As the digital finance sector is advancing at a breakneck speed, proper regulations need to be put in place.
The trio of Jandhan, Aadhar, and Mobile access has made digital payments a reality. It is evident by the increasing volumes, the wider usage seen across Indian markets, and the consumer socio-economic segments; and most importantly, it cuts across the literacy spectrum. Fifteen years ago, we could not have imagined monetary transactions being done without using currency notes or coins or any conventional physical mechanisms like cheque books. India has come a long way in reshaping financial access using digital mediums.
The speed of technological and digital advancement, if not matched with adequate safety aspects, could become a supervisory-burden for the global financial regulators. The regulators will need to balance the positive outcomes of the emerging technologies, alongside the negative impact, especially if these technologies have a bearing on the markets, and can influence the way fiscal and monetary markets operate. The regulators also have a role in ensuring that adequate consumer protection guard-rails are in place; these are equally important as developmental policies for larger socio-economic positive outcomes.
The speed of technological and digital advancement, if not matched with adequate safety aspects, could become a supervisory-burden for the global financial regulators.
Therefore, it is natural for regulators to have genuine worries around TechFin practices, antitrust issues, cybersecurity risks, too-big-to-fail issues, and challenges around data privacy. A core basis of financial stability is consumers’ trust and their confidence in the stability and resilience of the system.
“We have also seen that cryptocurrencies are not amenable to definition as a currency, asset or commodity; they have no underlying cash flows, they have no intrinsic value; that they are akin to Ponzi schemes, and may be even be worse," Dr T. Rabi Sankar, (Deputy Governor, RBI) said in a recent speech.
But, as the International Monetary Fund (IMF) blog mentions, “Many of these entities lack strong operational, governance, and risk practices. Crypto exchanges, for instance, have faced significant disruptions during periods of market turbulence. There are also several high-profile cases of hacking-related thefts of customer funds. So far, these incidents have not had a significant impact on financial stability. However, as crypto assets become more mainstream, their importance in terms of potential implications for the wider economy is set to increase.”
One of the key regulatory concerns is anything that could become a national security issue. In this aspect, the regulators fear the misuse of crypto currencies using its anonymity for weakening its anti-money laundering efforts. India, being a part of the Financial Action Task Force (FATF), has to abide by its standards that seek global cooperation between sovereign member nations.
FATF, in its 2021 guidance note on Virtual Assets (like crypto), raised a red flag—“This Guidance outlines the need for countries and VASPs, and other entities involved in VA activities, to understand the money laundering and terrorist financing (ML/TF) risks associated with VA activities and to take appropriate mitigating measures to address those risks.” The crypto industry has not yet been able to address these concerns with any concrete measures.
The regulators fear the misuse of crypto currencies using its anonymity for weakening its anti-money laundering efforts.
This has been amplified further by the recent statement of RBI Deputy Governor—“The Financial Stability Institute of the Bank for International Settlements identifies difficulties in regulating cryptos—such as the international nature of crypto transactions, absence of technological solutions to ensuring FATF’s ‘Travel Rule’, the problem of ‘unhosted wallets’, the fact that P2P transactions do not involve any entity subject to AML-CFT regulations, etc. Let us suppose India decides to regulate cryptocurrencies. How would it regulate and redress a case of mis-selling as it has no access to the ledger, nor to any audit trail? As it is not always possible to know of the persons who are the management for cryptocurrencies (e.g., Bitcoin), at whom would the regulatory action be directed?”
On the other hand, investor protection is always an important mandate of financial regulators. From regulatory perspective, crypto assets are currently seen with suspicion about its intent-of-existence, as well as being observed as overtly speculative asset, without any underlying value to it. With over 10,000 cryptocurrencies in global circulation, and most of them with high volatility of value and trading volumes, global regulators will need to boost their investor safeguard measures, until they either ban them or regulate them tightly.
However, if large investor base knowingly invests in cryptos and loses money (irrespective of how small those investments individually are), the regulator or government gets blamed for not doing enough!
The official stand on digital assets has changed considerably over the recent times, from RBI’s warning to the public investing in crypto in December 2013, RBI prohibiting it’s regulated entities in dealing with virtual currencies (in April 2018), the Supreme Court of India overruling RBI’s April 2018 circular, to the upcoming bill for Parliamentary approval. “The Cryptocurrency and Regulation of Official Digital Currency Bill of 2021”, actually has missed its twists and turns in the Parliamentary debate, and instead is playing it out in the form of media statements and speeches, and undue public speculation.
