Cryptocurrency Bill: Killing the messenger?
Srinath Sridharan | 21 Feb, 2021
| Top Stories
The Indian government is planning to ban all operations
of cryptocurrencies in the country, except for a state-backed digital
currency. The ban will be operationalised with a new law coming to
effect. The Cryptocurrency and Regulation of Official Digital Currency
Bill of 2021 is slated to be introduced in the budget session of the
Parliament. In context of evolving digital finance globally, the
Government of India should reconsider its thinking about these new
financial systems that are being developed.
The move is expected
to hit the nascent field in India and impact 342 companies and an
estimated 5 million users involved in trading and holding
cryptocurrencies. Reports also suggest that users holding on to these
cryptocurrencies could be fined, once the new law comes into effect,
with probability of them being given time to liquidate their holdings.
like Bitcoin, Ethereum, Bitcoin Cash, Monero and Litecoin etc, are
digital assets designed to function as a medium of exchange and records
of ownership and transactions are kept on a decentralised-ledger called
blockchain with strong cryptography. But these digital assets are known
as tokens are not issued by a central monetary authority and are not
backed by any physical asset. These tokens are "mined" by users who
contribute computer processing power and are rewarded for their efforts.
The price of these tokens is simply ruled by the forces of demand and
The genesis for the idea for cryptocurrencies is older
than people believe. The 1980s saw the rise of the Internet and along
with it the idea of a sovereign cyberspace, which would transcend
borders and free from all controls of nation states. But this utopian
vision of a cyberspace still needed a currency for people to carry out
transactions and conduct commerce. Following numerous experiments to
create this system, the first cryptocurrency, Bitcoin, was created in
the aftermath of the 2008 global financial crisis. But its development
was a culmination of various digital peer-to-peer payments experiments.
enigmatic creator(s?) Satoshi Nakamoto noted a fundamental issue
problem with fiat currency and the centralisation of finance. "The root
problem with conventional currency is all the trust that's required to
make it work. The central bank must be trusted not to debase the
currency, but the history of fiat currencies is full of breaches of that
trust," he (or they). The distrust of central banks by early adopters
of Bitcoin was probably fuelled by the actions of central banks which
ultimately bailed out the erring investment banks which caused the 2008
India & CBDC
Contrast this with what
the government is attempting to do with its virtual currency.
Essentially, the government of India is looking to introduce the idea of
Central Bank Digital Currency (CBDC) where it acts as a digital
representation of a country's fiat currency and will be backed by a
suitable amount of monetary reserves like gold or foreign currency
reserves. These digital fiats will be regulated by the country's
In India's case, this would fall in the
jurisdiction of the Reserve Bank of India (RBI). Both CBDCs and
cryptocurrencies use blockchain technology as their backbone for
maintaining an immutable ledger for the transactions that take place
using these tokens. However, while the blockchain on cryptocurrencies
are open to public where everyone can view and authenticate
transactions, the blockchain on CBDCs are permissioned where limited
entities can carry out the functions of authenticating and viewing
CBDCs are a ‘virtual store of value' and they can
be converted to cash in local currency at a fixed rate. CBDCs tokens
also would bear interest on the central bank's balance sheet. Currently
there are two modes of CBDCs being developed in the world – a retail
token (meant for direct use by savers) and a wholesale token (meant to
be used by banks and lenders subject to central bank regulations).
modalities are still being worked out, but it could also serve as an
excellent vehicle to push the central bank's plan to increase retail
investors participation in the Government Securities. However, there is a
risk to them. The yield on government securities is a little higher
than bank deposit interest rates and savers might find the returns on
CBDCs more attractive than what banks are offering, thus banks could
lose of their primary means of funding.
As more savers move their
money from demand deposits, it will force them to rely on costlier
means of funding. Central banks also would be on the risk on their
balance sheet in the event of another financial crisis and will have to
function as a crucial financial intermediary in those times. And if
CBDCs also take shape as a viable payment system, it raises several
privacy issues with the state being allowed to see all transactions by a
CBDCs do bring interesting potential uses for the Indian
economy in general and it's heartening to see India join a growing list
of countries like The Netherlands, China, Sweden, the United States,
Canada and Norway are looking to introduce a digital version of their
currency. It is a worthwhile experiment to follow, but it doesn't make
sense on why they cannot co-exist with existing cryptocurrencies.
