Background

Cryptocurrency refers to a form of virtual currency that exists solely in the online realm. Although it cannot be physically seen or touched, it has an assigned value. This type of virtual currency does not have a central bank or governing body overseeing its regulation. It operates based on digital records stored across computers worldwide. In various countries, cryptocurrency can be utilized for purchasing goods or making payments.
In contrast, Nepal declared cryptocurrency transactions illegal during the year 2074 B.S. The Nepal Rastra Bank has been issuing warnings against engaging in such transactions. Due to concerns about potential fraud affecting the general population and risks of illegal money transfers and capital flight from the country, cryptocurrency has not been legally recognized in Nepal so far.
According to the CoinDesk website, Nepal ranks 16th globally regarding cryptocurrency transactions according to the Global Crypto Adoption Index of 2022. Countries like the UK and Indonesia rank lower than Nepal. This indicates that despite the ban in Nepal, there remains a significant level of activity related to cryptocurrency.
Currently, approximately 23,000 cryptocurrencies are in circulation around the world. Among these, Bitcoin is notable as it has been in existence since 2009. Bitcoin accounts for 42% of the total market capitalization of all cryptocurrencies.
Not only Nepali citizens residing in Nepal but also foreign nationals living in the country and expatriate Nepalis abroad are found to be involved in cryptocurrency transactions. There are indications that many individuals, attracted by the prospect of quick profits, have fallen prey to pyramid schemes and hyper-fund networking activities associated with cryptocurrencies.
Presently, economic transactions in Nepal require the involvement of buyers, sellers, banks, financial institutions, and intermediaries. These entities are typically involved in some capacity within the transactions. However, cryptocurrency transactions can occur directly between a seller and a buyer without requiring intermediaries or their assistance. Consequently, the role of regulatory bodies is diminished because the transaction occurs directly between the parties involved.
Since cryptocurrency lacks legal recognition, it cannot replace official currency. Distinct institutions like the Nepal Rastra Bank exist to manage national currency. Nevertheless, cryptocurrency can facilitate the buying and selling of items akin to traditional currency. Many nations recognize cryptocurrency as a form of electronic asset, allowing governments to collect taxes on transactions made through them.
In developing countries like Nepal, cryptocurrency remains a novel concept. Without understanding the methods and implications involved in investments, one cannot confidently claim that good returns will be achieved. Residents in developed countries tend to be more informed, enabling them to assess risks versus benefits accurately, influencing their investment choices accordingly. Conversely, due to its novelty, there seems to be a higher risk associated with cryptocurrency in Nepal.
This technology is rooted in advanced concepts. Accessing it necessitates an internet connection, and it also requires powerful graphic cards and computers. A significant amount of energy is needed for its operation, which can negatively impact the environment due to energy consumption. Since cryptocurrency operates outside the purview of central financial systems, risks cannot be disregarded. There are ongoing reports of individuals investing with insufficient knowledge, exposing them to considerable risk. Such unregulated financial transactions could pose significant threats to the economy in a fragile economic landscape like that of Nepal.
Due to the intangible nature of cryptocurrency, when errors occur during transactions, correcting them becomes challenging. In cases where an individual who deals in cryptocurrency passes away, their assets might become unclaimed. This topic is generating extensive discussion in the global economy. While it can be used to buy and sell services or commodities, most countries do not officially recognize it as currency.

Technologies and Sources of Cryptocurrency

In current payment systems, if cash serves as the payment medium, it is crucial to verify whether that cash is genuine or counterfeit. For electronic payments, the banking or financial institution responsible for the payee maintains a record to confirm the validity of those transactions. This includes verification of the balance, proper payment orders, etc. In the context of cryptocurrency, such authentication occurs using blockchain technology without the need for financial intermediaries.
When any transaction occurs on the blockchain, all members connected to that network receive notification of the transaction. A collective consensus validates new groups of transactions (also known as blocks), and these validated blocks are organized in sequence with previous blocks. Each new block links to the prior block, making it difficult to spend funds that are not owned or to re-spend already spent funds (double spending), as doing so would require altering all previous blocks. Blockchain is often referred to as a distributed ledger.
Cryptocurrency can primarily be acquired through two sources: mining and purchasing. Mining involves maintaining account records of transactions on a particular cryptocurrency network; thus, it is also termed validation. During cryptocurrency transactions among users, validators/miners compete to confirm the legitimacy of the trade, and those who succeed in validating the transactions earn cryptocurrency as a reward.
Additionally, cryptocurrency can also be obtained by purchasing it from other parties. Such purchases can be conducted through cryptocurrency exchanges. Globally, there are currently around 450 cryptocurrency exchanges.

International Practices Regarding Cryptocurrency

While some countries globally permit cryptocurrency use for payments, none, apart from El Salvador and the Central African Republic, have granted it the status of legal tender. In contrast, other nations do not recognize cryptocurrency as currency but acknowledge it as a commodity or digital asset, regulating its mining, purchase, sale, and ownership.

United States:
Cryptocurrency exchanges are considered legally compliant in the United States. They fall under the regulatory framework of the Bank Secrecy Act (BSA) and must be registered with the Financial Crimes Enforcement Network (FinCEN). Furthermore, they are required to adhere to Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) obligations.

FinCEN classifies cryptocurrency as a medium of exchange operating similarly to money in certain environments, although lacking all characteristics of traditional currency. These cryptocurrencies act either as equivalents to real currencies or function as substitutes.
• The Securities and Exchange Commission (SEC) typically regards cryptocurrency as a security, while the Futures Trading Commission (CFTC) categorizes Bitcoin as a commodity, and the Treasury describes it as a form of currency.
• The Internal Revenue Service (IRS) states that transactions involving cryptocurrency are subject to taxation, similar to property dealings, which means that cryptocurrency taxpayers must disclose their transactions when filing returns.

