzle gets to place the next block on the block chain and claim the rewards.  The rewards, which incentivize mining, are both the transaction fees associated with the transactions compiled in the block as well as newly released bitcoin.

Mining is competitive and today it can only be done profitably with the latest ASICs.  When using CPUs, GPUs, or even the older ASICs, the cost of energy consumption is greater than the revenue generated

How does a transaction in bitcoin happen?
A transaction is a transfer of value between Bitcoin wallets that gets included in the block chain. Bitcoin wallets keep a secret piece of data called a private key or seed, which is used to sign transactions, providing a mathematical proof that they have come from the owner of the wallet. The signature also prevents the transaction from being altered by anybody once it has been issued. All transactions are broadcast between users and usually begin to be confirmed by the network in the following 10 minutes

What determines the value of a Bitcoin?
Ultimately, the value of a Bitcoin is determined by what people will pay for it. In this way, there's a similarity to how stocks are priced. The protocol established by Satoshi Nakamoto dictates that only 21 million bitcoins can ever be mined -- about 12 million have been mined so far -- so there is a limited supply, like with gold and other precious metals, but no real intrinsic value. (There are numerous mathematical and economic theories about why Nakamoto chose the number 21 million.) This makes Bitcoin different from stocks, which usually have some relationship to a company's actual or potential earnings.

Without a government or central authority at the helm, controlling supply, "value" is totally open to interpretation. This process of "price discovery," the primary driver of volatility in Bitcoin's price, also invites speculation.

How do small investors invest?
Investors can invest in bitcoins via bitcoin exchanges. Some of the Indian players are Zebpay, Coinsecure, Coinmama among others. 

What do the lawmakers say?
Although the Reserve Bank of India (RBI) advises caution on its use, bitcoin is not illegal in India. Cryptocurrency exchanges operate freely and hence we can say that bitcoin is legal. 

The RBI has so far issued three notifications pertaining to bitcoin and other virtual currencies (VC). In all these, starting December 2013, the RBI has cautioned users, holders and traders on the risk of these currencies and clarified that it has not given any licence or authorisation to any entity or company to operate such schemes or deals. In a December 2013 notification, the RBI said, “The creation, trading or usage of VCs including Bitcoins, as a medium for payment are not authorised by any central bank or monetary authority. No regulatory approvals, registration or authorisation is stated to have been obtained by the entities concerned for carrying on such activities.” Other than cautioning the public, the RBI hasn’t taken any regulatory stance on virtual currencies yet.

Though there are still no clear regulations or proper jurisdiction, the income-tax department is clear that tax has to be paid on all cryptocurrency transactions. Though there is no mention of cryptocurrencies in the Act, income tax will still have to be paid on any gains accruing from cryptocurrency transactions. 

(Shubham is a Chartered Accountant and MBA (Finance). She is on the forum of “Economic Times” experts on Taxation.   She specialises in Individual Taxation and Taxation of Freelancers & Small businesses. She can be reached on for answering your tax related questions.)
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