Cryptocurrencies: The Good, The Bad and The Ugly

 Over 20 million Indians are holding crypto assets worth about $6.6 billion currently, according to a Nasscom report, and the number is growing. The demand, especially from tier-II and III cities, shows a paradigm shift in sentiment towards the digital medium of exchange.

While the Government has taken a ‘calibrated approach’, it is also exploring ways – directly or indirectly – to discourage people on investing in cryptocurrencies, while simultaneously exploring alternatives. It is also attempting to see how this new asset class can integrated into the financial ecosystem, by guaranteeing privacy and ensuring national security is not challenged.

Pic source: Google images

What are Cryptocurrencies?

Unconfirmed reports have said that the first cryptocurrency was introduced by a group of people who were averse to paying a fee or tax in order to send their hard-earned money back home. Besides, the money was also taking time to reach their families.

According to Wikipedia, the first cryptocurrency was invented in 2008 by an unknown person or group of people using the name Satoshi Nakamoto. The currency began to be used in 2009 when it was released as open-source software. 

It is a decentralised digital currency, without a central bank or single administrator, and can be sent from one user to user on the peer-to-peer Bitcoin network without the need for intermediaries. Transactions are verified by network nodes through cryptography and recorded in a public distributed ledger called a blockchain.

Currently it is estimated over 10,000 cryptocurrencies are being traded across the World. (source).

Challenges around Crypto

Crypto currency is neither legal tender nor recognised by the Government, and is not guaranteed by any institutions.

The problems are leakage of revenue – Taxation, threat to sovereignty, money laundering, and funding illegal activities. Bitcoin became more popular and has begun to replace hawala or sponsoring terrorism (reference).

Clearly it’s a big threat to any nation since unregulated cryptocurrencies can destabilise the macro-economy and create huge speculative bubbles.

Cryptocurrency is decentralised and its peer-to-peer format may allow entities to bypass the financial controls built into traditional financial marketplaces.

T Rabi Sankar, Deputy Governor, Reserve Bank of India in his speech said that total crimes using cryptocurrencies in 2021 were estimated to be $14 billion (Wall Street Journal, January 06, 2022. The amount itself is not much but the implications for the AML/CFT (Anti-Money Laundering/Combating the Financing of Terrorism) framework built painstakingly over the last two decades is rather substantial. The socially wasteful energy use of crypto infrastructure has been a subject of widespread discussion. About 900 new bitcoin a day require electricity worth $45m a day.

According to experts, cryptos are designed to evade governance and regulation of any kind. So the fundamental challenge for the policy makers is how to govern the crypto ecosystem, which is unique. The Government cannot ban them since people have got them and are even benefiting from them.

Current status

Many countries have launched or are exploring the possibility of launching national cryptocurrencies. The Indian Government is yet to take a stand.

In the recent budget, the Union Finance Minister proposed a 30 percent tax on profit made from the sale of all crypto assets, with 1 percent tax deducted at source on all such transactions. This led to speculation that the government had effectively legalised them.However, the Government has clarified tax on cryptocurrencies "does not mean" it has been legalised.

While many debate over its future, recent developments, including the Supreme Court lifting the ban on crypto trading in India and most recently even asked the Government to clarify its stand.

RBI in 2018 had forbidden banks from dealing in all transactions related to bitcoin and other such assets. In 2021 again RBI informally urged lenders to cut ties with cryptocurrency exchanges and traders as the highly speculative market booms, despite a Supreme Court ruling that banks can work with the industry.

"Private cryptocurrency is a huge threat to macro-economic stability and financial stability...investors should keep this in mind that they are investing at their own risk," said Reserve Bank of India Governor Mr Shaktikanta Das.

Government’s dilemma

Government’s dilemma is understandable not only because it threatens thesovereignty and national security, there are few other practical problems.

The first and foremost is it viable to recognise/ legalise cryptocurrencies.

Consider this, cryptocurrencies can be launched, mined and/or distributed by any private person. If cryptocurrencies are to be recognised/ legalised/ regulated or need to be made a legal tender, then the question is how many cryptocurrencies/ coins, digital tokens and non-fungile tokens, the Government can legalise. Today, general estimate is that around 10,000 such cryptocurrencies are in the market.

This is certainly not a viable or even a possible option to consider and at the same time blanket ban is also not possible.

Even recognising cryptocurrencies also proven to be wrong.

For example, in 2021, El Salvador became the first country, which depend on remittance largely and largely cash economy, to recognise Bitcoin as a legal tender.

But, the International Monetary Fund (IMF) has urged El Salvador to reverse its decision. "Large risks associated with the use of Bitcoin on financial stability, financial integrity and consumer protection" and with issuing Bitcoin-backed bonds, said IMF.

