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Regulation Of Cryptocurrency In India (In Contrast To India’s Proposed Final Ban)

In simple terms, cryptocurrency is a form of digital/virtual currency through written code that relies on cyptography (encryption) and is independent of any central issuing authority. It is enabled through blockchain technology that allows users to record transactions in a Distributed public ledger to ensure transparency and such that no transaction can be altered once published. It emerged as a person-to-person issuance and transaction system that uses private and public keys that enable authentication and encryption for secure transactions.

If we look back in the past, we can trace the creation of cryptocurrency back to 31st October 2008 when pseudonymous developer, Satoshi Nakamoto published a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System that gave insight into the functionality of a Bitcoin Blockchain Network.

This event carved the path to the present day system in digital currency we have today. Fast forward two years and the cryptocurrency market sprang up. Mt. Gox, the first cryptocurrency exchange was set up and purchases were made through cryptocurrency. Multiple digital assets such as Litecoin and XRP entered the market. In 2014, Mt. Gox experienced the first major cryptocurrency exchange hack, having 85,000 BTC stolen from it.

This incident marks the largest theft of BTC in Bitcoin history, which was valued at $460,000,000 at the time (current date value of almost $3 billion). This saw the Bitcoin prices crash by 50% and didn't recover till late 2016. Ethereum, which is the second largest crypto asset, entered the market in 2015 bringing smart contracts to the forefront. The Crypto market has seen ups and down but has only expanded since then, reaching an all-time high in the end of 2017. Over 2000 crypto assets have entered the market and are a part of the industry currently.

Regulation of cryptocurrency around the world

Cryptocurrency has been a hot topic in the field of finance, technology and law since its inception and has garnered a wide array of opinions from countries all across the globe. It is no secret that cryptocurrency has earned somewhat of a bad reputation due to several issues which we shall look into later on in this article.

Countries are divergent in their methods of regulation. Japan, Switzerland, Germany, Italy, Singapore and Canada have adopted cryptocurrency and regulate it under their anti-money laundering provisions. Japan went further and accepted it as a form of payment. Italy too went on to accept it as a means of exchange that is separate from legal tender.

Other countries such as Saudi Arabia, Taiwan and China have completely banned the use of cryptocurrency. It has been around for nearly a decade, yet it still operates in an unchartered legal territory as it is difficult to fit it under one solid definition and moreover, the existing laws that are tasked with regulating the crypto-tokens were written before its inception and are unfit to cope with its use and understanding to regulate it effectively.

Major Issues with Cryptocurrency

  • Decentralized nature
    Unlike Government issued currency like notes and coins that are controlled by the central issuing authority and are backed by stored gold. Cryptocurrency is owned by no one person and is highly decentralized making it very difficult to regulate. This is further hindered by a lack of suitable legal framework. This also serves as an advantage for crypto owners as the government finds it hard to impose rules on them.
     
  • Volatility
    Cryptocurrency derives its value from demand-supply, media projections and the work done on mining the coins. They are known to be extremely volatile with value making huge deviations both negative and positive overnight, unlike gold which backs fiat currency which is relatively stable. Bitcoin, the leader in crypto saw a huge plummet in its value by 50% in 2014, after the Mt. Gox hack and bankruptcy and did not recover till late 2016. It again rose to an all-time high in December of 2017 where one coin was worth nearly $20,000. But it soon crumbled and by April of the next year it fell to $7500 and later to $3500. This sudden and extreme volatility can be bad for the economy and will lead to market instability.
     
  • Money Laundering and Funding Terrorism
    Any talk of cryptocurrency inevitably brings about the question of money laundering. Due to the ease of motion of cryptocurrency with no checks, purchasing or selling coins with money can be difficult to track. The transactions aren't directly linked to any names or physical addresses and hence create large room for unscrupulous activities like money laundering, drug dealing and funding terrorism.
     
  • Taxation
    Taxation is a major hurdle when trying to regulate cryptocurrency. Most countries are of the opinion the cryptocurrency should be taxed but are split on whether they are to be taxed as a currency or a commodity. Border taxes are another loophole that needs to be plugged as the online ease to get the tokens across border checkpoints without being charged border tax depicts the need for a better regulatory framework both within and between countries.
Other issues are that users need to be careful while entering the details for a transaction as the payment once done is permanent. Interruptions and hacking are also experienced. Bu security measures are taken against the same.

Benefits of Cryptocurrency
Despite these gross issues that are apparent. One cannot deny the advantages that cryptocurrency opens up. Its benefits are many and profound.
  • Cryptocurrencies reduce the need for a middle man thereby making transactions easier, faster and require less or no additional transaction fees. It eliminates the current social and financial structure and gives power back to the people. P2P companies that trade directly with each other will be most benefitted.
     
