Why the government should regulate and not ban cryptocurrency

The Indian government must not permanently ban cryptocurrency (also referred to as ‘token’ or ‘coin’ or ‘digital currency’). Any permanent ban on cryptocurrency would only reflect a lack of understanding of the positive impact the technologically powerful cryptocurrency can create on the Indian economy.

Many governments have expressed fear over tokens as there is no central authority to regulate the value or oversee the exchange of tokens. The fear stems from an inability to regulate the crypto market or monitor the valuation or track the transfer of cryptocurrency. With fiat currency, governments can do all of the above.

Most central banks world over, in conjunction with their respective governments, pass monetary policies each year. The goal of the monetary policies is to specifically control the global value of money. The government through its monetary policies regulates employment, spending, investments and inter alia controls investment.

The Indian government can mitigate the above threat by issuing Central Bank Digital Currency (“CBDC”). CBDC shall be backed and controlled by the RBI. CBDC would have legitimacy and would encourage the public to purchase/trade. It would have the ability to become mainstream (as it is backed by the Central Bank) and help to push India towards a cashless society.

CBDC can help a significant population group to access the financial system without access to the banking system. Further, if CBDC became popular, the government could adopt it as a mechanism to monitor payments to public officials.

Many nations such as China, Sweden, Canada, Switzerland, and Singapore are engaged in developing a pilot of their own CBDC. CBDC can help develop the digital economy and provide for more financial stability once it has the full backing of the government. Moreover, there may be more trust in the financial systems as there shall be less volatility while conducting transactions through CBDC.

A CBDC shall also help reduce the shadow trading or the black cryptocurrency markets and the RBI shall be able to control cash supply more effectively. A CBDC shall provide effective competition to private cryptocurrencies such as Libra. Moreover, money laundering issues can be solved if there is a central backing to a digital or crypto rupee.

Concerns regarding the security in dealing with cryptocurrencies can be suitably dealt with. Cryptocurrency is backed by blockchain technology protocols, which means that every transaction is recorded as a part of Distributed Ledger Technology (“DLT”).

DLT simply means that the transaction shall be validated by several computer networks before the transaction is recorded on the DLT. DLT is known to be a foolproof technology and an individual’s cryptocurrency wallet cannot be hacked like a traditional online wallet.

If the Indian government were to release CBDC, such cryptocurrency could bear two layers of protection – with one layer through the DLT technology and another through its own centralised system.

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India’s Crypto revolution: benefits of lifting the ban on cryptocurrencies

The development of cryptocurrency business i.e. Initial Coin Offerings (“ICOs”), Security Token Offerings (“STOs”), cryptocurrency exchanges, the exchange of cryptocurrency for goods and services, and the creation of CBDC would collectively help in building blockchain technology platforms which can have a variety of use cases in other fields.

For example, transfer of land, when migrated to a DLT platform, would create transparency on all land transfers and potentially reduce litigation on matters concerning illegal land grabbing. Most importantly, it would eliminate all forms of manipulation of land-related documentation, as the transactions are recorded on DLT.

Moreover, land and real estate tokenisation will increase liquidity as the value and ownership can be digitised and put into fractional tokens to be distributed around the globe. This gives investors the right to own a portion of real estate, thereby increasing liquidity of the underlying asset. This ultimately could open yet another avenue to draw in foreign direct investment in real estate.

Banning cryptocurrency negatively impacts early-stage startups from raising funds. The ongoing COVID-19 pandemic has caused widespread recession across India. Early-stage startups are likely to struggle in raising funds.

An Initial Coin Offering (“ICO”) is one such way for early-stage startups to raise funds. In an ICO, the issuer publishes a white paper with details about the project for which money/investment is intended to be raised from the public. Subject to conducting a risk assessment of the proposed project, interested members of the public may subscribe to the tokens offered on the ICO with either fiat currency or other tokens of repute (e.g., bitcoin).

Moreover, crowdfunding activities could be carried by the introduction of a token and associating the rights to it as a normal share would have. Hence, the ban on cryptocurrency would impact such effective alternative sources of funds for early-stage startups.

The government’s position so far seems to be that, in an ICO, there is the potential of laundering money to fund projects and also the inability to track the source for the payment for the purchase of coins in an ICO. However, the government’s reasoning is flawed.

The RBI in India regulates payment systems. It is therefore capable of tracking all coin purchases in an ICO by regulating it within the framework of a payment system. Further, the Indian government can adopt regulations to regulate an ICO. Some measures can include:

1. Limiting the investment amounts in an ICO for each individual investor;
2. Requiring the tokens being issued through an ICO to be under the purview of the Securities Exchange Board of India (“SEBI”) and amending the SEBI (Listing Obligations and Disclosure Requirements) (“SEBI LODR”) to regulate cryptocurrencies issued under an ICO;
3. Mandating the ICO issuer to publish their project on SEBI website; and
4. Bringing the purchase of coins through an ICO under the Prevention of Money Laundering Act, 2002.

As far as STOs are concerned, the issue associated with it is the volatility in the value of such STO and the ability of the government to regulate the same. The government could treat such STO as any other security and can amend the Securities Contract Regulation Act, 1957 to bring STOs under the framework. As stated above, issuers of STOs may be mandated to make disclosures as required under the SEBI LODR.

STOs may be deemed to be an unregulated deposit under the provisions of the Banning of Unregulated Deposit Schemes Act, 2019 (“BUDS Act”), and therefore may entail a monetary penalty of up to Rs 10 lakh, and imprisonment up to five years as per Section 21 of the BUDS Act.

Accordingly, SEBI would do well to take note of the nature of STOs and regulate them, providing comprehensive classification on how STOs be deemed as securities.

One of the main sources of business in the crypto-asset markets is cryptocurrency exchanges. While cryptocurrency exchanges are currently deemed legal in India, commercial and scheduled banks have been reticent with regard to offering their services to cryptocurrency exchanges and their customers.

To give comfort to banks, the government and the RBI could pass regulations to obligate cryptocurrency exchanges to conduct comprehensive KYC procedures on their end customers/holders of cryptocurrency. Such KYC norms will help the government to track cryptocurrency traders and their source of funds.

Moreover, crypto assets may be regulated under the Prevention of Money Laundering Act, 2002 (“PMLA”), by way of making an amendment to include cryptocurrency businesses as “designated businesses and profession” within Section 2(a) of the PMLA, and this would also bring crypto businesses under “client due diligence requirements” as given by Rule 9 of the Prevention of Money Laundering (Maintenance of Records) Rules.

Globally, cryptocurrency is slowly moving into the mainstream. A failure to regulate the cryptocurrency market would not have the effect of halting the cryptocurrency sector but rather have the effect of taking it underground, bringing into life all of the government’s fear concerning cryptocurrency.

Cryptocurrency can be a way to raise public funds and create productive commercial activity within the economy. Therefore, the government should strive to understand the immense potential and the use of cryptocurrency and take initiatives to regulate the cryptocurrency market rather than impose any form of prohibition.

A note has been moved by the Ministry of Finance for consultations, post which it shall be sent to the cabinet. The note is most likely to introduce the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 to the parliament.

If a Bill banning cryptocurrency is passed, it would cause a huge shock to the fledgeling cryptocurrencies, crypto exchanges, investors and the DLT market space, which is avoidable at best.