What is the way out?

No country or experts could find a solution for this yet, while most of them are trying to find solution to control atleast for now and see what the possible alternates are.

RBI is planning to come out with a central bank-backed digital currency, using blockchain technology in 2022-23.

But there is a fundamental difference between RBI's proposed CBDC and private crptocurrencies. The CBDC will be based on a permission blockchain technology, unlike the permissionlessblockchain technology generally used by other private cryptocurrencies like Bitcoin and Etherum.

Permission less blockchain technology is an open network where any private person can contribute, create and mine coins by adding nodes to the blockchain. Because of this, any private person can mine Bitcoins with enough technological support. However, with permissioned blockchain technology, like CBDC, only the Central Government and other agencies authoised by the Government will have the authority to mine, tweak the value and control the supply.

Another difference between CBDC and cryptocurrency is CBDC will have an intrinsic value or market value backed by the Government itself, unlike the notional value based crypto.

On cryptocurrencies, Union Finance Minister said that the government will state its position on cryptocurrencies after completing the ongoing consultation process. Asked whether she saw a future for crypto in India, Sitharaman said, "Many Indians have seen a lot of future in it. And therefore I see a possibility of revenue in it."

The recent statements and tax on crypto transactions have clearly shows that they are not enough and Government’s position is more like a cat on the wall.

The only way out could be is creating a progressive regulatory framework to create a good crypto ecosystem in the country in a secure, simple, and transparent manner to protect the retail investors, who are currently vulnerable.

The Ministry should engage industry stakeholders to keep track on innovation crypto offers, and the regulations will have to evolve as technology finds new dimensions. Customer protection should be at the forefront.

The possible options which the Government can explore include setting up a watchdog under the aegis of SEBI, create awareness among the investors on the risks involved with crypto.

For example, the UAE has introduced a law on regularion of virtual assets and announced the formation of Dubai Virtual Assets Regulatory Authority (VARA).  VARA will be responsible for licensing and regulating the sector across Dubai’s mainland and the free zone territories (excluding DIFC). Source

Banning is not a solution it will have a huge fall out since crores of money already pumped in by Indian, so public opinion will not be favourable.

We can look at some case studies like El Salvador, which has officially recognised Bitcoin. Some countries accept other forms of cryptocurrency as transactional currency, for e.g. Canada.

Most nations still play a ‘wait and watch’ game and nations exploring use of technology for governance.

Either as investment or speculation, the interest in cryptocurrencies across the world is growing exponentially. If you can’t beat them, join them! or it will be like a snow ball. When we fail to break the ball when its small, as it grows big on the roll, it will be on you.

Ends

Data points

NASSCOM, trade body and chamber of commerce of the Tech industry in India, in partnership with crypto exchange WazirX published a report titled Crypto Industry in India. Some of the findings from the report (https://nasscom.in/knowledge-center/publications/cryptotech-industry-india-decentralized-systems-center-stage-digital)

* CryptoTech Industry is a fast growing Industry globally – CryptoTech applications in trading accounts for 70% of market, followed by P2P payments, and remittances. The market is expected to reach a size of USD 2.3 billion by 2026 globally, up from an estimated size of USD 1.6 billion in 2021

* The CryptoTech industry in India has registered a significant growth of 39% over the last five years. Currently, cryptotech provides employment to nearly 50,000 individuals in India. There are more than 230 CryptoTechstartups in India, with 15 million+ retail investors.

* In terms of the number of crypto owners as a percentage of the total population, India stood at the fifth spot at 7.30%. Ukraine ranked first with 12.73% people of the total population owning crypto followed by Russia (11.91%), Kenya (8.52%) and the US (8.31%). Source: https://www.livemint.com/market/cryptocurrency/india-has-highest-number-of-crypto-owners-in-the-world-at-10-07-crore-report-11634110396397.html

* Cryptotech has the potential to create more than 8 lakh jobs by 2030, up from 50,000 individuals employed currently.

* The industry is expected to reach $241 million in size by 2030 in India. So far, $6.6 billion have been invested by Indian retail investors in different crypto assets such as Bitcoin, Ethereum, Polygon, etc.,

* Nasscom report added that the crypto industry can potentially create an economic value addition of $184 billion in form of Investments and cost savings by 2030.

* Number of users from Tier-II and Tier-III cities have grown by 2,648 per cent and contributed to 55 per cent of total signups on WazirX in 2021. Crypto has immense potential to contribute to our $5 trillion economy vision, Nischal Shetty, Founder and CEO, WazirX was quoted.