Bitcoin exchanges are set to come under investigative agencies’ scanner after the government warned people of the risk of investing in cryptocurrencies, which are not backed by government fiat, and likened them to Ponzi schemes.

Enforcement agencies could act against bitcoin platforms and exchanges for illegal money pooling, an official at an enforcement agency said on condition of anonymity.

The capital markets regulator, the Securities and Exchange Board of India (Sebi), too will take action against these exchanges if they are serving as collective investment schemes, a senior Sebi official said on condition of anonymity.

On Friday, the finance ministry warned that there was a real and heightened risk of an investment bubble in virtual currencies of the type seen in Ponzi schemes, which can result in a sudden and prolonged crash.

“Consumers need to be alert and extremely cautious to avoid getting trapped in such Ponzi schemes," the ministry said.

Sebi chairman Ajay Tyagi said on 20 December that bitcoin had so far not posed any systemic risk, but added that it can no longer be ignored.

The finance ministry’s statement on Friday followed notes of caution sounded by the Reserve Bank of India on the risk of investing in cryptocurrencies after a rapid rise in the value of bitcoin, which closed at around $15,000 last week after starting the year at $1,012.

Bitcoin exchanges are unhappy over the regulatory attention focused on the cryptocurrency, which they think the government has not understood.

“The opinion of the government is coming from a lack of understanding. The only way to take this forward is to educate people more. We have made representations to the government. There is a process to it," said Vishal Gupta, founder and chief executive officer, Searchtrade.com. “Again the problem is which institution will take liability for it. Bitcoin comes under the preview of which department is not known because it has multiple properties. Maybe multiple regulators will regulate multiple aspects of bitcoin. If it was illegal, countries such as Japan, Singapore and the US, would not be regulating this."

Bitcoin exchanges say it’s wrong to characterize trading in cryptocurrencies as a Ponzi scheme.

“Bitcoin prices are volatile. But volatility doesn’t make it Ponzi. Ponzi is something where someone guarantees a return. Something that is traded between you and someone else and the price is volatile doesn’t mean it is a Ponzi scheme. In case they are calling bitcoin a Ponzi scheme, does it mean Japan and the US are running a Ponzi scheme by allowing it there?" said Praveen Kumar, chairman and chief executive officer of Belfrics Global SDH, a company that runs bitcoin exchanges in Singapore, Malaysia, Bahrain, Japan, Kenya, Nigeria, Tanzania and India.

Some bitcoin exchanges have limited transactions and some have stopped certain payment options. “We have decided to stop operations in India and wait for further clarity on this. Currently, no directives have come to the exchanges to stop trading," Kumar said.

So far, banks and payment gateways have stopped functioning for bitcoin exchanges. For instance, Coinsecure has notified its customers not to put money in its Yes Bank account, which has been permanently disabled.

Lawyers say bitcoin can’t be prohibited. “The way bitcoins are created through blockchain technology, they are unlikely to cause pooling of funds. In fact, funds create the pools, so to speak. Similarly, currency is not within the definition of securities and therefore under current regulatory restrictions, Sebi would not be in a position to prohibit their trading," said Sandeep Parekh, managing partner, Finsec Law.

Friday’s finance ministry statement followed a survey by the income tax department in December, after which the department sent notices to as many as 500,000 high network individuals to disclose their bitcoin holdings and gains.

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