• The US Federal Reserve is conducting research on the operation, benefits, risks, and applications of Central Bank Digital Currency (CBDC).

India:
• The Reserve Bank of India (RBI) introduced the "Cryptocurrency and Regulation of Official Digital Currency Bill, 2021" in Parliament, aiming to prohibit all private cryptocurrencies in the country but allowing exceptions to promote underlying technology and usage.
• The bill lacks clarity in defining private cryptocurrencies and grants investors a six-month period to liquidate their holdings.

• The Reserve Bank of India plans to introduce a state-owned cryptocurrency or digital currency.

• Cryptocurrencies are not regulated in India. The government has declared that cryptocurrencies are not legal tender and has advised its citizens against engaging in cryptocurrency transactions. A committee was formed to report on the use of cryptocurrencies in India, which recommended a complete ban on private cryptocurrencies.

• However, following the announcement in the federal budget for 2022 that a 30% income tax would be levied on transactions involving intangible assets and Non-fungible tokens (NFTs), it appears that the Indian government has somewhat legitimized cryptocurrencies.

Countries that have recognized cryptocurrency legally

• United Kingdom
• Australia
• El Salvador
• Central African Republic (CAR)
• South Korea
• Canada
• Japan
• Switzerland
• European Union among others.

Countries that have imposed bans on cryptocurrency

• China
• Nepal
• Bangladesh
• Morocco
• Qatar
• Saudi Arabia among others.

Nepal

• It has been observed that both local and foreign nationals residing in Nepal, as well as Nepalis abroad, are illegally trading in cryptocurrencies, sometimes through pyramid schemes like hyperfunds promising quick profits.
• Considering the potential capital flight, adverse impacts on remittance flows, and challenges in managing foreign exchange reserves, the Nepal Rastra Bank has imposed a ban on cryptocurrencies under Section 12 of the Foreign Exchange Management Act, 2019.

• The Nepal Rastra Bank first made a public announcement on July 13, 2017, declaring Bitcoin illegal, and later on July 15, 2022, it issued additional information related to cryptocurrencies.

• Given the inquiries from various stakeholders about cryptocurrencies, the Nepal Rastra Bank conducted a risk analysis incorporating various related topics.

Incidents involving cryptocurrency transactions:
• On January 28, 2022, Raviindra Adhikari, 30, from Duwakot-2, Bhaktapur, was arrested on charges of being involved in the trading of banned digital currency cryptocurrencies, reportedly amassing transactions worth NPR 14.844 million within three months.

• Three individuals were arrested by the police for conducting financial transactions using cryptocurrencies/Bitcoin. They were identified as Rajan Bhattarai, Bishal Shrestha, and Dipenraj Shrestha, who engaged in extensive transactions with hundreds of people between November 2022 and January 2023.

• Vishwaram Shrestha from Mandandeupur, Kavre, was detained on July 17, 2022, for allegedly trading in cryptocurrencies and foreign currencies, leading to court charges regarding these transactions.

• The Central Investigation Bureau (CIB) has claimed damages exceeding NPR 40 million in a Bitcoin trading case filed in Kathmandu District Court against several individuals involved in online financial transactions.

• Prashant Pratap Shah was caught conducting Bitcoin mining activities after renting premises in Dolakha, where police seized a significant amount of equipment during a raid.

Challenges

• Investing in cryptocurrency poses risks of capital flight, which could greatly threaten economic stability and complicate management of foreign exchange reserves due to possible mass exodus of funds.

• Given that Nepal's economy heavily relies on remittances, allowing cryptocurrency trading could significantly reduce remittance levels.

• Cryptocurrencies can facilitate not only online black market activities but also the laundering of illegally obtained money and enable illicit trades similar to hawala systems.

• Engaging in cryptocurrency transactions may heighten the risk of funding criminal activities, including terrorism.

• Cryptocurrency use has been linked to illegal activities, especially scams and tax evasion.

• In a country like Nepal, where financial literacy is low, users of financial services might be at even greater risk.

• Cryptocurrencies have the potential to become tools for hiding corruption or illegal income beyond mere transactions and payments.

• Such cryptocurrencies may also be utilized in the promotion of drug trafficking and human smuggling operations.

• Lack of legal recognition currently leaves users without recourse for disputes, resulting in vulnerabilities such as fraud and loss of investments without any legal remedies.

Suggestions

Given Nepal's low level of financial literacy, consumers of financial services remain vulnerable, further exacerbated by the risk of losing investments. It is crucial to gain clarity on how to regulate or control cryptocurrencies through expert studies on their current status.
• There should be a complete ban on cryptocurrencies to discourage illegal trading activities.
• An expert committee needs to be formed for researching cryptocurrencies and digital currencies.
• Educational campaigns through all media channels should be launched to warn the general public against investing in cryptocurrencies or digital currencies.
• Advanced blockchain analysis techniques should be developed and employed to trace and track suspicious transactions and activities.
• Strict actions need to be instituted against those participating in cryptocurrency and digital currency trading.

Conclusion

The potential for capital flight from cryptocurrency trading poses risks not just to the economy but also to individual investors and participants who face considerable uncertainties. With no backing from any nation or regulatory body, these assets lack protection and serve primarily speculative purposes, often exploited by specific groups for their interests. Therefore, it is imperative that investments in cryptocurrencies and digital currencies be heavily discouraged.