Crypto innovators need a safe harbour to experiment

This November, the government listed the Cryptocurrency and Regulation of Official Digital Currency Bill 2021 for discussion in winter session of Parliament. Indian crypto businesses and asset holders are sitting tight as the legislation draws near.

The industry has been jittery ever since the government’s last decision to ban crypto altogether. In April 2018, regulators had said that banks could no longer process cryptocurrencies. The matter ended up in court and the ban was quashed. The new thinking is that cryptocurrency would be regulated rather than banned outrightly. This, even as regulators scratch their heads over what it actually does and what it actually is—a tech or an asset?

“We have always been forced to adopt others’ standards and then cry foul. Whereas in this ecosystem, we are the leaders in many senses,” says Meghna Bal, author of a report by Esya Centre, commissioned by the Observer Research Foundation. The report makes a case for regulation.

In spite of lack of clarity on rules, the Indian crypto asset industry has flourished over the last five years. India has 15 million crypto asset holders who have invested Rs 66o crore, says Esya Centre. India already has more than 350 crypto start-ups. Two are unicorns—Bengaluru-based CoinSwitch Kuber and CoinDCX, worth $1.9 billion and $1.1 billion, respectively.

Experts say cryptos may not be governable but can definitely be regulated through trading platforms because the system is tied up with ‘exchanges’—cryptocurrency trading platforms where investors buy, sell and trade Bitcoins and other popular virtual currencies. The journey that India is undertaking is one that many countries have been through. So, why is it so hard to define and classify cryptocurrencies or crypto assets or ‘virtual currencies’ as RBI calls them? One of the biggest reasons is that ‘crypto’ is so many different things—they are issued in a digital form, have no underlying value and are not legal tender because their purchasing power is never fixed due to extreme volatility in prices.

“What makes regulators wary of crypto is lack of transparency around transactions. As cryptos would be privately controlled by blockchain networks, it would mean domestic central banks lose their ability to govern and regulate financial markets,” says Rajosik Banerjee, partner and head, financial risk management at KPMG India.

“Once cryptos become more stable, we may see emergence of some payment use cases. Until then, they continue to have better usage as store of value, assets, utility tokens,” says Manhar Garegrat, chief of staff at CoinDCX, a crypto exchange. “Basically, there are many tokens out there and nothing like them has existed so far.”

Tokens is another way that the crypto community refers to these virtual currencies or assets. “So, they cannot be bracketed into any single entity because it depends on how you use it. It can exhibit various properties. For instance, Bitcoin as a currency can be used for payment, though it isn't the best currency out there. Cryptocurrencies may also be used as store of value. They display all these properties. It depends on how I or someone else sees it. There is no standardisation and it’s all subjective.”

One emerging approach is piecemeal. “It doesn't matter if you classify them as asset or currency. You can classify according to how it has been used and then apply the classification for that particular transaction,” says Garegrat.

But jurisdictions around the world are looking at frameworks which are both innovation-friendly and meet various policy concerns such as investor protection, anti-money laundering and prevention of terror funding.

Neither government nor RBI has any doubt about banning it as a private currency but not as an asset that works as a store of value. “It is the brilliant part of cryptocurrencies—that it is only between two people where it becomes a medium of exchange without an intermediary—that is not liked by them. What we can expect is RBI coming up with a CBDC (Central Bank Digital Currency). Crypto can never be a currency but may be held as an asset," says Raghavan Ramabadran, executive partner at Lakshmikumaran & Sridharan Attorneys.

Regulators also worry about P2P transactions where no exchange is involved, or even if an exchange is involved, it is beyond India's geographical boundaries and jurisdiction.

“There is nothing as effective as a safe harbour for enabling innovation. It means you need certain conditions that would insulate companies from some amount of liability. I think this balances innovation and policy concerns adequately. It builds rapport and foundational trust between public institutions in the private sector in order to develop an ecosystem. Besides, many risks are mitigated by the technological nature of crypto itself,” says Bal.

While there are risks associated with cryptos due to their volatility and possible usage in money laundering and terrorist financing activities, with rising interest of the investor community, it is hard to keep them out of the financial system altogether.

Banerjee has another take: “For crypto to realise its potential, institutionalisation is needed. This will mean ‘at scale’ participation in the crypto market by banks, exchanges, payment service providers and brokers. Institutionalisation is the necessary next step for crypto to create trust and scale,” he says.

“If recognised as a virtual asset class, there needs to be a proper mechanism around payments and settlements of crypto transactions. Exchanges can play the crucial role of making sure settlements are honoured. This can be achieved through measures such as margin money set aside in the form of a guarantee of funds,” he adds.

Further, experts say that the tech that underlies crypto—blockchain— may be the basis of Web 3.0, a vision of the future of the Internet in which people operate on decentralised, quasi-anonymous platforms.

“Tech is extremely unpredictable. Even experts don't know where it's going. There may never be a Web 3.0 but there is so much activity around it. All tech colleges in India have cohorts working towards developing an ecosystem. Blockchain is an open tech and you can build on top of it without permission from anyone.”

Web 3.0 already has a lot of institutional backing with venture capitalists too rushing in. So, it may not be beyond what is conceivable. “Real innovation happens on fringes of any industry, in the unseen borders of any technological ecosystem. So, if it is not on your radar, that doesn't mean it’s not possible or it is not there. That is not a valid argument for any heavy-handed regulation,” says Bal. Banning something means you’ve buried your head in the sand, “You accept you don't know how to reckon with this,” she says.