A blanket ban on cryptocurrency can be both unenforceable on the ground and counterproductive. A robust yet flexible regulatory regime, as existing internationally, is a better solution.
Cryptocurrency is a subject so polarising that nuance evaporates at its very mention. While adulation flows from an Elon Musk, brickbats fall by the hands of a Warren Buffett. Regulatory authorities across the world have been trying their best to make sense of this new piece of technology. While most countries have gone in for healthy, flexible regimes of regulation, India is contemplating a complete ban on “private cryptocurrencies”. Oddly, India would be the first major country to impose a ban if it goes forward- a shot in the dark, and a rejection of lessons learnt globally across jurisdictions moving towards better regulation. Such a step would be an unenforceable and counterproductive move that defeats its intentions while dragging down our technological innovation base. Furthermore, considering that control over technology is becoming a source of commercial and strategic superiority, shutting down an entire ecosystem around a promising technological concept could dearly cost India.
Motivations for a Ban
Any policy move by a country, especially when it is this drastic, is framed by a set of strong motivations. The Government’s opinion to ban “private cryptocurrencies” as a part of the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, is no different. Three possible motivations for such a recommendation by the high-level Inter-Ministerial Working Committee (IWC) can be inferred from India’s economic experience and various news reports:
Prevention of Money Laundering and Terror Financing;
Capital Flight, and India’s Economic Stability;
Safety of the platform, Experimental, Difficult to Understand Products.
While these concerns are indubitably pressing and valid, administering a blanket ban could instead dent these key priorities rather than protecting them. Plus, such a ban would breed an additional litany of problems, inflicting severe collateral damage on other important strategic and technological concerns. All of these concerns would be subsequently analysed in this piece. The takeaway, however, is certain- for the better servicing of the aforementioned broad, overarching National priorities, a relook at the present opinion of a prohibition must be revised in favour of a responsible regulation model. Also, as sophistication in New and Emerging Technologies (NETs) embodies not only commercial but governance and strategic concerns, providing fecund grounds to innovation should be held as a natural guiding principle.
The root of many problems in India’s policymaking is an over-conservative bureaucracy. On both fronts, conceptual and procedural, the ‘system’ has a peculiar characteristic of being extremely restrictive when it comes to new ideas. Sections of the bureaucracy are still redolent of the pre-liberalisation days, marked by an overzealous tendency to be controlling. Furthermore, despite the ‘all of government’ push in recent years, the Indian bureaucracy is notoriously siloed, where different units barely coordinate to generate a harmonious whole. A small example is India’s labour laws- till the Union Government brought in four labour codes in 2020, twenty-nine different laws were in effect at the Central level. These superceded laws were often mutually inconsistent, outdated, and simply impractical. Even today, this mindset is tinting the policy landscape, and the crypto ban seems to be the handiwork of such antiquated ideas of governance.
Why a Ban may be Potentially Self-Defeating
Cryptocurrency is not Always a Currency; its Technology is Useful
A careful look at the technologies involved, and utilities provided, would mean that enforcing such a ban would imply trying to ban very dissimilar entities with distinct features and uses.
Not all cryptocurrencies are like Bitcoin (ticker: BTC), where the ultimate aim is to mimic characteristics of a currency; one also sees cryptocurrencies that essentially trade some underlying service or an idea. A good example could be Ether (ticker: ETH), which trades computing power for running Decentralised Applications (Dapps) on the Etherium blockchain. Another illustration is that of Basic Attention Tokens (ticker: BAT), which empowers a blockchain-based system for tracking media consumers’ time and attention to efficiently distribute advertising money between stakeholders. Furthermore, the argument that cryptocurrencies that do mimic currencies could threaten India’s macroeconomic stability is a vapid fallacy at best: anything from financial assets such as stocks or gold to bartering goods can mimic aspects of currency. One, none of these have state backing which binds us to accept these as payment. Two, all of them are well regulated, taxed, and provide financial utility to the public at large. Thirdly, and most importantly, we are yet to see evidence of cryptocurrencies causing macroeconomic troubles for countries- regulated or unregulated. If anything, the step seems unreasonable and disproportionate which would lock India out of a burgeoning financial ecosystem.
On the security front, it is pertinent to note that most blockchains have banking industry-level encryption standards aside from the intrinsic security blockchain provides. For example, BTC along with most cryptocurrencies use the SHA256 encryption standard, which banks use during online transactions. “Hacking” here isn’t the penetration of the core technology (the blockchain) but the compromising of crypto exchanges- the inevitable result of hostile regulatory engagement.