With over 10,000 cryptocurrencies in global circulation, and most of them with high volatility of value and trading volumes, global regulators will need to boost their investor safeguard measures, until they either ban them or regulate them tightly.
Technically, there is neither a ban on the use of cryptocurrencies (or crypto assets) in India, nor a regulation that govern their actual usage. The crypto bill which has been touted for long, and yet is pending across multiple sessions of the Parliament, is expected to “create a facilitative framework for the creation of the official digital currency to be issued by the Reserve Bank of India”. This bill will also ban all private cryptocurrencies, except for allowing “for certain exceptions to promote the underlying technology of cryptocurrency and its uses”.
“Whatever the government does, we consult and have discussions with the Reserve Bank of India and therefore, we take calls. So, if we were to tax 30 percent and then also go and discuss GST and everything else, I would be tying RBI's hands if I hadn’t even talked with them…There is a level of partnering with each other that is happening,” Finance Minister Nirmala Sitharaman stated during a media conference. Prior to this, the RBI Governor had cautioned investors about cryptocurrencies by saying that the cryptos are a “threat to macroeconomic and financial stability”.
India recently decided to tax digital assets like cryptocurrencies and non-fungible tokens (NFT), a 30-percent tax on transfer of such assets as well as a 1-percent tax deduction at source (TDS) on every transaction. This TDS while being low cost that won’t create feeling of being expensive transaction would, however, offer the list of those who trade in cryptos. The move has triggered a debate on the legality of such assets and whether taxes on them have legitimised them. The fact is that it is not illegal now to have crypto assets, however, taxing them does not make them necessarily legal either.
For all the crypto industry players’ arguments about a large number of investors whose money have been invested into the sectoral products, the RBI has a counter argument: “Data informally gathered in November seems to indicate that crypto investments by Indians is nowhere near to being significant (although the pace of growth could make it a concern in future). This data showed that four out of five investor accounts held investments of less than INR10,000, with an average holding size of INR1,566. Wealth loss, if at all it is a possibility, is likely to affect only a small fraction of these investors.”
India recently decided to tax digital assets like cryptocurrencies and non-fungible tokens (NFT), a 30-percent tax on transfer of such assets as well as a 1-percent tax deduction at source (TDS) on every transaction.
It is also important to note the observation that there is no official statistics on the actual crypto investments of individual investors, and therefore, a policy narrative cannot be formed solely on the basis of the arguments claiming “consumer choice of crypto products”. However, this proposed TDS on digital assets would help in officially collating data on its usage and thereby would form as input to the policy and regulatory framework.
Dr. T Rabi Sankar, Deputy Governor, Reserve Bank of India said in a recent address that “cryptocurrencies are decentralised systems where transactions are authenticated by participants themselves by consensus. They are designed to bypass the financial system and all its controls. They cannot be traced or a confiscated or frozen by governments. They are anonymous—transactions are verified, but not the purposes or counterparties of transactions.”
Even in the Union Budget announced recently, it was made clear that the RBI would launch India’s Digital Rupee in FY 2023. The above RBI stand has the argument that the regulator would want to know the purpose of digital-asset transactions, and not just the parties involved in the transaction.
One of the argument floating in the tech world is that the digital rupee may not use blockchain for this rationale: A blockchain is considered to be a ‘permission-less network’, with multiple nodes that verify transactions.
Assumedly, the RBI would want to be in control of the digital rupee, which would then need RBI as the sole-validator of transactions. That would make the digital rupee concept a “permissioned” one, which is anti-blockchain ideology.
To make the digital rupee available to the citizens, the RBI will have to rope in more nodes for handling the transaction volumes. Without this, the digital rupee could remain restricted between the RBI and the banks, which does not solve for anything!
This crypto policy and regulation debate has seen surges of overt-optimism as well as cynical suspicions. It has seen exuberance to develop a law which by now has supposedly seen many changes in its draft version, and never been placed in public domain for any feedback. Hopefully, this topic of ‘crypto-legality’ will be put to rest with a policy decision soon.
Policymaking around digital finance suddenly looks tougher than ever before. Is it cold-pressed with facts or hard-pressed for further narratives?
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