After waiting patiently for a week for someone to dig out the “The Cryptocurrency and Regulation of Official Digital Currency Bill 2021” (“the 2021 Bill”) and give us an analysis, I decided to take a shot at analysing the history of the ‘Indian crypto ban’ and what this could mean for the crypto industry in India.
Most of the reportage on the proposed Indian crypto ban revolves around the brief description that surfaced in the bulletin of the lower house that proposes to ‘create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India’ but also more alarmingly mentions a ban on all ‘private cryptocurrencies’. Since then speculation has been rife over what the government means by ‘private cryptocurrencies’ to what this would mean for the Indian crypto-verse.
Reportedly, the revised 2021 Bill has not been made public, therefore it is unclear how different the 2021 draft bill differs from the previous draft. However most of the arguments made in this article against a ban being imposed still hold good.
What’s the Indian crypto ban about?
The Bill was proposed by an Inter-ministerial Committee (“Committee”) formed in 2017 under the chairmanship of the Secretary, Department of Economic Affairs, Government of India with participation from Indian regulators. The news on the proposed ban created a stir but was subsequently eclipsed by an RBI circular in April 2018 prohibiting financial institutions regulated by RBI from offering services to individuals and businesses dealing in virtual currency such as Bitcoin. This had a catastrophic effect on crypto investing in India – most exchanges shut shop or converted to peer-to-peer (P2P) platforms.
In March 2020, the Supreme Court set aside the RBI circular, leading to a resurgence in cryptocurrency trading through Indian exchanges. Well, the outcome of that Committee is this Bill, which apart from setting a framework for a digital rupee, proposes to ban all cryptocurrency apart from the official digital currency.
The 2019 Bill
The Bill defines ‘Cryptocurrency’ quite broadly which includes any cryptographic token that is not the ‘Official Digital Currency’ and which provides a digital representation of value which is exchanged with or without consideration or that functions as a ‘store of value’ or ‘unit of account’ and also bans the use of Cryptocurrencies in any financial transaction or investment or investment schemes. This would include any cryptocurrency that is not the proposed digital rupee.
Chapter 4 of the Bill sets out a legal framework for a Central Bank Digital Currency (CBDC) as legal tender and currency and classifies all foreign digital currency as ‘foreign currency’ that will be subject to Foreign Exchange Management Act (FEMA). This is a direction that most global central banks are taking, no surprise here.
Chapter 5 of the Bill contains the prohibition on use of Cryptocurrency. Sec 6 of the Chapter states that Cryptocurrency is not to be used as legal tender and currency, a store of value, a medium of exchange or a unit of account. This Chapter in subsequent sections, prohibits ‘persons’ (which includes individuals and a host of entities and legal persons recognized by Indian law) from directly or indirectly:
- Using Cryptocurrency as a payment system.
Comment: India does have payments legislation, however, the prohibition would exclude Cryptocurrencies from even being used to settle payments in any payment system in India. This probably means that even if DLT technologies are adopted for payment systems, the digital rupee would be the only cryptocurrency used for settlement or as ‘gas’ for completion of transactions on a blockchain.
2. buying, selling, storing Cryptocurrency.
Comment: This includes the average person that wants to buy bitcoin, ether or altcoins or any Cryptocurrency
3. providing Cryptocurrency related services such trading, settling and cryptocurrency with Indian or foreign currency.
Comment: Exchanges would be prohibited from operated either as a centralized exchange or even P2P platforms.
4. issuing cryptocurrency related financial products.
Comments: No crypto-related funds, bonds or any financial products too.
5. Using cryptocurrency as a basis of credit.
Comments: No lending or using Cryptocurrency as collateral for a loan.
6. issuing Cryptocurrency as a means of raising funds.
Comment: No ICOs too
7. Using Cryptocurrency as a means for investment.
Comment: I am not sure what this means.
Persons holding Cryptocurrencies have ninety days from when this Bill becomes law to make a declaration of their Cryptocurrency holdings and liquidating their holdings will be subject to rules, made by the Indian Government.
