Crypto rules are needed to avoid systemic risks. But how we classify them matter

In my view, in the history of mankind, cryptos are the fastest asset creators, creating $2-$3 trillion in the 10 years since Bitcoin was launched in 2009. Today, it is one of the most talked about asset classes — or should I say a puzzle. To utilise this asset and to enjoy its benefits as a part of the economic mainstream, regulators and policymakers worldwide are racking their brains on how to set boundaries around it.

A typical crypto could include cryptocurrencies, virtual assets and digital currencies, among others. However, for the purpose of this discussion, I am focussed on crypto coins, tokens and their derivatives that are cryptographically secured. Crypto coins work through a distributed ledger technology, which keeps a secured record of individual coin ownership. The ownership can be transferred from one person to another electronically.

Given the digital nativity of these currencies, lack of transparency about trades and traders, and the global ubiquity of the crypto platforms, an unregulated crypto could be a big systemic challenge. A person could purchase crypto coins in a foreign currency abroad and sell it to someone in India, earning large sums of money by avoiding taxation and bypassing know-your-customer (KYC), anti-money laundering (AML) or foreign exchange regulations. Effectively, unregulated cryptos could mean unfettered money laundering, unregulated outflows and inflows of forex and a side-door to full convertibility of the currency. As an alternative currency, it could pose a threat to monetary policy, and cause issues related to investor protection and fair market practices, security and technological risks.

So, is there an option but to regulate the crypto market? Some may say ban cryptos in India. But is that really an option? Crypto is a digital product with no physical traceability. It may already be existing in the Indian market in some form or the other. Regulating the crypto market with very strong checks and balances could be a solution.

The big question that most regulators across the globe are grappling with is how to regulate this market. Indian policymakers could also look at the approach followed in some countries. In the UK, the Financial Conduct Authority had provided a guidance and regulatory approach in 2019. Further, a conducive environment for innovation was fostered by addressing uncertainty around taxation and KYC/AML. Any sale, use or exchange of crypto assets attracts capital gains tax, and exchange wallet providers are required to be registered.

Singapore has also adopted a very supportive approach with a comprehensive regulatory framework, including MAS licensed and regulated digital payment tokens and service providers, Financial Action Task Force (FATF) rules around AML/CFT (combating the financing of terrorism), and taxation rules with no capital gains on long-term holdings. In Japan, cryptocurrencies are recognised as crypto assets and are regulated by the securities regulator. AML/CFT compliance as per FATF have been mandated, and income/gains from cryptocurrencies are taxed as miscellaneous income. Brazil has not issued any specific regulations but existing regulations for the financial sector cover the crypto business. Capital gains tax is applicable, and it is the responsibility of citizens to divulge details to tax authorities.

China, on the other hand, has announced a ban on cryptocurrency transactions. It is conducting a multi-year experiment with its Central Bank Digital Currency or CBDC (termed as e-CNY) which was rolled out in 4 cities to 21 million people and over 3.5 million corporate wallets, resulting in over RMB 34.5bn of transaction value.

In my view, the regulatory framework would depend on how we define a cryptocurrency: is it a currency, an asset or a commodity? The overall regulatory framework/response could be:

1. A detailed KYC framework for any crypto transaction or ownership wherein one leg of the transaction is in India or by an Indian
2. A detailed ALM framework based on the trace of money
3. An adequate taxation framework
4. Securities laws depending on whether it is considered a security or a commodity

Of course, given that crypto is a new and evolving technology, the regulatory framework too will have to be dynamic and evolving. Finally, a panel of crypto experts should be created to assist the government, regulators and policymakers to keep a regular tab on the situation and to facilitate appropriate decision making.

In conclusion, I would say that business as usual is not an option. No action from the government would mean acceptance of the status quo, which has several risks. Undoubtedly, it will certainly not be easy to regulate cryptos. But it is damn if you do, damn if you don’t. A swift and evolving regulatory response is a must to decode the cryptic cryptos.