The behaviour and attributes of cryptocurrencies are wildly divergent. Naturally, trying to target only one kind of cryptocurrency (such as BTC) is a very difficult thing to do, while banning them all would bar India from reaping the benefits of potentially game-changing technologies with real-world applications. Many cryptos already are solving missing-market problems, and banning such advances only takes us backwards.
Simultaneously, every cryptocurrency may attempt to classify itself as not technically a cryptocurrency, inviting a barrage of litigation, regulatory headache, and circumvention of the law (Eg. “My crypto isn’t crypto, it’s a software/asset/capital good and hence should come under FEMA Regulations”). At the very outset, classifying units in open-source, decentralised, publicly accessible systems as “private” would be a problem on a definitional front. Such a broad ban also does not augur well for investor confidence in experimental research, an already funds starved arena which impacts India’s technological capabilities.
Ban Makes it Harder to Fight Crime
Banning cryptocurrency will not end its presence in India, instead, it will only drive unscrupulous and hazardous elements to seek them now that the ecosystem has plunged into the black markets. Embodying the classic “lemons problem” in economics, with diligent exchanges outlawed, maverick groups will proliferate black exchanges which are painstakingly difficult to detect and fight. This will give a fillip to terror financing as well as capital flight; Meanwhile, legalising and putting in place a regulatory mechanism would serve to keep the system cleaner and under the scanner of law enforcement. In an era where economic warfare is a reality, and terrorists are getting tech-savvy, a ban would be exacerbating the problem instead of solving it.
The Financial Action Task Force (FATF), of which India is a member, has gone as far as providing a Risk-Based Approach Guidance on Virtual Assets which does not recommend a ban by any means. It specifically addresses money laundering and terror financing concerns, while recognising the possibilities cryptocurrencies offer.
Talent, Brain drain- Economic, Strategic Loss
Technologies such as Artificial Intelligence and Blockchain are rapidly attracting the best talent, funding, and opportunities. Being umbrella technologies at the bleeding edge of innovation, the future is being constructed on the back of these concepts. Cryptocurrency is a very large chunk of the blockchain system, and by outright banning it, India would lose and disincentivise its talent and experts. Not only would this be an economic loss, but an irreparable setback against strategic competitors who would, in the future, be able to impose their terms on India owing to their sophistication. Nischal Shetty, the CEO of WazirX, one of India’s largest cryptocurrency exchanges, puts it succinctly- “Banning cryptocurrencies would be like banning Internet in 1990s and will set India back by years”.
One also needs to accept that India is leading in very few critical technologies of the future, and is playing catch up in most. From Artificial Intelligence to strategic minerals, India is lagging in the race. In such a scenario, India could build up its abilities by “leapfrogging” on other key technologies by offering an environment where innovation is encouraged. A nifty and nimble regulatory setup where innovators are pushed to try (and fail) in experimental technological progress can prove to be a game-changer. However, it is easy to forget that such technologies, when growing in adoption and sophistication, also need a helpful environment. Banning cryptocurrency is not only crippling one such potential key technology, but would be sending all the wrong signals. From students interested in being the next Steve Jobs to Venture Capital fueling ambitious entrepreneurs, everyone is watching this closely.
Government use of blockchain
As outlined by the draft National Strategy on Blockchain (January 2021), there are potential uses for blockchain in the field of governance. Countries such as Sweden have already begun rolling out such projects, while SEBI and the National Digital Health Mission have Sandboxes allowing for blockchain solutions. There are other pertinent uses for blockchain in Governance. Potentially, land records may be put on a blockchain, leading to cleaner titles and ensuring accountability at every stage. If FIRs and filings related to law, order, and justice are put up in a blockchain, it could bring forward a revolution in public trust and the integrity of the process. The unique properties of a suitably constructed blockchain could very well be the next big thing in building accountability and popular trust in the governance machinery. The natural corollary is that we would require a vibrant ecosystem to stay ahead of the global competition, as well as a world-class talent pool. A ban that removes key stakeholders and puts incredibly restrictive conditions on research threatens to stymie India’s position in a key NET. The adverse effect of such an action would limit the talent pool in key strategic uses such as cryptography and communications, apart from commercial possibilities and governance. Cryptocurrency is a misleading name as outlined above, and empowers effective and secure allocation of resources or information.
A slightly more far-fetched possibility is of the Government ultimately having to rely on public blockchain-based technologies for transactions in case the global financial system indeed gets more fractured. International payment systems like SWIFT are controlled by individual countries, which is an intrinsic geopolitical risk in an increasingly raucous world. Cyber and economic warfare have become the prime tools of State Policy; attacks on international transactions networks could be targeted in the coming days. Having a small reserve of cryptocurrencies as a contingency fo such events is only judicious.