The Bill proposes stiff penalties ranging from 1 to 10 years imprisonment and hefty fines amounting to three times the ‘gain made’ or loss caused and if the loss or gain cannot be determined then, the fines outlined in the Schedule to the Bill, range from Rupees 1 Lakh (USD 1370) to Rupees 25 crore (USD 3.4 million). Taxes are payable on these supposed illegal gains.
In particular, ICOs, offering cryptocurrency related financial products and using cryptocurrency as a means for investment are deemed to be so severe that they are deemed to be cognizable (arrest without warrant) and non-bailable offences.
The Report: The Path to the Bill
The Report concluded on 28th February 2019 contains the research and finding of the Ministerial Committee.
Outdated research on legal frameworks
While the Report does cover the use and application of blockchain and Distributed Ledger Technologies (DLT), the information on global regulatory legal structures in relation to virtual currencies that existed in 2018 to 2019 when the Report was concluded is outdated and indeed, to give them credit, some Committee members have acknowledged that this Report may need an update.
The research mentions the regulatory frameworks of just few countries such as Russia, China, Switzerland, Thailand, Japan, Canada and ‘New York’. Fast forward to 2021 and we’ve moved forward with lightning speed with jurisdictions such as Singapore, United Kingdom, Malaysia, Malta, United Arab Emirates, Germany, Switzerland now having legal frameworks and a licensing regime for centralized virtual asset exchanges. Many more jurisdictions will follow the Financial Action Task Force (FATF) Recommendation 15 which recommends licensing of exchanges with view to curbing money laundering and terrorist financing risks.
No public consultation or participation
Usually, the press release section of the Lok Sabha contains announcements inviting comments on proposed bills, policies and rules published here. Considering that this Bill impacts the Indian public that could have bought or be holding Cryptocurrencies by imposing stringent penalties, no comments from the public were invited, neither was there any engagement with the cryptocurrency industry or exchanges. The Report was put together by researchers from the Macro/Finance Policy team and subsequent meetings attended by regulators, bureaucrats, the minutes of which can be read in Annexure A of the Report. If you have the time, I urge you to read the Annexures as they contain insights into discussions of the Committee members and motivations for the ban.
With even a draft of the revised Bill still unavailable, is doubtful that any public comments were sought. In fact, its is reported that the government may take the Ordinance route to push the Bill through.
Of Virtual Currencies…
The Report cites examples of other jurisdictions that do not accept Cryptocurrencies as legal tender or currency or a medium of exchange. Of course, most jurisdictions would not recognise cryptocurrencies as legal tender but certain jurisdictions such as Japan and Singapore have legislated to accept cryptocurrencies as payment tokens or an ‘alternate’ medium of exchange.
Cryptocurrencies were previously considered too volatile to be a store of value. And they are however certain cryptocurrencies such as Bitcoin, on account of massive adoption, scarcity (only 21 million Bitcoin will ever be mined) and investment by institutions and companies such as Tesla Inc. are emerging as an alternate store of value and a hedge against hyperinflation, which could possibly be an outcome of pandemic stimulus by governments.
Though cryptocurrencies such as Bitcoin are neither centralised nor have sovereign backing or a formal, verified backing of bullion, legal tender isn’t fully backed by bullion as most governments. The issue of the Indian rupee itself is backed by approximately 5% of bullion only and the rest is backed by domestic and foreign investments. See the Balance sheet in the RBI’s Annual Report.
I am no economist; however the co-relation between the effect of stimulus provision and inflation is hard to ignore and people should have a choice to hold assets that can act as a hedge against possible hyperinflation. This could be in the form of Gold or Bitcoin, an asset whose price is determined by the market and not by a centralised authority.
The Report also cites examples of jurisdictions such as Russia and China that have supposedly banned Cryptocurrency.
