India needs legal recognition of cryptocurrency as macro asset

Bitcoin, the first cryptocurrency (CC), was presented to the world in a 2008 White Paper by the pseudonymous Satoshi Nakamoto, as a functional alternative to currency issued by states through a public authority like central banks. Details of ownership and issuance of CC are stored in a cryptographically secured digital ledger, validated through blockchain.

It is not issued by a sovereign or public entity. Indian CC holding is estimated to be Rs 100 billion. This esoteric fintech development swiftly embraced by investors has left regulators grappling with an ideal regulatory regime.

CC caught the attention of Indian regulators in 2013 with RBI’s sceptical stand followed by the finance ministry’s warning likening it to Ponzi schemes. Public Interest Litigations to ban CC were filed in 2017 in the Supreme Court. 2018 saw the Indian regulatory stance escalating from a cautioned approach to a ban with the finance minister discrediting CC as legal tender followed by the RBI essentially banning it by prohibiting exchanges from dealing in CC through stringent penalties. An attempt was made to legislatively sanction the ban through a 2019 bill based on recommendations of an Inter-Ministerial Committee.

Also read: RBI asks banks not to refer to its 2018 circular on virtual currencies

A ray of hope for CC was a 2020 decision of the Supreme Court quashing the ban on it by characterising it as disproportionate and impeding the fundamental right to trade and commerce. The 2021 ‘National Strategy on Blockchain’ by the Ministry of Electronics and Information Technology paves the way for use of blockchain in various arenas which affirms faith in technology that edifies CC. Another step in recognising CC is the March 2021 amendment to the Companies Act which mandates reporting of CC holding by companies. Contradicting these enabling measures is the circulation of an unpublished bill of March 2021 banning private CC but provides an impetus to Central Bank Digital Currency (CBDC) or government-issued digital cash. There is no embargo on CC in India, but it does not enjoy regulatory treatment to foster its growth.

These disparate regulatory measures appear to be informed by two key apprehensions namely the use of CC as legal tender threatening official currency resulting in erosion of control of a public body over legal tender, and additional cost of preventing misapplication of CC to nefarious activities like terror financing and money laundering. CC’s intangible nature, volatile pricing, anonymity in holding, decentralised determination of value, and easy cross border reach which do not fit with conventional paradigms have made banning it attractive to Indian regulators.

Banning CC is likely to make it more desirable in creating a parallel illegal market, loss of tax revenues to the state, loss of returns to Indian investors, hamper financial inclusion and ease of business and impede global recognition of CC. After much vacillation, China banned CC to promote its CBDC, whilst most major economies are keen on harnessing the potential of CC through regulation rather than prohibition.

CC being inherently regulatory requires minimal external regulation. This does not imply deregulation. Some self-regulatory features like recording transactions on a tamper-proof digital ledger, finite supply, incentives to investors to maintain the system to create new CC and that developers oversee the system ought to assuage fears of a hands-off approach demanded of regulators. Strict regulation will greatly dilute CC.

The need of the hour in India is the legal recognition of CC as a macro asset. CBDC as legal tender can coexist alongside private CC as an asset.

Classification of CC as an asset class calls for light-touch regulation, one which facilitates investors and gives a formidable role to self-regulation by CC exchanges.

Investor centric regulation means protecting investors from theft, fraud, price manipulation and other practices which diminish the value of CC. Some of these regulatory measures are licensing of and ensuring that exchanges maintain secure systems, a safety net to cushion losses and safeguards against hacking.

Concerns of misapplication of CC may be addressed through disclosure by exchanges; stringent KYC norms; and permitting exchanges to evolve internal code of conduct for monitoring.

The main thrust of the state’s role ought to be providing a robust legal regime by revamping privacy, property, foreign exchange, consumer protection, anti-money laundering, taxation, and criminal law, framing regulations to enable CC and educating CC investors.

CC is a burgeoning sector fraught with untold potential notwithstanding its arcane and intractable nature. It ought not to be wished away through a ban. Instead, India should seize this opportunity to bridge gaps in extant regulation through innovative light-touch regulation which is aimed at enhancing investor confidence in CC and augmenting the development of common global standards for the growth of CC.

(The writers are advocates based in Bengaluru)