Effective Regulation, not a Ban
India is fortunate enough to witness regulatory regimes regarding cryptocurrency elsewhere in the world. Even in jurisdictions where fragmented regulatory jurisdictions exist, such as the US, cryptocurrency does not face a blanket ban. Instead, every product is analysed separately and placed in the closest fitting regulatory system. All in all, a somewhat harmonious regime of cryptocurrency regulation has taken shape in the US:
The Securities and Exchange Commission (SEC) carefully weighs each product to ascertain whether they can be classified as Securities through the Howes Test, and pronounces Initial Coin Offerings as Security issuances or not. Similarly, it issues guidelines and questions regarding Cryptocurrency stakeholders and itself;
The Commodity Futures Trading Commission (CFTC) administers crypto derivatives and deliveries taking place after 28 days;
The Internal Revenue Service (IRS) treats BTC as “property” for Federal Taxes, while State and Local Governments can choose to differ with this ruling for their taxation processes;
The Financial Crimes Enforcement Network (FinCEN), a bureau of the Department of Treasury which is the US’ prime Anti Money Laundering and terror financing combating agency, extends regulations concerning “money transmitters” to convertible cryptocurrencies while exempting users;
States in the US have their specific statutes governing money transmitters and are varying in their views towards cryptocurrencies. The State of New York has a first of its kind “BitLicense”, where its Department of Financial Services licenses cryptocurrency businesses and imposes regulations tailored to the nascent industry.
While rather cumbersome, it goes to prove the point that even when one can argue that banning cryptocurrency is the easier option, countries have chosen consciously against it. India would be the first major jurisdiction to exercise a blanket ban- a shot in the dark with unforeseen risks. The above-outlined structure attempts to strike a harmonious balance between protecting consumer rights, the security of the State, and not smothering innovation. Prudence calls for an evaluation of practices worldwide and embracing regulation instead of throwing the baby with the bathwater. The United Kingdom, Singapore, and other countries which attract the finest talent in the financial world have unanimously refused to ban cryptocurrency. Perhaps, we should take lessons.
India can prevent this panoply of agencies having fractional jurisdiction through this Bill. The reason why the US has been unable to build a streamlined regime is due to the inherent nature of Federalism in the country, as well as continued dependence on Statutes from a bygone day and age. The Bill can take lessons from regulatory regimes prevailing in the world’s financial centres, and design a suitable framework of its own, filling their gaps and providing experimental or NETs with a shot in the arm.
A potential regulatory landscape could include:
Exchanges to be licensed and prescribed KYCs be tied to wallets while outlawing any transaction beyond this licensing regime. This breaks the aura of anonymity and makes it possible for law enforcement to monitor transactions. With honest business on our side, cracking down on unauthorised exchanges which may facilitate illicit transactions would get a fillip.
Simultaneously, there needs some technical talent on the part of existing regulators to appropriately judge products and choose rules for what suits the situation. This requires a more proactive interface with not only banks but all stakeholders- down to programmers themselves.
Cryptocurrencies like BTC can be treated more like gold- it's unlike equity as it does not have any underlying “asset” which drives its value, and neither is it a stream of payments like debt. In the same vein, gold can be seen as currency, property, or a commodity depending on the context of use. With this in mind, we can synthesise our own long regulatory experience concerning Gold with foreign regulations on cryptocurrencies to align the industry with National priorities. Furthermore, by taxing crypto transactions, the country could expand its tax base.
Other cryptos with some underlying idea or value source can be judged case-by-case to ascertain if it is a security (as done by the SEC in the US), whereby SEBI may get involved.
Domestic cryptocurrencies or blockchains could be given sandboxes first, to ascertain their impact before they proliferate.
With the Finance Minister hinting at a revised, softer, stance in the first week of March, there’s cheer and caution abundant in equal measure. License based regulation not only ensures that the motivations of the Bill are fulfilled but avoids all the cumbersome fallouts of the same. Such an idea is nothing new, for it exists as an established practice in most jurisdictions. It also prevents India from losing out on the potential of this technology platform, strengthening India’s technological capabilities going forward. Most pertinently, it would be a shot in the arm for Indian innovation, which has been yearning for a more responsive and accepting schema of regulation.
(Deekhit Bhattacharya is a Research Associate at Global Order, and a Research Associate at Pooja Terwad and Associates, which is a Startup Oriented Law and Business Firm, where he is Specialising in Fintech, Cryptocurrency, and Blockchain. Views of the author do not necessarily represent those of his organisations, and are his alone. Reach him at deekhitdb@gmail.com, or deekhitdb@globalorder.live ; connect with him at https://www.linkedin.com/in/deekhit-bhattacharya/ )