  • Cryptocurrency exchanges are unique between two parties and ensure confidentiality. It reduces the chance of identity theft. It also ensures that no one person or authority exercises complete authority over the system but also maintains integrity and nullifies manipulation as everything is hardcoded in the system.
     
  • Cryptocurrency finds itself in the centre of technology and finance and with more people having access to the internet than the banks on a global scale; it opens the opportunity for underprivileged people to establish credit. It could prove to be a game-changer and driving force in banking the unbanked and a more equitable means to distribute wealth.
     
  • It opens us up to the global financial market and offers an opportunity for international business people or parties to make one-on-one exchanges online without the complications and added fees that traditionally come with international currency exchanges that involve third parties.
     
  • Cryptocurrency transactions are considered highly secure. Even more secure than bank transactions.
     
  • It's a boon for entrepreneurs to raise funds through ICO's. It will help firms get a grasp over financial coverage by assisting in smooth transactions, digital wallets, online payments and purchases and other financial liberties.

Cryptocurrency in India

Riding on the exponential growth of cryptocurrency worldwide, India saw a massive surge of cryptocurrency exchanges operating from 2012-2017. Seeing a wide base of users and massive popularity of the crypto-market within a year, the regulators and authorities began to take notice and in 2013 the Reserve Bank of India (RBI) issued a press release cautioning the public against dealing in virtual currencies including Bitcoin. But this was to no avail and demonetization opened the gates for massive transaction volume of currency volume in 2016.

This forced the RBI and the Ministry of Finance to release another Press Release that reiterated the security concerns of the 2013 one. In November, 2017 the Government of India constituted a high level Inter-ministerial Committee under the chairmanship of Shri Subhash Chandra Garg, Secretary, Department of Economic Affairs, Ministry of Finance to report on various issues pertaining to the use of virtual currency and suggest suitable action to be taken as well. This Committee submitted its report in July of 2019 recommending a ban on private cryptocurrencies in India.

In April 2018, the RBI issued a circular preventing commercial and co-operative banks, small finance banks, payment banks and NBFC from not only from dealing in virtual currencies themselves but also directing them to stop providing services to all entities which deal with virtual currencies.[1] This essentially crippled the crypto industry as exchanges needed the banking service for sending and receiving money converting cash to cryptocurrency and for paying salaries, vendors, office space etc.

Crypto users were forced to cash out quickly and the industry was hit hard on two fronts with the loss of both banking facilities and reduced transactions. The Internet and Mobile Association of India (IMAI) The industry body - whose members carried out cryptocurrency transactions among each other, filed a writ petition in the Supreme Court on My 15 2018, in Internet and Mobile Association of India v. Reserve Bank of India[2], looking to overturn the RBI circular. They argued that cryptocurrency was more on the lines of a commodity and the RBI had no powers to impose a ban.

The scenario completely changed in on March 4th 2020, when the apex court in a well-conceived judgment passed a decision, quashing the earlier ban imposed by the RBI. With this crypto traders and investors heaved a sigh of relief and the industry began to see steady growth once again. But things didn't end there. On June 12th, news reports were out stating that the government plans to issue a lasting ban on cryptocurrency by introducing a law[3].

The claim being that a law would be more effective than a circular by the RBI in this regard. Reports were that a note was passed by the Finance Ministry for inter-ministerial consideration Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 was in the works for a while and would be introduced as a law to effectively ban cryptocurrency once and for all and decimate the industry.

Under the Bill, Cryptocurrency is defined as ‘any information, code, or token which has a digital representation of value and has utility in a business activity, or acts as a store of value or a unit of account'[4]. The bill would effectively prohibit the mining, holding, selling, trade, issuance, disposal or use of cryptocurrency in the country. This definition might be too vague and broad and could be interpreted as tokens that are not generated through cryptographic means. It could include gift cards, online discount coupons, reward points as a digital store of value. It is to be noted that the Government does hold the right to exempt certain activities at its discretion, in public interest. But a more specific definition would be appreciated for easier understanding and clearer scope.

The penalties prescribed under the bill are hugely disproportionate to other similar economic crimes. Mining, holding, selling, issuing, transferring or using cryptocurrency is punishable with an imprisonment of up to 10 years which is on the same bar as money laundering related offences.

Steps that can be taken to Regulate Cryptocurrency

Banning of cryptocurrency is an expression of the Governments fear of being unable to regulate the crypto market which gives rise to risks such as money laundering and the volatility of the market. But regulation is possible in a systematic step by step manner. By regulation, you can curb the risks and issues that we have come to see with the crypto industry as well as maintain and grow the legitimate businesses and gain from the advantages that cryptocurrency possesses.

