Report on Regulation of Private Crypto-assets in India

As of May 2021, the crypto-asset market in India stood at USD 6.6 billion. With no signs of slowing down, crypto-assets have become an undeniable part of both Indian and global financial markets. In the face of this rapid growth, policymakers are faced with the critical task of developing a regulatory framework to govern private crypto-assets. 

This report is an introductory resource for those who are looking to engage with the development of such a framework. It first provides an overview of the technical underpinnings of crypto-assets, their history, and their proposed use cases. It then examines how they fit within India’s current legislative and regulatory framework before the introduction of a dedicated crypto-asset law and how the government and its institutions have viewed crypto-assets so far. We present arguments for and against the adoption of private crypto-assets and compare the experiences of 11 other countries and jurisdictions. Finally, we offer specific and actionable recommendations to help policymakers develop a cohesive regulatory framework. 

What are crypto-assets? 

At their core, cryptocurrencies (CCs) or virtual currencies (VCs) are virtual monetary systems consisting of intangible ‘coins’ that use blockchain technology and serve a multitude of functions. While the word ‘cryptocurrency’ is often used as an umbrella term to describe various assets within the crypto-market, we note that these assets do not all share the same characteristics and often serve different functions. Therefore, for the purposes of this report, we use the term ‘crypto-assets’ rather than ‘cryptocurrencies’ when discussing the broad range of technologies within the crypto-marketplace.

Crypto-assets utilize a distributed ledger technology (DLT) known as blockchain technology. A blockchain is a complete ledger of all recorded transactions, which is created by combining individual blocks, each of which stores some information and is secured by a hash. Blockchain, by the very nature of its architecture,  can be used to ensure decentralisation, authenticity, persistence, anonymity, and auditability. 

History and proposed uses of crypto-assets 

While other forms of crypto-assets have been proposed in the past, the modern conception of one can be traced to a research paper published under the pseudonym, Satoshi Nakamoto, which first proposed the idea of bitcoin. Bitcoin, as it was presented, seemingly solved the ‘double spending’ problem by utilising a form of DLT known as blockchain. Bitcoin, which was first operationalised on 3 January 2009, has since become the dominant crypto-asset globally – trading at over USD 57,000 per bitcoin. 

Following the popularity of bitcoin, several alternatives (known as alt coins) were launched, the most popular of which is ethereum. According to CoinMarketCap, as of April 2021, there are over 9,500 traded cryptocurrencies in existence, with a total market capitalisation of over USD 2 trillion. The rise of bitcoin and other crypto-assets also led to the emergence of crypto-exchanges such as Binance. These exchanges act as platforms for users to buy, sell, and trade crypto-assets. 

Many potential use cases for crypto-assets have been identified, including: 

1. A method of payment 

2. A tradeable asset 

3. Initial coin offerings 

4. Crypto-asset funds and derivatives

5. Crypto-asset-related services

Legal frameworks and private crypto-assets in India

While crypto-assets are also referred to as virtual currencies and cryptocurrencies, they do not currently satisfy the legal requirements to be considered as currency under Indian law. Although they have not yet been classified as a financial instrument, it is possible, through executive action, to include them within the definition of any of the following instruments: currency, foreign currency, derivative, collective investment scheme, or payment system. Such a move would give the government a legal basis to regulate the hitherto unregulated crypto-asset market, thereby bringing about much-needed stability and minimising the risk of fraudulent practices.

Understanding the case for private crypto-assets 

This report examines both the benefits and limitations of crypto-assets across a number of their use cases. 

