The legal status of cryptocurrency in Russia

The rapid rise of Bitcoin’s exchange rate, which has already crossed the 6,000-dollar mark, unsurprisingly sparked an increase in its popularity, including in Russia. If virtual money was previously used mostly to pay for illegal services, today it is actively used for lawful purposes, and the number of those wishing to create their own cryptocurrency (miners) is experiencing virtually geometric growth. At the same time, it is impossible to talk about Bitcoin as an established legal institution with a certain legal status. Such uncertainty is fraught with significant risks for both professional market participants and ordinary miners.

Bitcoin

Bitcoin (from the English ‘bit’ plus ‘coin’; a bit is a data unit) is an electronic unit of money, introduced in 2009 by a user whose handle was Satoshi Nakamoto; people believe this was linked to the 2009 crisis more than anything else. According to some sources, this pseudonym does not belong to a single person, but to a group of engineers, but the creator of Bitcoin has not been identified to this day.

The principal feature of Bitcoin is that it is not tied to any existing government currency, but can be exchanged for dollars or Euro.

Blockchain

At the foundation of most cryptocurrencies is the so-called peer-to-peer principle, which presumes that users have equal rights when they are circulated, based on the principle of decentralization. By the same principle, torrent trackers have been set up –servers that are popular today to exchange information over the Internet (music, movies, programs, etc.), and they most often presume that users not only passively download information from the Internet, but actively distribute it. And that they do not take this from some kind of special server, but in reality from the computers of other, similar users in a decentralized network. A peer-to-peer network, as a general rule, automatically turns a participant not only into a consumer, but into an active participant in the entire process.

Thanks to the peer-to-peer principle, cryptocurrency (unlike physical currency) is isolated from administration on the part of government agencies.

The technology by the name “blockchain” (from the words block and chain) represents a distributed database that contains information on all the transactions performed by the system’s participants. This data is stored in the form of “chains of blocks”, and in each one a certain number of transactions is recorded. The key property for the system is distribution. There is no single place where all the entries in the registrar or cryptocurrency bank are located. The registry is stored simultaneously with all the participants in the system, and an updated version is produced automatically when any change is entered.

This means that the users act as a “collective notary” that vouches for the accuracy of the information in the database.

Mining

The process of issuing bitcoins, so-called mining, is the only way to receive cryptocurrency. The essence of mining lies in the fact that computers located in different spots around the planet solve math problems, and as a result bitcoins are created.

In total, the algorithm is designed to mine 21 million bitcoins, and according to calculations the last bitcoin will be mined in 2140.

Legal regulation

From the point of view of legal regulation, bitcoin, like other cryptocurrencies, is still outlawed. The fact is that the very concept of cryptocurrency is not named as a proprietary item under Article 128 in the Russian Federation Civil Code (hereinafter the RF CC) that has the necessary commercial negotiability.

Proprietary items include things like cash, certificated securities, and other property, including cashless settlements, uncertificated securities, property rights, the products of work or the provision of services, the legally protected products of intellectual activity property assets and intellectual property designations (intellectual property assets), which have the same legal status, and intangible benefits.

The most obvious way out of the situation that has arisen seems to be an attempt to confer the status of money on cryptocurrency, owing to its obvious substantive similarity, and apply the appropriate legal doctrine by analogy. However, upon deeper analysis this kind of analogy is not well-founded. And here is why.

All money is categorized by legislative bodies as property, with cash as goods and cashless settlements as other property.

Section 1, Article 75 in the Russian Federation Constitution establishes that:

–the unit of currency in the Russian Federation is the ruble

–currency issuance is performed exclusively by the Bank of Russia

–issuing other money is not allowed.

In accordance with Article 140 in the Russian Federation Civil Code, the ruble is legal tender that must be accepted at face value anywhere in the Russian Federation. The procedure and conditions for using foreign currency in the Russian Federation are determined by law, or in accordance with the procedures established by it.

In accordance with Clause 2, Section 1, Article 1 I Federal Law 173-FZ, dated December 10, 2003 “On currency regulation and currency control,” foreign currency includes:

–currency in the form of bank notes, treasury notes, and coins in circulation that are a lawful means of cash payment in the relevant foreign state (or group of foreign states), as well as bank notes that are in the process of being withdrawn, or have already been withdrawn, from circulation, but are redeemable

–funds in bank accounts and in bank deposits denominated in the currency of foreign states, or in international monetary or payment units.

This means that Bitcoin, in terms of legal regulation, does not count either as Russian money or foreign money, and is a sort of currency substitute.