To better understand how regulation can take place, let's break the crypto market into segments.
On a wider scale cryptocurrency and its related assets can be regulated under the Prevention of Money Laundering Act 2002 by including crypto businesses under definitions within Section 2(a) of the Act. Even after the Supreme Court judgement, banks are not drawn towards cryptocurrency exchanges and may be turning business away to other soil. The RBI needs to focus on bringing back the business. To provide comfort to the banks, RBI could ensure Know Your Customer (KYC) procedures are followed and made mandatory as this will help keep track of investors and traders and their source of fund.

Another important feature of cryptocurrency is Initial Coin Offering (ICO), which is basically an unregulated means of fundraising to support a new project via cryptocurrency. There is a potential of money laundering to fund projects. This unregulated means can be regulated through SEBI. Although SEBI's initial stance was that they were not best suited to regulate the crypto tokens and that they would only step in when transactions involve securities within Section 2(h) of the Securities Contracts (Regulation) Act, 1956, SEBI needs to rethink this stance as it could be hugely beneficial in regulating cryptocurrency exchanges for ICOs. They can make it mandatory for the ICO issuer to publish their project on SEBI website and SEBI thereby requiring all tokens to be under SEBI purview and can further put a cap to each individual investment.

Security Token Offering (STO), while similar to ICO where an investor is issued with a crypto coin or token representing their investment. But unlike an ICO, a security token represents an investment contract into an underlying investment asset, such as stocks, bonds or funds. The main issue with STO's being its volatility in value and the ability to regulate the same by the Government. STO's could be treated as any other Security and amendments to the Securities Contract (Regulation) Act, 1957 could be made to bring it as well under the ambit of the Act.
In terms of taxation the Indian scenario is rather immature with respect to cryptocurrency and needs to be considered when it comes to regulation. A major decision needs to be taken in terms of whether to tax cryptocurrency as a currency or a commodity.

Indirect taxes such a GST needs to be clarified. Many exchanges in India are currently paying GST on the fee portion collected from the customers for paying the same to the department. The traders also need to analyse the implications of GST on the P2P sales which are executed by them since those have profit element too. The term Cryptocurrency would need to be included within the Act. Tax Authorities may also consider getting in transaction tax approach on these trades where each transaction can be considered to be separately taxed like STT (security transaction tax) as there is a large volume of trade in each transaction.

The Government under the draft Bill aims to introduce a digital rupee which is a Central Bank Digital Currency (CBDC)[5]. CBDC shall be backed and controlled by the RBI under the relevant provisions of the Reserve Bank of India Act, 1934 Banning cryptocurrency and further introducing this would be counter-productive. Instead introducing a digital rupee while further working on regulating all other crypto-tokens would go a long way in encourage the public to purchase/trade and help to push India towards a cashless society. Concerns related to the use of cryptocurrency can be put to bed and more opportunities for growth in the sector can be explored.

Conclusion
To conclude, through this article I have portrayed multiple ways to regulate cryptocurrency in India in contrast to permanently banning private cryptocurrency as a whole which would decimate the industry and we would have to start over from scratch with a central authority backed digital currency. Cryptocurrency has proven to be ‘money for the digital age' and has seamlessly integrated itself in the world's financial ecosystem despite its challenges.

Proper regulatory framework will not only help the law enforcement agencies understand the technology but will also help capitalize on an industry that is worth billions and provides employment to over 5 million people in the country, that are involved both directly and indirectly. Technology is making its way in every other industry, then why are we so against regulating its use in the financial sector. No doubt there are risks and benefits associated with cryptocurrency, but plenty of these risks can be controlled by testing it in regulatory sandboxes before actually taking a step towards banning.

There is a long time before we can see cryptocurrency on the same line as where banks stand in our financial system, but it would be unwise to not notice the rowing trend the industry is seeing and the evolution that is bound to take place in the future. At this point of time what is required is to find a healthy balance between banks and cryptocurrency and find a way for both to exist and for the public to reap the benefits as a whole

End-Notes:
  1. Reserve Bank of India ,Prohibition on dealing in Virtual Currencies (VCs), (April 6th 2018), www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11243&Mode=0
  2. IAMAI v. Reserve Bank of India Writ Petition (Civil) No.528 of 2018
  3. Deepshikha Sikarwar, The Economic Times, With a law, India plans lasting ban on cryptos (June 12, 2020, 04.46 PM IST), https://economictimes.indiatimes.com/news/economy/policy/with-a-law-india-plans-lasting-ban-on-cryptos/articleshow/76330403.cms
  4. S.2(1)(a), Banning of Cryptocurrency &Regulation of Official Digital Currency Bill, 2019
  5. S.4, Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019

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