Crypto regulation: There are enough ways we can regulate cryptos

Regulation is better than ban is a motto that fits in well with the twenty-first century ethos. This is a great approach to take when tackling matters involving legal or moral ambiguity, be it trading cryptos or smoking pot. So the news that the government is looking to regulate cryptos rather than banning them outright is welcome indeed.

While the current crypto valuations seem to be a result of mass frenzy, rather than any intrinsic strength, there is no rational explanation for valuations of most startups either. Most of them seem to be valued based on their ability to burn cash rather than earn it: so cryptos are not such an odd man here after all. The argument that cryptos are too risky for retail investors looks increasingly untenable, especially after the PayTM IPO. Having said that, I agree that regulating cryptos is not as easy as regulating traditional financial products because we have never seen anything like them before. Probably the biggest challenge is in labelling them under a known asset-class; a kind of “is it a bird, plane or UFO” conundrum. Lawmakers should answer this first, after which questions on accounting, taxation, KYC, money laundering and transparency, among others, have to be addressed.

Let us start with labelling. There seems to be a school of thought that cryptos are digital commodities. But this approach may be flawed. To define the nature of cryptos, it is best to start with their creators’ intent and follow that up by observing what cryptos actually do.

Bitcoin inventors clearly conceived the crypto as a currency and intended it to coexist with or replace fiat currencies. While a commodity, say copper, has myriad uses in the real world and derives its value from demand emanating from these uses, a digital currency has little use other than as an alternative medium for settling payments and storing value. Since cryptos were created to be used as currencies and the only probable use-case for cryptos is as a currency substitute, there is no convincing logic in labelling them as anything other than currency.

Once we take this leap of faith and start looking at cryptos as a new breed of currency, most challenges related to their accounting, control and regulation resolve on their own. There is already a regulatory window for individuals to invest in foreign currency assets (up to $250,000 per annum), called the liberalised remittance scheme (LRS). Cryptos can be simply made a subset of the investments allowed under LRS.

A natural offshoot of defining cryptos as foreign currencies would be that they can no longer be held or used in India as that would contravene exchange control regulations. Any concerns about cryptos undermining the heft of the rupee would also go away as they shall stand excluded from the domestic market by virtue of the definition. It so happens that we have the GIFT City, a deemed offshore booking centre within India with a strong regulatory framework, whose ambit can be extended to cover cryptos also. Investment, trading and accounting of cryptos for Indian citizens can be centralised at GIFT with provision for grandfathering of assets and contracts. This will solve several problems in one go; it will ring-fence cryptos from the domestic currency area, while simultaneously improving controls and oversight by placing all players within the purview of a single authority.

Now, let us look at the question of transparency, anti-money laundering (AML), taxation and such. Most of these can be addressed by prohibiting investors from holding cryptos in personal custody (that is in their laptop or PC) and making it mandatory to hold crypto assets in KYC-completed vaults of accredited depositories — something similar to holding shares in demat accounts. If need be, investors can be allowed to retain some small fractions of cryptos in their wallets for making payments and such transactions.

Provision already exists for individuals to hold foreign currency notes up to a specified limit, and this can be extended to include cryptos. Restricting crypto holdings to demat form — for want of a better word — will create end-to-end audit trails for KYC-AML, taxation, accounting and such oversights without the need for creating a new set of systems and processes.

To sum up, recognising cryptos as a breakout currency and treating them on a par with foreign currencies would solve most of the challenges relating to regulating them. The question is, can the Reserve Bank of India (RBI) bite the red pill and accept that cryptos are here to stay and cannot be brushed aside as a transient fad anymore.

(The author is Head of International Financial Institutions Group at IndusInd Bank)