Along with that, as established by Article 27 in Federal Law 86-FZ, dated July 10th, 2002 “On the Russian Federation Central Bank (the Bank of Russia)”, introducing other monetary units, and issuing currency substitutes, is prohibited.

This kind of uncertainty with the legal status of cryptocurrencies is aggravated by the existence of a range of ambiguous signals coming out of various government agencies, and from various officials, as well as by the fact that different bills get introduced that contradict each other.

Specifically, the first official mention of Bitcoin in Russia dates back to 2014, and is associated with the release of an Informational Bulletin from the Bank of Russia dated January 27th, 2014 “On the use of ‘virtual currencies for transactions, and Bitcoin in particular’ (hereinafter - Bank of Russia Informational Bulletin); regulators used this to draw the attention of interested people to the lack of security and legally parties when cryptocurrency is being circulated. According to the Bank of Russia, operations that use it are speculative in nature, are performed in so-called virtual exchanges, and are marked by a high risk that the currency’s value could be lost.

A similar legal position was expounded in an Informational Message from Rosfinmonitoring (the Federal Service for Financial Monitoring), dated February 6th, 2014 “On using cryptocurrencies”, which also issued a warning on the consequences of using bitcoins.

If we follow “official activity”, then we can conditionally single out at least two basic approaches that exist today toward the regulation of cryptocurrencies. Let’s call them “permissive” and “prohibitive”.

Strangely enough, the Bank of Russia is among the supporters of the first group. After the Bank of Russia released its Informational Bulletin in 2014 on the inadmissibility of using cryptocurrencies, and the related risks, regulators softened their rhetoric somewhat and took a more tolerant stance, indicating that the technology is being studied and, over the long term, can be covered by the appropriate legal regulation. In particular, during his time as first deputy chairman of the Bank of Russia, Georgiy Luntovskiy (who left the position on September 1st this year) repeatedly stated that the Bitcoin market is being watched, the issue is being studied, and possibly in the future appropriate statutory regulation will be enacted¹.

At the same time, the position of the «power» coalition of government agencies is quite unambiguous and steadfast, and calls for introducing a total ban on cryptocurrencies and applying penalties, including for mining. For example, on September 1st, 2017 it came out that for the first time in Russia, in Kostroma, criminal charges were filed against three members of a group who were engaged in mining of bitcoins and selling them on the Internet. These individuals are charged with committing a crime under Section 2, Article 172 in the Russian Federation Criminal Code, meaning illegal banking activities committed by an organized group associated with deriving an especially large amount of revenue. This regulation calls for a penalty that can entail incarceration for up to seven years.

Having said that, everyone seems to agree that the technology itself can, over the long term, become a promising instrument and convenient platform –for example, to perform international transactions.

As an illustration, we can single out the deal between Irish dairy producer Ornua and the Seychelles Trading Company, made using blockchain technology in September 2016. Settlement under a letter of credit for 100,000 dollars to ensure the export of a batch of cheese and butter from the Irish agricultural cooperative to the Seychelles Trading Company (STC) was made, with Barclays (UK) and the startup Wave (Israel) also taking part. The transaction was concluded in less than four hours, keeping in mind that this kind of process usually takes from one week to ten days due to the difficulty of drafting the supporting documentation, including the necessity of exchanging the originals using mailing service companies. In the described situation, the cryptographic protection and verification mechanisms from blockchain permitted accomplishing all operations over the Internet, without the need for third-party verification².

A bit later, in December 2016, the first major business-to-business transaction of its kind took place: S7 Airlines and Alfa Bank concluded a transaction and paid for services provided under a letter of credit using blockchain technologies. Both stages in the transaction were registered in the form of smart-contract transactions, and were recorded in the blockchain distributed register. For example, the customer that ordered the work submitted an application to open a line of credit, and the contractor presented the bank with the documents attesting that the work was performed and the services were provided. The money was transferred from the customer’s account into a special holding account when the credit application was submitted, and then into the contractor’s account when the final documents were presented³.

Given these circumstances, and taking into account the large number of users involved in the process of cryptocurrency exchange, the issue of applying penalties does, without any doubt, needs to be worked through in more detail. Establishing a complete ban on the technology could have a negative impact on people doing business; they could, along with that, lose their competitive advantages when compared to their foreign partners.

Based on what is stated above, it is worth noting that despite the optimistic words spoken by “media” officials and specialists, when making strategic decisions we must remember Bitcoin’s current position as a currency substitute and, when evaluating the relevant risks, keep in mind the penalties that currently apply.