"Money for nothing?"
of the proposed crypto ban indicates that the government might believe
that there is no intrinsic value in cryptocurrencies; and also might not
like the way its value is pegged to market mechanism. In its first
attempt to eliminate cryptocurrencies was reactionary as many people
fell prey to shady operators posing as cryptocurrency companies and the
RBI issued a circular where it said that while cryptocurrencies were not
banned, it did bar entities regulated by it, including banks, from
providing services to any person or firm dealing with cryptocurrencies.
Supreme Court of India had quashed the RBI's cryptocurrency order in
March 2020 giving a brief respite to cryptocurrencies holders in the
country and saw the resumption of services by different players.
the Indian government thinking is ruled by the mantra that "Blockchain
is good, but cryptocurrencies are bad." It's evident by the bulletin it
put on the Lok Sabha where it said that it would allow "certain
exceptions to promote the underlying technology of cryptocurrency and
its uses." This seems contradictory statement when it is looking to stop
all research into this space and innovations that it is creating.
policy might have originated in protecting the interests of the common
man. But this raises the question on who invests or cryptocurrencies? Is
it the common man who buys Bitcoin or HNIs?
While it is true
that few cryptocurrencies might be inflated and there could be few
Ponzi schemes posing as crypto businesses, the Indian government can
issue detailed signposts and guidelines for investors planning to invest
in them, like what the Australian government has done. The Indian
government's policy thinking to ban cryptocurrencies might also stem
from the narrative that they are used for terror financing and money
laundering. While during its inception, Bitcoin might have been as used
for conducting illicit deals on the dark-web, today the
cryptocurrency-related crime is on the decline.
In 2020, the
‘criminal share' of all cryptocurrency activity fell to just 0.34 per
cent, or $10.0 billion, in transaction volume, according to a report by
Chainalysis, a company the specialises in cryptocurrency investigations
for governments, exchanges and financial institutions. The report also
shows that cryptocurrencies are almost never used for terror financing
and most cryptocurrency-related crimes are scams, ransom ware, darknet
market deals, and stolen funds.
It stands to reason of course. A
mal-actor would have to be extremely stupid to conduct terror financing
on an immutable ledger which can be seen and must be authenticated by
all nodes on a blockchain. In India, traditional offline assets like
real estate and gold still account for most money laundering operations
and financing mal-actors.
Real estate is still not covered under
the Money Laundering Act while purchasing gold does not even require
KYC. Legitimate cryptocurrencies in India have been pushing for better
KYC to open wallets for cryptocurrency transactions. Government can
extend these requirements formally to cryptocurrencies as well.
paucity of understanding can also be seen in the language the
government is using to describe non-CBDCs as "private cryptocurrencies"
and not using established nomenclature. Cryptocurrencies like Bitcoin,
Litecoin, Ethereum etc. are considered public cryptocurrencies as users
can view and verify all transactions and their details using these
tokens on a public ledger and the blockchain used is open-sourced.
such as Monero, Dash and Zcash on the other the hand are designed to be
private where transaction details are hidden. However, these
cryptocurrencies are still public in the sense that they have public
open ledgers, but transaction information is obfuscated in varying
degrees to protect the privacy of the end users. And then there are
efforts like Facebook's Libra, now re-named Diem, that use a private or
permissioned blockchain where only a few trusted entities can keep a
track of the ledger and allowed to mine the tokens for its transactions.
There are varying degrees of complexity and innovation that can
be beneficial people in general, but the government is dismissing and
banning all of them by using a catch-all phrase called "private
Who should regulate Crypto in India ?
reluctance to engage with cryptocurrencies in India could emanate from
deciding on which regulator will have to deal with them. If it is
treated as a currency, the burden of regulation would fall on the RBI.
If it is considered a security or a commodity, the Securities and
Exchange Board of India (SEBI).
Contrary to misperception that
there are no regulatory frameworks for them now, the way how
cryptocurrencies are being used and traded, is more akin towards a
digital commodity. Cryptocurrencies are traded directly through
exchanges and even through financial derivatives like ETFs, options and
futures, and contract for differences (CFDs). Indeed, with the
uncertainties in the world right now, cryptocurrencies and decentralised
finance were the best performing asset class, beating gold, stocks, and
other global commodities in 2020.
