Opinion | Designing cryptocurrency regulations in India post Supreme Court order


While the judgement came as a respite for the fledgling sector that was crippled by the circular, investors continue to remain concerned about the future of the industry given how the government would seek to regulate the industry post the verdict is yet unknown. The judgement itself does not offer any guidance on regulation but simply invalidates the RBI circular on the basis that it impinges on the fundamental right of those engaged in virtual currencies-related businesses without providing adequate rationale.

Meanwhile, the lifting of restrictions on trading of cryptocurrencies due to the SC ruling and the absence of any defined regulatory framework has led to an explosion of the industry during the covid-19 induced lockdown in the country. Perhaps owing to more time in front of the desktop, trading volumes of cryptocurrencies have increased 400 times during the lockdown months with estimates suggesting that the daily trading volume in India may be $10-$30 million. This, even as the Draft Banning of Cryptocurrency and Regulation of Official Currency Bill, 2019 continues to remain pending in Parliament.

The enormous financial potential of the cryptocurrency industry is clearly evident and it is an opportune moment for the regulatory authorities, in consultation with the government and the stakeholders concerned, to adopt a fresh outlook towards the regulation of the sector in India. An exhaustive set of regulations would define what constitutes cryptocurrencies in a clear and unambiguous manner, the range of permissible services that may be offered by organisations, how the operations of engaged entities would be supervised and monitored, and finally, the taxation structure for the investors concerned.

Defining virtual currencies and other stakeholders

In order to regulate the potential risks associated with the use of cryptocurrencies, it is first important to adopt a crisp definition of virtual currencies as well as the scope of their usage. Presently, the draft bill carries a broad definition which has the effect of including in its ambit even those virtual currencies that may not have been generated through cryptographic methods and only provide a digital representation of value for individual website portals. For instance, this would include online discount vouchers or loyalty points which usually do not present the same risks associated with other cryptocurrencies. Instead, the government must refer to guidance published by the Financial Action Task Force (FATF) and legislation adopted by countries with matured cryptocurrency markets like the United States or Japan, in order to distinguish between convertible and non-convertible currencies, centralised and decentralised currencies and clearly identify the participants involved in the cryptocurrency ecosystem.

The FATF defines cryptocurrency as a math-based decentralised, convertible virtual currency which is protected by cryptography. Such a definition unambiguously communicates that cryptocurrency is a digital medium of exchange, which has an convertible value in real currency, but instead of being validated by an entity like a central bank, is secured using cryptographic technology of blockchains. Here it must be mentioned that although the draft bill prohibits the use of cryptocurrency, it exempts the use of the distributed ledger technology underlying its development.

The government might choose to adopt stricter regulations for the non-convertible decentralised currencies like Bitcoin, Ethereum vis-a-vis non-convertible currencies like the ones designed for specific web portals or centralised currencies which are governed by a single administrative authority, for instance the Libra cryptocurrency launched by Facebook.

Similarly, in order to design comprehensive know-your-customer (KYC) norms for cryptocurrency companies, any legislation for the industry must clearly outline the scope of the roles for the all the participants which compose the cryptocurrency ecosystem, namely, the exchanger, the administrator, the user, miner, wallet provider, inter alia.

Scope of services and anti-abuse provisions

Next, the regulators must clearly state the range of services associated with cryptocurrencies that would be permitted in any new legislation for the industry. While the government may opt to retain the provision banning the use of virtual currencies as legal tender in India, it must re-evaluate the potential of cryptocurrencies as a payment mechanism or as a form of investment given that it was estimated to be a $20 billion industry before being crippled by the 2018 RBI circular.

Cryptocurrencies have the potential of transforming the financial technology landscape in the country with the promise of an efficient, risk-free and low-cost transaction services for customers and businesses alike. Further, they support a highly secure, compliance-free international remittance system, encourage financial inclusion for unbanked communities and have now also started serving as a fundraising mechanism for early stage start-ups through initial coin offerings (ICO).

In order to align with global practices, India must revisit its proposed legislation on cryptocurrencies and design a comprehensive regulation framework for the sector. It may design it in such a way that the use of cryptocurrencies as a payment mechanism continues to be governed by the RBI while their use as a financial asset which can be bought and traded on an exchange is regulated by the Securities and Exchange Board of India (Sebi). This distinction would ensure that these entities are subjected to the most advanced norms of regulation in the country and would also avoid any potential conflict between regulatory bodies.

It is no secret that cryptocurrencies carry considerable money laundering and terror financing risks given that they facilitate anonymous peer-to-peer transactions which are completely secure and outside the reach of government interference. The risks are compounded by fact that these transactions happen on a digital universe in an international financial system where its often difficult to establish jurisdiction of a particular country. In order to tackle the risks enumerated above, global watchdog FATF recently came out with a report which conceives a radical KYC/ anti-money laundering framework to regulate, supervise and monitor the conduct of cryptocurrency transactions. Apart from proposing stronger international cooperation on cryptocurrency governance, the report calls on countries to adopt risk-based local regulations which are based on the robustness of its financial system and the relative maturity of the cryptocurrency industry.

India may opt to have stringent licensing, compliance and inspection norms for cryptocurrency transactions, which may perhaps be warranted, given that the sector is still at a nascent stage and the digital literacy in the country’s population is relatively weak. However, it must endeavour to do in a way that cryptocurrencies do not lose their cost advantage in the marketplace.

Finally, the government must ponder on introducing an attractive tax structure for the cryptocurrency industry in India which may augment adoption rates of cryptocurrencies as a means of payment and at the same time, improving the reportage of income earned through cryptocurrency transactions. For instance, government may opt to introduce a lower-than-usual capital gains tax rate for cryptocurrency exchange in order to boost its acceptability as an investable asset. Further, instead of normal slab rates, the government can introduce a low tax deducted at source (TDS) rate for all other income associated with cryptocurrencies to amplify activity in the sector.

India has been behind the curve in cryptocurrency adoption vis-à-vis its regional counterparts like China as well as the rest of the world. The time has now come to bite the bullet and let the cryptocurrency sector flourish in the country.

(Taarush Jain is pursuing Chartered Certified Accountancy from ACCA, UK. Views expressed in the article are the author’s own.)

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This article was originally published on Livemint
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