Digital currencies have spread their wings into global fora, and the nation requires vision to avoid missed opportunities
Cryptocurrencies have become synonymous with quick money, being cool, and participating in the future, which has impacted the minds of the current generation. Even with increased consumer awareness, trading platforms, informative literature and numerous advertisements, cryptos are not legal tender in India. It is a combination of scepticism among lawmakers and consumers, and the volatility of the indices, that have staggered the sudden spike that we witnessed a while ago.
Learning the basics
To begin with, we must try and understand the basics of blockchain and cryptocurrencies. Simply put, blockchain is a type of database that stores data in blocks chained together. Every time a new data input is made to a fresh block and the block gets filled up, it gets chained onto the previous block that already hosts data in chronological order. It is so well designed that it can process copious volumes of data and be accessed and manipulated quickly from anywhere by any number of users.
Cryptocurrency is essentially a digital or virtual currency that relies upon cryptography for security. Several known cryptocurrencies premise themselves on decentralised blockchain technology, a distributed ledger enforced by a disparate network of computers. The decentralised technology stores the currency information in blocks, thus providing safe and secure storage without the necessity of a national bank for accounting and retention purposes.
Anonymity and security are the buzzwords associated with cryptocurrency and have also proliferated the growth of private cryptocurrencies, which use novel tactics such as stealth addresses, and ring signatures to hide a user’s real wallet balance and address. Foreign jurisdictions (South Korea and the US) have restricted private cryptocurrency trading or developing tools to remove the secrecy of transactions conducted through private networks.
Several jurisdictions have been reluctant to impose reactionary restrictions on cryptocurrency trading, owing to the pervasive amounts of investment already secured by such technologies, standing at USD2.3 trillion globally as of 15 December. Furthermore, blockchain technology is rooted in decentralised ledgers, which may render any reactionary ban or embargo futile. People will always rely on ingenious methods to continue accessing such exchanges and ledgers situated outside the country.
In China recently, cryptocurrency mining and trading were both outlawed. This ban was applicable across natural and juristic persons, and resulted in several entities shifting their businesses and setups outside the country. For the period between the distinct bans being implemented, individual users also migrated to foreign exchanges to maintain their investments.
However, while China did weed out the rampant proliferation of cryptocurrencies from their soil, citing environmental, social and governance (ESG) concerns as reasons for the ban, there is still a heavy dependency on the use and deployment of the decentralised ledger technology.
Across the border in India, the tale is not very different. Earlier, in 2018, the Reserve Bank of India (RBI) had imposed a ban on banking and financial institutions from trading in cryptocurrencies, and did not ban the instruments per se. With several homegrown companies offering solutions and currencies stemming from this technology, there was a split between the “adopters” and “naysayers”, and this action of the banking regulator was challenged before the Supreme Court. The legal tussle yielded in the apex court directing the RBI to withdraw the ban, and opened up the floodgates for Indian and foreign exchanges to pursue large-scale operations.
While countries like El Salvador proceeded with adopting a particular cryptocurrency to be accepted as legal tender, India witnessed a continued struggle for an effective bargain between deregulation and complete embargo. The proposed Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, was scheduled to be introduced during the winter session of the parliament, amid ambiguity on the government’s stance towards the regulation of cryptocurrencies.
The bill is posed to create a facilitative framework for creating an official digital currency to be introduced by the RBI, and to prohibit all private cryptocurrencies in India. However, from how it appears, there is a possibility that there could be an allowance made for certain exceptions to promote the underlying technology of cryptocurrency and its uses. Owing to the disparity between user demands, entities and the discussions that the government intends to make, it appears that the bill will not be legislated before the end of this year.
In India, the bill recognises the reliance of several sectors, including the financial sector, on blockchain technology, and there is an intention to allow continued use of the underlying technology across several sectors and industries. This is similar to the developments in China. Even the premier government think tank has issued strategy notes discussing the adoption and implementation of blockchain across sectors.
Certain prevalent issues that the government has also acknowledged in India arise because blockchain technologies (some of them) allow for anonymity in their transactions. This becomes a roadblock for the banking and financial sector, where the non-repudiation concept is baked into the consumer journey, which will not be realised for blockchain-based cryptocurrency.
As the financial sector also has other obligations to be met with – in respect of anti-money laundering provisions, know-your-customer obligations, combating of financing of terrorism, and likewise – it could be difficult for technology providers to meet these elements in a uniform manner across their customers.
Given how the technology works, there is the potential of information being stored across nodes on a blockchain network outside the Indian territorial jurisdiction. This will defeat data localisation requirements currently in place, which may come to be should there be the adoption of blockchain technology for banking and financial services. Therefore, any regulation of cryptocurrency will invariably create a ripple effect across other sectoral laws, including but not limited to data privacy and statutory compliance, among others.
Moving away from a complete ban on transactions related to cryptocurrencies, the RBI has come around to accepting that virtual currencies are here to stay. This has resulted in a stated intent to introduce its own version of virtual currency. The proposed bill will have to address this expression of intent and may clarify the presently prevailing confusion around the interplay between existing investments in cryptocurrencies on the one hand, and the virtual currencies that may be issued by the central bank or the regulator on the other.
Central Bank Digital Currencies (CBDCs) are being considered across several jurisdictions to curb the frenzy among investors willing to partake in this dynamic economic venture. The CBDCs typically act as the virtual form of fiat currency, as issued and regulated by the central banking authorities. The intention is to ease the distribution of benefits or calculation and collection of taxes.
Before one decides on taxation, at this juncture it is also important to note that there are different schools of thought on whether cryptocurrencies should be classified as a security or commodity, with several jurisdictions devising novel methodologies.
For instance, the US implements the Howey Test to determine whether a financial instrument will be considered an investment contract, and therefore, a security. The regulation of cryptocurrency as a security would lead to greater oversight and engender greater customer confidence.
In view of the discussions and the anticipated legislation, it will be left to the course of the market and the regulations to decide, and evaluate whether the creation and adoption of a CBDC is the right way forward, and whether to assess this opportunity as one that generates revenue and taxes for the public exchequer.
With the volumes of investment that have been parked by Indians, a complete ban would lead to an opportunity lost. For something that is here to stay, and will most likely find wings to soar high, it is best suited that the RBI, alongside the introduction of the CBDC, also identifies cryptocurrencies as a class that can be taxed and regulated, or at least used as a valid means of trade across sectors.
At a time when the RBI is moving towards tokenisation and tap-and-pay systems, walking away from this might not lead to the desired results.
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