While the People’s Bank of China has in the past issued advisory statements that it would block access to domestic and foreign cryptocurrency exchanges, ICO websites and indeed a ban on ICOs was imposed in 2017. Neither Russia nor China has actually enacted laws that would prosecute citizens holding cryptocurrency. In 2020, Russia backed away from a full ban on holding of cryptocurrency however restricted cryptocurrencies from being used as a medium of exchange.
Unfortunately, if this Bill becomes law, India will have the dubious distinction of being the only country in the world that will prosecute its citizens from holding and dealing in Cryptocurrency.
Justification for a ban on Cryptocurrency should be based on research related to conditions in India as opposed to emulating other countries that are considering bans. The Report is missing research on cryptocurrency adoption among Indians – how cryptocurrency is purchased, how many Indians have participated in ICOs and how many have suffered losses attributed to cryptocurrencies etc. This could have been a basis for justification of a crypto ban or regulation rather than assumptions that people have suffered losses after being coerced to invest in cryptocurrency.
It is clear from the minutes of the meeting that it is the lack of clarity on how to regulate DLT technology and cryptocurrencies despite acknowledgement that a ban would be difficult to implement and would actually drive people and operators to trade cryptocurrencies underground.
Regulation vs Ban – which is easier?
In a country where basic financial inclusion is very low and adoption and awareness of cryptocurrencies even lower, wouldn’t regulation and consumer education be a better approach? Regulation would require Indian regulators to step up and put in tremendous effort and resources to regulate cryptocurrency.
The risks of cryptocurrency investment are no different from losses on investment in penny stocks and even shares of large companies on Indian exchanges, corporate debt or losses due to bad market timing decisions i.e. buying high and panic selling when prices dip.
Regulation however isn’t easy. As the the Monetary Authority of Singapore (MAS) and the Financial Conduct Authority (FCA) who are reportedly overwhelmed with licensing application backlogs following the introduction of cryptocurrency licensing regimes. Post-licensing supervision of exchanges would be even more challenging. There would no doubt a steep learning curve for regulators however once implemented successfully, the benefits would be a strong KYC regime which is need of the hour in India and access to reporting and data from regulated exchanges.
Enforcement of a crypto ban would require a very sophisticated surveillance system which India simply does not have and involve considerable time, resources, effort and money by enforcement agencies and the time and cost of prosecution of the small portion of the Indian public trading in cryptocurrency. These resources on enforcement of the ban and prosecution would be better spent on regulation and consumer education.
So which do you think is easier – regulation or a ban?
The CBDC may to a small extent resolve issues of money laundering, tax evasion and black money. However, all of this will continue as along as physical currency continues to exist.
The ban on Cryptocurrencies if implemented, would only enable development of a ‘closed system’ using DLT technologies with only the digital rupee or ‘closed loop tokens’ as settlement currency. The scope of the definition of ‘cryptocurrency’ in the Bill is so wide that any kind of protocol token essential to blockchain technology to tokenised stocks would be covered by the ban in India. Tech Start-ups would have no incentive to develop any DLT projects in India as ICOs would be ruled out. The only options for funding would be venture capital or listing on an exchange – an difficult task for small start-ups.
The ban on Cryptocurrencies could possibly exclude India from access to tokenisation of shares facilitating instant settlement of securities instead of the T+3 settlement of a traditional stock market or blockchain based payment and remittance systems.
A ban on say Ether would mean ERC-20 blockchain can never be used in India. I could go on but these are the few issues that immediately came to mind.
I suppose decentralisation of finance and subsequent disintermediation of the financial system is something most regulators have yet to wrap their heads around. Regulation though challenging would be a better tool than a limit risks of holding cryptocurrencies and prevent its misuse.
Banning cryptocurrency altogether would have the effect of isolating India from global developments in blockchain technology which India would have to spend years catching up to.
While we await the draft of the 2021 Bill, it is doubtful that there has been a change in position of the government and the regulators as it appears that its previous position of a ban on cryptocurrencies remains unchanged.