The Government’s Position on Cryptocurrency
While the novelty factor of cryptocurrency and the blockchain technology has not abated since 2009, Indian regulators have only recently begun evaluating the financial and security risks posed by virtual currencies such as Bitcoin. The Finance Minister, Mr. Arun Jaitley, announced in his 2018 Budget Speech that the government does not consider cryptocurrencies as legal tender and will take all measures to eliminate use of these cryptoassets in financing illegitimate activities, or as part of the payment system.[i] This statement, while shedding light on the ‘currency’ aspect of cryptocurrency, was ambiguous about the status of crypto-exchanges and the nature of the crypto-asset itself – whether security, commodity or a separate asset class.
On April 6, 2018, the Reserve Bank of India – India’s central banking institution – barred banks from dealing in virtual currencies or providing services for dealing with or settling virtual currencies.[ii] While the notification does not directly ban cryptocurrencies, it makes trading in them next to impossible.[iii] It is understandable that regulators are keen to implement measures to protect Indian consumers from such a rapidly evolving technology, However not only could regulatory flip-flops push the cryptocurrency network underground or overseas,[iv] but it could also stifle new-tech driven industries and innovation in this space.[v] Instead of attempting to delink virtual currencies from the underlying blockchain technology and solely fostering the growth of the latter, the government must shift its resources to the task of risk mitigation and regulation of cryptocurrencies and its exchanges.
Reasons to Regulate Crypto Exchanges
Even though the blockchain technology is considered unhackable, exchanges – where a majority of the cryptocurrency activity takes place – are susceptible to hacking attempts that can result in high-value losses. A recent example is the Bitcoin theft worth around Rs. 19 crore from Delhi-based cryptocurrency exchange Coinsecure.[vi] The regulation of cryptocurrency exchanges can address this issue as exchanges can be mandated to submit periodic reports on their system risk management and to maintain a certain standard of protection from cyberattacks.[vii] Such a move has been implemented in Japan where its financial regulator ordered all cryptocurrency exchanges to report on their system risk management following a hack on the exchange Coincheck.[viii] Furthermore, exchanges can be required to maintain capital reserves to withstand major downturns or crashes[ix] and implement stringent KYC norms as is being done in South Korea where trading in cryptocurrencies is permitted only from real-name bank accounts.[x]
Oversight by regulatory bodies would also minimize the risk of price manipulation of cryptocurrencies on exchanges by automated trading bots using the classic pump-and-dump scheme.[xi] This is a scheme of coordinated purchases when the coin value is low in order to “pump” the price and attract new investors only to “dump” the coins when they attain a peak value.[xii] Price manipulation can also be employed by the exchange itself as in the case of Bitfinex and its currency Tether which was used to artificially prop up the value of Bitcoin.[xiii]
In the event that regulated exchanges become the predominant medium of fiat-to-crypto flow or vice versa, regulators will have access to a one-stop shop for transaction records and tax information.[xiv] The government will have the power to ask for disclosures of trades above a certain amount to the financial intelligence unit to curb fraudulent transactions and money laundering.[xv] As of now, tax authorities are clamouring to tax profits even though there is no clarity on the categorization of cryptocurrencies as capital gains or speculative business income.[xvi] Through regulation, the government can impose tax documentation requirements and disclosures to minimize reliance on self-reporting for the payment of taxes, thereby decreasing the likelihood of tax evasion.
Considering the fact that the Indian government is keen to capitalize on the blockchain technology, it could evaluate the possibility of incorporating the technology to monitor complex transactions and record the audit trail of suspicious activity.[xvii] Financial institutions would have to enlist in a coordinated attempt to act as nodes in the blockchain and flag suspicious activity as soon as it occurs.[xviii] A decentralized cryptocurrency exchange on the blockchain could also be explored to manage the risk of hacking.[xix]
Expertise of Industry Players and Self-Regulation
In addition to the above recommendations, it should be recognized that micromanaging every nook and cranny of disruptive technologies by regulators risks impeding its natural and potentially groundbreaking transformation. Industry players should be given a more active role in the policy discussions on cryptocurrency as they possess the expertise and tools to address new and challenging issues being generated by the technology. An example of this is the Japan Blockchain Association which has implemented self-regulation standards, including the use of cold wallets or wallets disconnected from the Internet, amongst its members.[xx] Self-regulatory bodies are also attempting to set standards and industry-wide best practices for initial coin offerings or ICOs.[xxi]
Instead of encouraging an unfavourable climate for investors by a protracted lack of clarity on what the future of cryptocurrencies in India holds, regulators must begin setting up a foundation for the revolutionary possibilities of this technology. A panel headed by the Secretary of Economic Affairs, SC Garg, is expected to submit its findings on cryptoasset trading in unregulated exchanges soon.[xxii] It is the hope of the author that the benefits of bringing exchanges into the ambit of legitimate financial institutions will win out, and the government will change course by providing banks with the confidence to allow transactions on such exchanges. India cannot isolate itself from global trends and expect to match pace with the rest of the world which appears geared to progress to the financial system of the future.
[This post is authored by Varsha Rao, a fifth year undergraduate student of National Law University, Delhi, during her online internship with TRA. Nehaa Chaudhari, Public Policy Lead, TRA, gave inputs.]