Cryptocurrencies are unviable
as a currency right now due to the massive changes in corrections and
the time it takes for a transaction to get authenticated by the various
nodes on the blockchain. Take for example the online games marketplace
Steam's decision to stop purchases using Bitcoin. The company explained
that Bitcoin transaction fees to buy a game shot up to $20 in 2017.
due to the price volatility, if the price of Bitcoin shot up at the
time of transaction, Steam had to refund the difference to the user and
conversely, if the price went down the users had to pay the difference
again. There is also an engineering concern to consider as every
transaction needs to be authenticated by every node on the blockchain
thus the time for a transaction increase.
Currently, the time
for confirming a Bitcoin transaction is about 10 minutes. Though there
are efforts being made by different cryptocurrencies to speed up the
process of authentication for more real-life use cases. But still, it is
nowhere close where users can buy a cup of coffee using a
With this in mind, the burden for regulating this
new form of finance could fall in SEBI's court. Ideally, SEBI should
strongly consider allowing cryptocurrencies as part of its regulatory
sandbox and combine its learnings from jurisdictions like the United
States, Japan and Australia.
Learnings from US, Japan, Australia
the United States does not consider cryptocurrencies as legal tender
but recognizes crypto exchanges as money transmitters as the tokens are
other value which substitutes currency. While the Securities and
Exchange Commission (SEC) recognises them as securities and is working
on enacting securities law on them. Meanwhile, the Internal Revenue
Service (IRS) recognises them as property and have guidelines for the
The United States also takes a pragmatic approach to
different offerings and takes a case-by-case approach. For example, the
SEC cracked down on Facebook's Libra cryptocurrency project. As Libra
used a private permissioned blockchain and controlled the number of
nodes, it was able to drive down the time for a transaction and was also
able to control its price volatility.
functioned more like are a stable private currency which could rival the
US Dollar and less like a security. Hence, the project did not take
off. However, it clarified how it was treating Bitcoin and said that
they are not treating it as a security but rather as a store of value
and noted that its rise was driven by the inefficiencies of the payment
systems in the country. But in both cases, it was made clear that they
are not legal tender.
Japan takes a longer view of the
ecosystem. It does not consider cryptocurrencies as a security, nor does
it treat it on par with fiat currency. Considering the many use cases
by different tokens, it defines them under the broader umbrella of
Crypto Assets. Exchanges are required to register themselves as payment
service providers under its Payment Services Act.
requires these exchanges to maintain strict Know-Your-Customer (KYC)
records of investors and users and comply with all anti-money laundering
and combating terror finance rules (AML/CFT). In addition, the property
rights framework will apply on these crypto assets.
stated particularly that Bitcoin and other tokens which share its
characteristics are considered property and will be subject to Capital
Gains Tax. In addition, it has now come out with detailed signposts and
guidelines for investors planning to invest in Initial Coin Offerings
(ICOs) with clear warnings about these risks along with case studies.
Don't be cryptic or critical of Crypto yet!
government's push to ban all cryptocurrencies in the country is simply
throwing out the baby along with the bath water. It is ironic that the
Indian government is following the same policy decisions as China, which
banned all cryptocurrencies as well in favour of its digital fiat
currency. The Indian government should in all manners should emulate the
idea that it is an alternative to China and not follow the same policy
prescriptions set by Beijing.
There is a risk that India will
lose out in the billions of dollars in the new cryptocurrency –led world
of finance by enforcing the ban. There might be another brain-drain as
more minds who believe in cryto-finance will leave India to set up shop
in friendlier countries.
Thus, the underlying asset of all
cryptocurrencies is the failure of governments globally and central
banks to provide better financial outcomes for citizens. Thus, the best
way to handle the proliferation of private cryptocurrencies is to make
sure that state institutions and fiat products work well for retail
participants. The Indian government's ban on cryptocurrencies is
overprotective at best and at its worst, it could be viewed as an
attempt to maintain an iron grip on how its citizens use their money.
Sridharan is an independent markets commentator and visiting fellow,
Observer Research Foundation. Shashidhar K.J. is an associate fellow,
Observer Research Foundation)
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