India tackles the difficulties of regulating cryptos

By Shilpa Mankar Ahluwalia and Shubhangi Garg, Shardul Amarchand Mangaldas & Co
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Cryptocurrency regulation started in 2018 with the Reserve Bank of India (RBI) prohibiting banks from involvement in crypto-based transactions. The Supreme Court overturned the ban, leading to significant growth in the trading of cryptocurrency, largely by retail investors and zero regulation. Over 10 cryptocurrency exchanges operate, offering investment, lending and transfers. While the RBI favours a complete ban, the government is likely to permit some crypto uses. Cryptocurrencies will probably be recognised, regulated and taxed as a new form of asset class, but not as an alternative form of currency or legal tender.

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Shilpa Mankar Ahluwalia
Partner
Shardul Amarchand Mangaldas & Co

Any technology-based revolution is a clash between regulation and innovation. Regulating crypto is difficult because it uses blockchain, a distributed ledger technology, meaning no single institution is responsible for the issue and governance of crypto assets. Transactions are recorded anonymously, and the underlying technology is not limited to a particular jurisdiction. Cross-border transactions are thus seamless, but difficult to control.

If crypto is regulated as an asset, not a digital currency, the Securities Exchange Board of India (SEBI) will probably be the crypto regulator. Crypto exchanges that facilitate not only trading but lending, investing and other forms of monetisation of crypto assets will be licensed. To counter money laundering and terrorism financing, crypto exchanges will likely have to undertake full know-your-customer exercises during customer on-boarding, similar to those required for SEBI-registered brokers and other reporting entities under the Prevention of Money Laundering Act, 2002. While several uses, such as payments or P2P remittances may be prohibited, it will be difficult to know whether crypto is being used as an asset or a shadow currency. How will a product that allows instant conversion of a crypto asset into a fiat currency that is then used for buying goods be viewed under the regulations?

The decentralised and anonymous form of blockchain technology makes it difficult to regulate on the basis of geopolitical boundaries. Regulators worldwide agree that a coordinated effort is required to effectively regulate cryptocurrency. It is unclear how the regulations will impose exchange controls on cross-border crypto transactions.

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Shubhangi Garg
Partner
Shardul Amarchand Mangaldas & Co

Crypto is subject to extreme price volatility with markets and users finding it difficult to value different cryptocurrencies. Discussion has taken place on educating investors on the risks of investing in this volatile asset class. In India, coin offerings backed by celebrity endorsements and marketing strategies have targeted retail investors. Some jurisdictions have prohibited advertisements promoting crypto investments, and India will likely introduce an investor protection regime.

A key challenge will be successfully differentiating between genuine and fraudulent crypto tokens and coins. It is unclear how regulation will treat issues of new tokens, as initial coin offerings could be seen as raising public market capital and subject to the same rules as securities offered by the SEBI. This is particularly so as such offerings often involve raising funds from public investors in advance. An issue framework may develop based on factors such as utility, functionality, technological innovation and the scalability of a cryptocurrency.

Given the many complexities involved in regulating cryptocurrency, the government is probably looking to extend its consultation with tech experts, regulators and the industry before outlining a final legal framework for crypto assets. Following this extensive consultation, a crypto bill will probably be introduced in the budget session with the government also changing existing taxation law to cover gains from crypto assets and the disclosure of investments in crypto holdings.

The government will allow the use of blockchain technology in financial and other services, such as for international cross-border payments. The crypto economy will be shaped by regulations expected in 2022. The market and investors are hoping for a balanced set of regulations that facilitates innovation, protects consumer interests and solves the systemic and financial risks that are triggered by cryptocurrencies.

Shilpa Mankar Ahluwalia and Shubhangi Garg are partners at Shardul Amarchand Mangaldas & Co

Disclaimer: The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Further, the views in this article are the personal views of the authors.

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