Last month, the government of El Salvador announced that it would begin accepting bitcoin as legal tender. This is the latest major development in the ongoing debate around cryptocurrencies and the way forward.
This debate has gained momentum in India as well. While the Indian government and the Reserve Bank of India (RBI) measure the pros and cons of allowing a free play of cryptocurrencies, the emergence of cryptocurrency exchange apps indicates that markets are running ahead of regulation.
As we debate the scope and desirability of cryptocurrencies, here are some factors that should be weighed.
Acceptance of Innovation
The power to issue currency is one of the fundamental pillars of a modern nation-state. Any innovation competing with this power is bound to be opposed. The Indian government and the RBI should resist the temptation to look at cryptocurrencies as an alternative to fiat currency. In the spirit of the regulatory sandbox, it should allow private parties to make mutual contracts using cryptocurrencies. As its use grows, we stand to learn at the expense of private capital.
Eliminate anonymity
Blockchain – the underlying technology on which cryptocurrencies are based – rides on the power of anonymous participants. If the asset class wishes to join the formal financial system, its owners and holders cannot remain anonymous.
Our financial system is based on and attempts to identify all participants under the KYC (Know Your Customer) principle. Therefore, all cryptocurrency holders must disclose their identity, the source of the funds they deploy, and the end-use of the currencies should be monitored.
KYC disclosure will also bring the use of cryptocurrencies within the ambit of existing anti-money laundering regulations. Questions have also been raised over where cryptocurrencies, a US dollar-denominated asset, fall within the purview of the Foreign Exchange Management Act. The government should consider including cryptocurrency investments under the purview of the Liberalized Remittance Scheme (LRS). These holdings can be combined as investors’ global assets and attract the current taxation regime applicable to global assets.
No Backstops
The importance of saying that there are no backstops when cryptocurrencies fail cannot be overstated. The government should clearly notify that cryptocurrencies are not withheld by the sovereign, they are not part of any deposit guarantee program, there is no guarantee on investments made, and that they are not subject to loans issued by any financial intermediary. will not be considered as collateral. Cryptocurrency exchange participants should be made aware that they are investing in an asset that has its own unique risks in terms of pricing and liquidity. Warning Emptor.
Regulatory oversight
Treating cryptocurrencies as financial assets that operate under the paradigm of private party contracts means that they are regulated by the capital markets regulator: SEBI. SEBI has vast experience in regulating a range of financial products and overseeing the exchanges where these instruments trade. SEBI also has experience in developing and managing independent bodies- depository participants that provide transparency and risk management framework for capital market products.
Educate and inform
As it does for financial products such as insurance and mutual funds, the government and regulators should focus on informing and educating investors on the risks associated with cryptocurrencies.
Widespread Use of Blockchain
Cryptocurrencies are based on blockchain technology, which is a plethora of publicly recorded, verifiable, accessible, and immutable information. For a country the size of ours and for a country where state design and architecture make access to information a colossal task, any innovation that helps facilitate easy access to information should be encouraged.
Blockchain can be used to digitize and update land records. The government could create a blockchain, and make land records information more accessible. Thus, a complete ban on the most popular product (cryptocurrency) in blockchain technology may deprive us of its other, possibly more impressive, uses.
Let the markets play
Cryptocurrencies are products of free markets. They are an example of voluntary participation by market players and private capital testing the limits of new technology. As long as we have protected the stability of the financial system, and have clearly communicated that all risk of innovation failure is on the participants, we must let the markets play.
The government and the RBI should focus on ensuring that there is no spillover from private contracts in the public markets, and any regulation at this stage should restrict only the receiving of it.