1. Benefits of crypto-assets as a currency and asset: 

• Decentralised and verifiable transactions 

• Reduced transaction costs 

• Confidentiality 

• Security 

• Easier cross-border transactions 

• A potential tool for financial inclusion 

• As a tool for verifying asset ownership 

2. Limitations of crypto-assets as a currency and asset: 

• High environmental costs 

• Replaces traditional transaction costs with new costs 

• A few actors dominate mining 

• Cannot replace traditional money 

• Introduces challenges in implementing monetary policies 

• Lack of network externalities 

• The limited actual impact on financial inclusion 

• Use for illegal activities 

• Prone to schemes and scams 

International Perspectives 

In order to draw inferences and lessons from a multitude of perspectives, we examined the regulatory frameworks governing private crypto-assets in the following jurisdictions: 

1. European Union 

2. El Salvador 

3. United States 

4. United Kingdom 

5. Japan 

6. Venezuela 

7. South Africa 

8. Singapore

9. Indonesia 

10. Switzerland 

11. China 

Recommendations

Keeping in mind the benefits and limitations, as well as the experiences of countries around the world, we recommend the following measures to develop an appropriate regulatory framework in India. We have divided our recommendations into 2 types: immediate or short term measures and longer term measures.

1. Immediate/ Short Term Measures  

1. Steering clear of bans private crypto-assets

Earlier, regulatory bodies made calls to ban private crypto-assets, but this resulted in crypto-assets being assimilated into the unregulated black market, thereby stifling potential innovation. To that end we recommend avoiding a ban, and adopting a regulatory approach instead. 

2. Recommend that regulatory bodies use their ad-hoc power to exercise interim oversight 

During the interim period, prior to the adoption of a dedicated crypto-asset legislation, crypto-assets could be included under one of the existing financial instrument categories. The regulations governing them would apply to both cryptocurrency exchanges as well as vendors who accept payments in cryptocurrencies.

2. Long Term Measures  

1. Specific Regulatory Framework

There needs to be an independent regulatory framework specific to crypto-assets since the unique features of crypto-assets make them unsuitable to be regulated through the existing regulatory frameworks.

2. Identify clear definitions

Policymakers should adopt a definition of crypto-assets that includes entities that have emerged within the crypto space but which cannot be classified as ‘currencies’. They must also categorise and define these various entities as well as crypto-asset service providers. 

3. Limit the scope of regulations to crypto-assets rather than their underlying technologies

Any proposed regulation must differentiate between the assets themselves and the technology underlying them. This would ensure that crypto-assets are not defined by the technology they currently use (i.e., DLT and blockchain) but by the purpose they serve. 

4. Introduce a licensing and registration system

A licensing system, similar to those adopted in other jurisdictions such as the EU or New York, can be adopted to ensure that the state is able to effectively monitor crypto-related activities. 

5. Make provisions for handling environmental concerns 

A dedicated taxation programme and strict limitations on mining can minimise the environmental costs associated with crypto-assets. 

6. Consumer protection measures 

Any potential licensing system must include mandatory obligations for crypto-asset service providers that ensure that consumer rights are protected.

7. Taking measures to limit the impact of crypto-asset volatility on the wider financial market 

Governments must take measures to ensure that the volatility of crypto-markets does not have a significant knock-on effect on the wider financial market. Such steps can include limiting financial institution holdings and dealings in crypto-assets. 

8. Extending Anti Money Laundering/ Counter Financing of Terrorism norms and exchange control regulations

Given the anonymous nature of crypto-assets and their potential for use in illegal activities, we recommend ensuring that crypto-specific anti-money laundering, prohibition of terror financing and foreign exchange management rules are introduced.

9. Create an oversight body 

Subject to the availability of resources, the government might consider establishing a dedicated body to oversee and research changes in the crypto-marketplace and make appropriate suggestions to the concerned regulatory authorities. 

10. Taxation

The existing uncertainty with regard to the correct tax provisions to be applied for various transactions when dealing with crypto-assets needs to be clarified with specific amendments to the tax provisions. 

11. Stablecoin Specific Regulation

Given the specific position occupied by stablecoins, and the unique role that they perform in the crypto-ecosystem, any legislation that seeks to regulate private crypto-assets must focus heavily on them. To that end, policymakers should pay special attention to identifying the various entities associated with stablecoins, applying greater regulatory scrutiny onto those entities and taking steps to limit the risk that stablecoins pose to the wider financial system. 

Note