Here’s how the Indian banking sector can embrace Cryptocurrency

by Rajesh Begur

Cryptocurrencies, largely since their inception, have been mired in regulatory controversies. However, that does not seem to deter public interest in them even slightly. Simply stated, cryptocurrencies are virtual tokens used as a medium of exchange like regular currency. They differ from traditional fiat currencies in two fundamental ways (other than being virtual) – one, they are not issued by a central bank, and hence, aren’t legal tender; and two, instead of using traditional banking channels or intermediaries, they use the Blockchain for enabling, recording and authenticating transactions.

But what makes regulators averse to these so-called technological revelations and what makes them tick with the public? We discuss in this article the approach of Indian law towards cryptocurrencies and where they stand in the larger scheme of things.

The regulatory stance in India

The RBI and the Finance Minister have, on multiple occasions, warned about the perils of investing in cryptocurrencies – the latter’s remarks on the 2018 Budget Day even causing a temporary Bitcoin crash, much to the chagrin of cryptocurrency enthusiasts. The RBI itself has issued multiple regulations in this regard – with one April 6, 2018 circular prohibiting entities regulated by the RBI from ‘providing any service in relation to virtual currencies, including those of transfer or receipt of money in accounts relating to the purchase or sale of virtual currencies’ – effectively barring banks and other intermediaries from facilitating cryptocurrency settlements, crypto-exchange accounts, and other connected activities. More recently, the Supreme Court has refused to stay this particular RBI circular.

On the legislative front, a draft Banning of Unregulated Deposit Schemes Bill, 2018 has been introduced in the lower house of the parliament with an aim to ‘ban unregulated deposit schemes and protect the interests of depositors’. Although the Bill does not mention cryptocurrencies, activities such as Initial Coin Offerings (a public offering of cryptocurrencies by new issuers) will be covered within its scope, if it is passed.

The volatility of these unanchored free-floating tokens is a cause for concern

The above aversion to cryptocurrencies is not particular to India – it’s a sentiment reflected all over the globe. Since cryptocurrencies are not legally issued tender, their use as currencies would create an economy parallel to the government-run economy – which, if it grows, could have problematic consequences. For example, the price of these unanchored free-floating tokens is highly fluctuating driven only by demand and supply – Bitcoin has jumped from USD 1000 to USD 20,000 in a span of 12 months and fell back to USD 6500 in almost half the time. Governments use sophisticated strategies to control price fluctuation and inflation in the system. Since cryptocurrencies have no such issuing authority, they also have no price anchor, and their price is prone to wild fluctuations due to uninformed and speculative investments by the public.

Taxability of such tokens is a challenge–cryptocurrency tokens are usually issued in a process called mining. Transfers happen on the stock exchange, or while purchasing items in a barter (although rare in India). Ideally, depending on how these tokens are acquired – they make be taxed either as income from other sources (for mining), capital gains (for transfer) or income from business or profession (for exchange), however, in the absence of a clear legal position, it is extremely unclear how will gains derived be taxed.

Are cryptocurrencies cash or commodity?

No rationale can be attributed to the cryptocurrency mania except the fact that people are using cryptocurrencies as an investment grade product rather than as a medium of exchange, which is what their anticipated use was. However, since the market is completely unregulated, any crash can have disastrous consequences to the economy.

The debate around whether these tokens are currencies or commodities exists in various jurisdictions. In India, regulatory oversight is also in a grey area – it is not clear whether such tokens would be covered under the definition of ‘securities’ under the Securities Contract (Regulation) Act 1956 or not.

Fungibility of one cryptocurrency into another is also a problem – without formal regulations in this regard, converting one cryptocurrency into another seems challenging – making a market of unregulated cryptocurrencies almost practically improbable.

On the other hand, cryptocurrencies can prove successful as another investment avenue for the public and drive up the economy if properly regulated. They may also be helpful in porting legal tender on the Blockchain–Singapore is already attempting to do so for the Singapore Dollar.

Regulatory solutions and the way ahead

The reasons for cryptocurrency aversion, as mentioned above, are clear–but probably uninformed. Blanket statutory ban will only prompt the market to move underground.

The regulators instead may formulate a middle-ground solution. For example, considering the potential of this disruptive trend–states like USA, South Korea, Singapore, Canada etc. have allowed trading of cryptocurrencies on their respective commodities exchanges. In doing so, they have bought the market under a controlled regulated platform, while also facilitating crypto-enthusiasts’ interests. Indian regulators can also allow trading of such commodities for exchanges or legislate to regulate the existing crypto-exchanges to facilitate the same – given that they already have the infrastructure.

Similarly, Initial Coin Offerings are being planned to be regulated under dedicated regimes in states like Philippines, UAE etc. SEBI can take steps to regulate the same and amend other regulations to bring cryptocurrency tokens under its purview. Tax regime, similarly, can be also be amended to cover gains from cryptocurrencies under relevant heads. Further, KYC norms can be introduced at the crypto-exchange level to prevent anonymity in transactions.

It is a given that extrapolating the current legal regime over this novel challenge may prove unsatisfactory and leave scope for problems – hence, new laws accommodating the broad features of this technology should be propounded. However, in our view, rushing legislation is also not ideal until law-makers first understand the technology in its entirety.

Rajesh Begur is Managing Partner at ARA LAW