What exactly is Bitcoin, and how exactly does it work? - Blackswan Fx

What exactly is Bitcoin, and how exactly does it work?

Bitcoin is a decentralized digital currency that is traded directly between two parties, without the need for intermediaries such as banks or other financial institutions.

Bitcoin, as outlined in a whitepaper published by Bitcoin’s anonymous creator Satoshi Nakamoto, is “a peer-to-peer version of electronic cash that would allow internet payments to be made directly from one party to another without the involvement of a banking institution.”

To comprehend Bitcoin, one must comprehend its basic structure, the method in which the Bitcoin ecosystem operates, and the scope of its use in India.

How does Bitcoin function?

With the help of its underlying technology, blockchain, Bitcoin eliminates intermediaries.

Currently, if you need to transfer money to someone, you can either give them cash or employ a trusted third party (example, a bank). Both techniques, whether real currency (with the country’s central bank as surety) or electronic transfer, include a middleman (in the later case, a bank or another financial institution). When intermediaries are involved, transaction expenses are incurred.

By replacing the trust that middlemen bring to the table with cryptographic evidence using CPU computing power, blockchain technology facilitates the elimination of intermediaries.

This cryptographic trust is embedded into Bitcoin via a wallet, a public key, and a private key.

By downloading the Bitcoin application, anyone can build a Bitcoin wallet at no cost. Each wallet includes both a public and private key.

The public key is analogous to an address or account number via which anyone can receive Bitcoins.

A private key is analogous to a digital signature and is used to send Bitcoins. The name implies that private keys should only be retained and known by the owner, whereas public keys can be shared with anybody in order to get Bitcoins. That is where you would have read about Bitcoins being lost owing to an inaccessible private key or being stolen by hackers.

The owners of Bitcoin addresses are not explicitly identifiable, but all blockchain transactions are public.

Since the launch of Bitcoin in 2009, every single transaction has been recorded in a ledger that is considered immutable, tamper-proof, and irreversible.

Using encryption, Bitcoin transactions are validated by network nodes and then recorded in a decentralized distributed ledger called blockchain. This is one of the characteristics that distinguish Bitcoin from other crypto assets, where all transactions must be routed or approved through a centralized exchange (like the stock exchange).

How is Bitcoin Mining Performed?

There is a network of miners in the Bitcoin ecosystem who use their CPUs to process transactions.

After a user who intends to send Bitcoin enters the public address, the number of Bitcoins to be sent, and the private key to generate a signature, the encrypted information is sent to the network of miners, who are tasked with determining if there is sufficient balance to transfer and authenticate the transaction.
The faster the CPU of the miner, the greater the likelihood that the transaction will be verified and that the miner will be compensated in Bitcoins for enabling the transaction.
Here, the miner’s main responsibility is to offer CPU power, which is used to automatically validate Bitcoin transfers by running the Bitcoin program. The Bitcoin miner does not do any manual actions.
As soon as a Bitcoin miner processes a transaction, the number of transactions is broadcast to the network of miners who receive a copy or download of the same block.
Through a timestamping process, these blocks are kept in sequential or chronological order to form a blockchain. Each miner on the network is required to have an up-to-date and comprehensive copy of the ledger or blockchain in order to facilitate Bitcoin transactions and earn cryptocurrency.
The program is designed such that the distributed ledger or blockchain is automatically updated.

According to the Bitcoin whitepaper, the likelihood of hackers interfering with the blockchain is close to zero because each miner carries an updated copy of the ledger. If someone attempts to tamper with or hack the ledger to obtain an unfair advantage, the miner is immediately deemed invalid and is prevented from processing transactions until they receive a copy of the untampered ledger.

Can Bitcoin be Regarded as a Genuine Currency?

As Bitcoin has no fundamental worth, it is controversial whether or not it is a currency and why any country would desire to replace it with their existing currency.

A currency is defined as “a system of money in general use in a particular country” or “the fact or attribute of being extensively accepted or used.” There is some growth in the number of businesses using Bitcoin as a payment method, but no major government or economy has embraced it as a currency for general use. El Salvador, which approved Bitcoin as legal cash in September 2021 and became the first nation to do so, is an exception.

The tightening of know-your-customer (KYC) and anti-money laundering (AML) laws by banks and other financial institutions is a significant factor in Bitcoin’s amazing development. There is now a lot higher sharing of information across international borders regarding financial system activity.

Consequently, it is asserted that Bitcoins are extensively utilized as an alternative channel for transactions that would otherwise be unlawful in a number of nations.

Bitcoin’s acceptability as a worldwide payment system, which is not tied to a particular country’s currency and is therefore not immediately impacted by the changes within a particular country, is another crucial factor.

Bitcoin regulation in India

This year saw two significant regulatory developments in India:

In February 2022, the Indian government proposed taxing virtual digital assets, which would imply a taxation system for cryptocurrencies. However, it is unclear if the Indian government views cryptocurrencies as legal “assets” or “currencies”.

Since then, India’s Finance Minister has declared unequivocally that “taxing cryptocurrencies does not mean legalizing them.” This suggests that the government is still reviewing all variables linked with cryptocurrencies, thus it is premature to speculate on their legality.

Bitcoin taxation in India
Even though India has not articulated its position on the legality of Bitcoin investments, the recently released Budget 2022 and Finance Bill 2022 propose to provide a framework for taxing virtual digital assets. Once the Finance Bill is signed into law, the aforementioned framework will become applicable beginning with the Financial Year 2022-2023.

Transfers of Bitcoin will be subject to a 30% capital gains tax, according to the proposed budget for 2022.

The government proposes to add a new section 115BBH to the Income Tax Act of 1961 (the “IT Act”) for the taxation of income derived from the transfer of virtual digital assets. In accordance with said clause, if the total income includes any revenue from the transfer of virtual digital assets, said income would be subject to a 30% tax rate, which would be increased by a surcharge rate, if applicable, and a health and education cess.

In accordance with Section 2 (47) of the IT Act, virtual digital assets are defined as any information, code or number or token (other than Indian or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value or functions as a store of value or unit of account, including its use in any financial transaction.

Consequently, the concept of virtual digital assets is sufficiently broad to encompass all types of cryptocurrencies, including Bitcoin.

Any gains arising from the transfer of Bitcoins would be subject to a 30% tax rate (plus appropriate surcharge rate and health and education cess), resulting in an effective tax rate between 31.2% and 42.7%.

Eligibility to claim a tax deduction for Bitcoin-related expenses.
The proposed regulations stipulate expressly that any deduction for expenditures (other from purchase costs) undertaken by the assessee in regard to such digital assets would not be recognized for computing gains from transfer of such assets. Simply put, only the cost of acquiring digital assets, such as Bitcoin, will be deductible.

If an individual earns a Bitcoin through mining, the Bitcoins can be viewed as self-generated capital assets. The rules of Section 55 of the IT Act, which govern the computation of cost of purchase of self-generated assets, do not, however, include a specific method of computation for cryptocurrencies.

Therefore, clarity about the computation of Bitcoin’s purchase cost when received from mining is essential.

Additionally, if a Bitcoin is received as a gift, the recipient would be subject to taxation in India, and the definition of “property” under Section 56(2)(x) has been changed to include virtual digital assets. The rule also prohibits the taxpayer’s or investor’s ability to deduct the loss from the transfer of virtual digital assets against other income.

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