How do we analyze the present scenario of cryptocurrency in India?
The entire cryptocurrency industry is more than a decade old now. What began as early discord on online discussion boards has now turned into a trillion-dollar industry.
Here at home, cryptocurrency and blockchain picked up momentum in the second half of the last decade. As of Jan 2021, More than 70 lakh Indians have invested and hold over 7000 crores worth of cryptocurrencies.
To give you a perspective of the industry growth; during the same 2016-2021 period, Indian investors added 1.28 crore new Demat accounts. Cryptocurrency investor base grew at 300% CAGR as compared to Demat account’s growth of 8% CAGR.
Of course, there is a base effect at play and we acknowledge that more Indians will continue to open Demat accounts than a crypto wallet. But one needs to also acknowledge that while most crypto wallets are active, only 1 out of 4 Demat holders invest actively.
Cryptocurrencies in India witnessed a huge inflow of capital after the supreme court of the country quashed an RBI circular prohibiting banks to deal with crypto exchanges. Supreme Court observed that during the course of the hearing, the apex regulator could not highlight any instance of cryptocurrencies affecting the existing financial system. Access full judgement here.
What are our takeaways from the current crypto bill and its provisions?
The Indian state has recently proposed to table the bill to ban all private virtual currencies. While the latest copy of the bill is yet to be available. We assume that it will follow the draft bill recommended by CBDT to the government in Aug 2019.
The government started the steps to regulate/ban virtual currencies back in 2017 when it formed an interdepartmental committee of the Ministry of IT, CBDT, SEBI and RBI to draft the crypto bill.
Private vs Govt token: The bill proposed to ban all private crypto-currencies. The word private is of the essence here. The govt, in its first draft bill, mentioned that the government will ban all private currencies but will launch its own digital currency which will be regulated by the RBI as a legal tender.
Not just Crypto: The proposed bill aims to penalize anyone who holds, transacts or mines any cryptocurrency. According to the draft bill, the ban is not just on cryptocurrency, but on any code/information that provides a medium of value.
Based on the above definition, video game currency, airline miles, food voucher, etc. can be deemed as virtual currencies.
Lack of discussion with stakeholders: While the committee has done extensive research over various regulations across the world as can be found in the minutes of the meetings; no consultation was observed from any private enterprises or investor base that it wishes to regulate.
Blockchain Yes, Rewards Missing: Additionally, the committee has mentioned the use of digital ledger technology but does not address how the individual nodes/miners would be rewarded for maintaining the blockchain. If they are to be rewarded in the form of national digital currency then how will this be different from the centralized money supply. Said coin can be withdrawn from miner’s wallet and is akin to current monetary system.
Blanket Ban on all tokens: The bill does not distinguish between a utility token and an asset-backed token also known as stable coins. Unlike utility tokens who’s worth is decided by inherent demand, asset-backed tokens are backed by an underlying asset such as gold, silver, fiat currency etc.
Let us take an example of Perth Mint Gold Token:
A blockchain-based stable coin backed by the Western Australian government-owned Perth Mint. The token is pegged to the price of 24K gold that is held with the Mint and has no transaction, storage or management fee. It is the cheapest way to own Gold and diversify your portfolio without incurring any counterparty risk. Outright crypto ban will take away such innovative stable coins.
What could have made the govt table what is reported to be a law banning cryptocurrency in India?
There are multiple reasons why any nation-state would want to ban any virtual currency that rivals its own fiat. We would exclude structural reason like controlling the money supply and address the ones mentioned by the inter-departmental committee:
- To avoid tax evasion
- To avoid money laundering
- To avoid the use of traceless digital currency for unlawful activities
- To prevent gullible Indian consumers from initial coin offerings (a pseudo form of IPOs) or any financial scheme not recognized by the government
To address the point of:
- Tax evasion: All existing stakeholders agree on taxing any capital gains arising from crypto transactions. Since the transactions are stored on the digital ledger, the computation of gains and losses are fairly simple if you treat it as commodity or stock.
- Money laundering: During the supreme court ruling, RBI could not point out any lapses performed by Indian crypto exchange in terms of KYC norms that may lead to money laundering.
- Traceability: Cryptocurrencies leave a digital immutable trace for all of the transactions that can be traced to the definitive wallet of the transacting parties.
- ICO fraud: All existing provisions of IPOs can be applied to mitigate any get rich quick schemes. For example –
- The issue price band upper and lower limit can be built in as a restraint on the coin offering.
- Minimum subscription criteria can be set and so on and so forth.
- Custodial services can be provided for any pegged currencies.
What are the reasons prompting the government to go for this & what is your take on such a regulation?
While we understand the government’s rationale to safeguard its consumers by establishing set rules that govern any financial transaction or store of wealth. Any outright ban without consultation from the industry stakeholders or consumers will be unfortunate and ensure that the financial innovation stays within banks instead of the hand of people.
We should not jump to Ban or regulate a nascent industry that is yet to prove its potential. The Indian State has always shown resolve while regulating any strategically important industry.
To give you an example; The insurance industry was re-opened to private companies in 1993. Only after several years of consultation between the stakeholders and the government panel, the government set up the regulatory body IRDAI in early 2000.
Further, IRDAI follows a nodal structure where all insurers have an appointed nodal officer that can assist them with any regulation of filing of a new product. We fail to understand why the same can not be implemented by the RBI.
We would also like to highlight the case of P2P lending that became a casualty of overregulation before the industry could even surface. Presently, the P2P industry is dominated by the same players that existed before the regulation and any new player is stifled because of the capital norms that are not warranted for a P2P lending exchange.
We recommend the regulator to rely on the consumer protection laws instead of drafting a fresh set of regulation outrightly banning a nascent industry. A decade will provide a good time for the industry to develop all use cases of DLT such as REiTs, Trade Financing, Lending, Capital raising etc.
Build Sandbox: We would like to highlight IRDAI and RBI’s sandbox policy that provides a regulatory framework to launch new products for a course of a few years and review its implications. If the government wants to have a single Fiat as a legal tender then so be it. Use VCs as a commodity or a stock.
If the government fears that the crypto-currencies are too complex for the consumers to understand, we can adopt
(A) Accredited-investor approach where the regulator can define an income cap of minimum X rupees a year in form of an income tax return to be classified as an accredited investor. There is a framework by SEBI that defines the process for investing in startups.
(B) Investment cap: Further, we can have a cap on investment up to INR 50L as in case of prudential norms implemented by RBI under P2P lending regulation. If the government needs, they can start the cap based on tax filed income to avoid any over-allocation on the asset category.
(c) Registration of all financial products: We can adopt the International International Securities Identification Number to help consumers to identify legitimate tokens. Further, the industry has its own independently monitored FCAS score that deals with the real-time financial health of any token.
If/when the bill gets passed, what are the options left for those Indians holding cryptocurrencies or/and the traders?
Before we get into the available options we need to understand that the bill has to be passed by both houses to come into existence.
Further, it is almost inevitable that the bill goes through a standing committee since it was not consulted with necessary stakeholders. Once the stakeholders advise the standing committee, the revised bill will get passed. Most likely, the revised bill may ban crypto as a currency but not as a commodity.
Now, addressing the scenario if the Bill gets passed as it is. It will provide a transition process to all crypto investors to convert their tokens into fiat. Presently nearly 7000 crore worth of crypto is held by 70 lakh Indians. A panic sale would be avoided by the government. They already have a clause in the draft that will allow a period of 90 calendar days to the existing investors to offload their holdings.
Secondly, existing investors can not be prosecuted retrospectively thanks to sec 20(1) of our constitution that prohibits governments from passing retrospective laws.