Who’s Afraid of Crypto?
Earlier this month, cryptocurrency investors and stakeholders in India suffered another jolt, as certain private banks denied services to crypto exchanges under pressure from RBI. This happened despite no written communication from the central bank, and in contravention of the Supreme Court’s judgment that held RBI’s 2018 circular prohibiting banks from providing services to crypto exchanges to be illegal.
In fact, GoI had earlier indicated that it may reconsider its proposal to ban private cryptos after intense lobbying by crypto stakeholders. The government’s many flip-flops have demonstrated that it has a woeful understanding of how cryptos and blockchain work, and would rather ban something it deems a problem rather than regulate it, without considering the second-order effects of its actions.
Cryptocurrency is more akin to cash than any payment method or asset known. Cryptos are stored in ‘wallets’. If you wish to transfer them out of your wallet, you only need to know the public address of the receiver’s wallet. No amount of regulation can prevent the actual transfer of crypto from one wallet to another — much like the physical exchange of cash cannot be prevented.
However, similar to what is done for cash transactions, crypto transactions can also be regulated to make them extremely tough, or filter the unwanted ones. GoI needs to start thinking of bitcoin and other cryptos as digital cash (not a novel idea). The same amount of effort and energy expended to combat illicit cash dealings needs to be expended to combat illicit crypto trade.
Cryptos are based on the blockchain, a decentralised ledger. A record of all transaction ever made on the blockchain is visible to everyone. Some cryptos, like bitcoin, are semi-anonymous — that is, a particular crypto wallet has a public key. Combine these two factors, and once you put a name behind a public key, GoI could theoretically access information on all transactions ever made by that wallet and, by extension, that person. This learning alone can be the starting point for regulation.
Strong know your customer (KYC) and anti-money laundering (AML) norms for crypto wallets in India should be the bulwark of the crypto ecosystem. It will serve as a rallying point for institutions and regulation around it. GoI should actively encourage institutional support for cryptos — be it exchanges, banks or payments systems. RBI could even mull over crypto-based new umbrella entities (NUEs) for crypto trade and payments like the National Payments Corporation of India (NPCI) is for Unified Payments Interface (UPI) transactions.
But why is this desirable? Cryptos seem to be untameable beasts. Much like cash and stock markets would have seemed to a regulator in the past. The market adapts, and so should regulators. Cryptocurrency exchanges were the first to bring liquidity to cryptos.
Now, certainty is being encouraged with financial intermediaries in the
mix. Mastercard, PayPal and BNY Mellon, among others, have proposed to process crypto transactions, essentially acting as custodians of cryptos. In such a custodianship model, the holder of crypto may not have a wallet but have the bank hold it on their behalf.
Exchanges have already put in place KYC norms mirroring those of stock exchanges to assuage the government’s fears. 90% of all crypto transactions take place on exchanges. This shows that institutions are toeing the government line even without active government support. You could also require exchanges and banks to allow wallet transfers only to other KYC-ed wallets. GoI should imagine its reach over cryptos if banks, which are tightly regulated by it, are allowed to actively join the mix.
This model is certainly more desirable for GoI since the latter already has capacity to regulate these institutions. GoI would be better equipped to regulate them and leave the grunt work to the banks and exchanges, similar to how it regulates banks holding cash or physical assets like gold. There are myriad possibilities to regulate crypto. There only needs to be conscious application of mind by those responsible.
It’s ironic that bitcoin, which was designed to circumvent the global financial system, may fall prey to it. Proper regulations put in place will make the crypto infrastructure act more like traditional banking systems. If GoI is willing to put in the work, anonymity will be way harder to find.
It’s time for GoI to engage with crypto stakeholders to come out with measured regulation. As for the traditional financial system, no regulation in the world is foolproof. And even crypto regulations may not be. However, best efforts must be put forward. Only trial and error would lead to desirable regulation of crypto markets.
The writer is a Delhi-based commercial lawyer
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