[i] Saloni Shukla, FM Arun Jaitley settles the Bitcoin issue for once and for all, THE ECONOMIC TIMES, Feb 02, 2018, https://economictimes.indiatimes.com/news/economy/policy/arun-jaitley-settles-the-bitcoin-issue-for-once-and-all/articleshow/62737852.cms.
[ii] Prohibition on dealing in Virtual Currencies (VCs), RBI/2017-18/154, Reserve Bank of India, April 6, 2018, https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NOTI15465B741A10B0E45E896C62A9C83AB938F.PDF.
[iii] Arti Singh, Anger, shock, confusion as RBI bars banks from cryptocurrencies, THE ECONOMIC TIMES, Apr 06, 2018, https://economictimes.indiatimes.com/markets/stocks/news/anger-shock-confusion-as-rbi-bars-banks-from-cryptocurrencies/articleshow/63638799.cms.
[iv] Abhishek Dey, Reserve Bank of India blocking banking services to cryptocurrency firms is impractical, experts say, SCROLL.IN, April 8, 2018, https://scroll.in/article/874757/reserve-bank-of-india-blocking-banking-services-to-cryptocurrency-firms-is-impractical-experts-say.
[v] Nehaa Chaudhari, The RBI’s virtual ban on crypto-currencies is illogical, MEDIANAMA, Apr. 6, 2018, https://www.medianama.com/2018/04/223-rbi-cryptocurrency-ban/; See also Anirudh Rastogi, Nehaa Chaudhari, RBI’s ban on virtual currency dealings harms consumers, the market and innovation, THE ECONOMIC TIMES, Apr. 11, 2018, https://tech.economictimes.indiatimes.com/news/technology/rbis-ban-on-virtual-currency-dealings-harms-consumers-the-market-and-innovation/63708913.
[vi] Bitcoins worth Rs 19 crore go missing from cryptocurrency exchange Coinsecure, BUSINESS TODAY, Apr. 13, 2018, https://www.businesstoday.in/current/economy-politics/bitcoin-theft-coinsecure-hack-bitcoins-exchange-india-19-crore/story/274770.html.
[vii] Alex Larsen, Risk management, regulation and the cryptocurrency markets, THE BLOCK, Feb 8, 2018, https://www.blockchaintechnology-news.com/2018/02/08/risk-management-regulation-cryptocurrency-markets/.
[x] Cheang Ming, New cryptocurrency rules just came into effect in South Korea, CNBC, Jan 29, 2018, https://www.cnbc.com/2018/01/29/south-korea-cryptocurrency-regulations-come-into-effect.html; See also Rishabh Sinha, Nehaa Chaudhari, How should India regulate the ticking time bomb called bitcoin?, QUARTZ, Dec. 17, 2017, https://qz.com/1155127/neither-sebi-nor-rbi-india-must-regulate-bitcoin-and-other-cryptocurrencies-as-an-asset-class-of-their-own/.
[xi] Timothy Tam, How bots are manipulating cryptocurrency prices, VENTURE BEAT, Dec 14, 2017, https://venturebeat.com/2017/12/14/how-bots-are-manipulating-cryptocurrency-prices/.
[xiii] Nathaniel Popper, Worries Grow that the Price of Bitcoin is Being Propped Up, THE NEW YORK TIMES, Jan 31, 2018, https://www.nytimes.com/2018/01/31/technology/bitfinex-bitcoin-price.html.
[xiv] Rownland Manthrope, Akram Hussein, Six ways to regulate cryptocurrency without killing it, WIRED, Jan 9, 2018, http://www.wired.co.uk/article/six-ways-to-regulate-cryptocurrency-without-destroying-its-future.
[xv] Peter Terlato, South Korea releases new crypto guidelines, FINDER, Jan 23, 2018, https://www.finder.com/south-korea-releases-new-crypto-guidelines.
[xvi] Sachin Dave, RBI bans Bitcoin and other virtual currencies, investors concerned for tax dues, THE ECONOMIC TIMES, Apr 7, 2018, https://economictimes.indiatimes.com/markets/stocks/news/rbi-bans-bitcoin-and-other-virtual-currencies-investors-concerned-for-tax-dues/articleshow/63651548.cms.
[xvii] Jason Bloomberg, Using Bitcoin or Other Cryptocurrency to Commit Crimes? Law Enforcement in Onto You, FORBES, Dec 28, 2017, https://www.forbes.com/sites/jasonbloomberg/2017/12/28/using-bitcoin-or-other-cryptocurrency-to-commit-crimes-law-enforcement-is-onto-you/#5bedc53a3bdc.
[xix] Supra note 7.
[xxi] Kim Larkin, How we regulate cryptocurrencies and ICOs is key to their success, SOUTH CHINA MORNING POST, March 10, 2018, http://www.scmp.com/business/companies/article/2136527/how-we-regulate-cryptocurrencies-and-icos-key-their-success.
[xxii] Sindhuja Balaji, India Is Not Banning Cryptocurrency, Here’s What It Is Doing Instead, FORBES, Feb 6, 2018, https://www.forbes.com/sites/sindhujabalaji/2018/02/06/india-is-not-banning-cryptocurrency-heres-what-it-is-doing-instead/#5c5f79c97c6f.