The Indian government will introduce a new bill to ban trading and investments in crypto-currencies during the Budget session of Parliament. At the same time, the proposed bill will provide the Reserve Bank of India (RBI) with the necessary legal powers to develop a central bank-backed digital currency (CBDC), according to the official Lok Sabha Bulletin Part II.
While the government wants to promote the use of blockchain across various use-cases, it has decided to enter the global race of digital currencies or CBDCs while at the same time banning “private” crypto-currencies like Bitcoin and Ethereum among others. This is a similar approach to that of China, which banned trading and investments in crypto-currencies prior to developing its CBDC, which is still being tested.
“To create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India. The Bill also seeks to prohibit all private cryptocurrencies in India, however, it allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses,” — Lok Sabha Bulletin
The government’s decision to introduce The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 comes a week after the RBI said it had begun exploring the possibility of issuing and developing a digital currency or digital Rupee. This is a reversal of the RBI’s position. Back in December 2019, RBI Governor Shaktikanta Das said that it was very early to speak on CBDCs. “Some discussions are going on. Technology has yet not fully evolved. It is still in very incipient stage of discussions and the RBI we have examined it internally,” Das said.
Indian crypto founders are taken aback by this news, but still hope that the government will work with the industry to ensure that there is some legality to their operations going forward.
5/ RBI considering banning private cryptocurrencies is the second point.
Notable points are private and few exceptions.
While there is no official label of private cryptocurrencies recognized elsewhere, it is important what the bill will be classifying private as.
— Sumit Gupta (CoinDCX) (@smtgpt) January 30, 2021
How has crypto-currency regulation developed?
Prior to the RBI issuing a circular in April 2018, which barred the banking system from providing services to crypto-firms in India, the crypto-industry was fairly un-regulated and represented a ‘free market’ in many respects. Once the RBI circular came into play, several companies facilitating crypto-trading had to shut down or move abroad. Those that continued to operate moved to a Peer-2-Peer settlement system to facilitate trading, since formal banking and payments companies would not do any business with them.
In 2019, A Finance Ministry committee on virtual currencies prepared a draft bill banning crypto-currency issuance, trading , investment and other activities in the country, punishable with fine of up to ₹25 crore or with an imprisonment term of one to ten years, or both. This legislation was never approved by Parliament.
The industry, under the aegis of the Internet and Mobile Association of India, went to court challenging the RBI’s direction and in March last year, the Supreme Court struck down the circular stating that its regulatory action was ‘disproportionate’. Thereafter, banks and payment companies began opening up their services to crypto-exchanges and other firms in India as the RBI did not issue a fresh circular or direction surrounding the efficacy of crypto-currency trading.
Between March and December 2020, trading volumes across the top 4 Indian crypto-exchanges grew by 500%. While the exchanges now have payments and banking partners, the Supreme Court verdict has also facilitated the growth in acceptance of decentralised financing options and platforms within India.
Can the Indian government ban crypto currencies?
Legally, nothing bars the executive and legislative branch of the government from banning trade or investments in specific financial instruments. Regardless of whether the government was inspired by the Finance Ministry committee’s recommendations, or routine speculation in crypto-market trading that requires investor protection, or the race by global central banks to develop CBDCs, it has the authority to ban trading in crypto-currencies.
However, what is more interesting is the timing of the move. While China could officially roll-out its CBDC in this year or the next to all of its citizens, other leading central banks, from the Bank of England, European Central Bank to the United States’ Federal Reserve, are also working on developing a digital currency. If the government wanted to provide its digital currency an advantage over private crypto-currencies, banning the latter while the former undergoes development is one way to do it.
To enable the RBI to issue digital currencies or a CBDC, necessary amendments would be required in the Reserve Bank of India Act of 1934, the Banking Regulation Act of 1949 and the Payment and Settlement Systems Act of 2007. However, with a ban on crypto-currency trading and crypto-firms in the country, it is possible that much of the activity would move underground without any regulatory oversight.
Is Bitcoin a currency?
While crypto-currencies can be used as a currency or as a means of exchange/payment, regulators across the world have adopted different approaches. Most regulators around the world treat the majority of crypto-currencies as investment vehicles, like in the case of the Securities and Exchange Commission of the United States. But since Bitcoins can be used as payment instruments in Singapore and Japan, the central bank in each country is in charge of issuing regulations for the use of cyrpto-currencies like Bitcoin as a means of exchange.
It is important to note, that each crypto-currency can have two or more use-cases. While Bitcoin can be used as a means of payment, it behaves like a stock and is traded every day for the potential returns on their investment. Other cryptos like Ethereum and Ripple, which are also traded for investment returns, are essentially building blockchain-based infrastructure and tools. These too can be used as means of payment if the recipient accepts them.
Is blockhain necessary for a digital Rupee?
A digital Rupee does not have to be built using blockchain. Till date, private industry-led efforts to create a blockchain-based solution for payments or information exchange, whether it is the global inter-bank payments system or the insurance information blockchain in India, have not been successful or at the least not cost-effective. The best and most viable use-case for blockchain continues to be crypto-currencies, although crypto-mining is extremely expensive from both a computational and cost standpoint.
In a blogpost in May 2020, former Finance Secretary Subash Chandra Garg, who headed the Finance Ministry committee on virtual currencies said that regulators should create a special wallet through which people can receive digital Rupees as the blockchain form of issuing CBDCs can be expensive. “Digital rupee can be created in a single unit of one rupee. It is easy in digital mode to make payment of any amount in units of one rupee. Demat rupee in digital wallet is our digital rupee- the next generation of rupee. The system of digital rupee does not make any difference in the authority and management of money by the Central Bank” he said.
What are CBDCs?
Unlike crypto-currencies which are issued without a central bank backing and are issued and traded on exchanges, a CBDC is a digital currency which holds the same value as fiat currencies issued by a country’s central bank. The value of the CBDC is pegged to the value of the fiat currency.
The idea of a Digital Rupee was first proposed by the Finance Ministry’s committee back in February 2019. “It may be possible to visualise some models of future official digital currencies but as of date it is unclear whether there is clear advantage in the context of India to come up with a official digital currency,” it said. In fact, the RBI said that it had set up inter-departmental group “to study and provide guidance on the desirability and feasibility to introduce a central bank digital currency,” according to its annual report for 2017-2018.
A CBDC can take many forms such as issued on blockchain ledger like private crypto-currencies, a demat account like in stocks, a specific payments instrument or an account based CBDC. There can be retail CBDCs which would be accessible to all types of consumers or wholesale CBDCs that are meant only for institutions. There are three models of issuing CBDCs:
- Direct: issued by a central bank to banks and then onto consumers and the claim on CBDC payments is on the central bank
- Indirect, wherein digital currencies are issued banks to customers and the claim on CBDC payments is on the bank or market players
- Hybrid: market players on-board customers and issue CBDCs, while the claim on payments is on the central bank
What should the regulatory approach be?
The Indian government’s approach fails to acknowledge the utility of different crypto-currencie and the various benefits they can provide in different areas. A ban on all crypto-currencies would ensure that Indians lose out on not only a fast growing investment vehicle like Bitcoin and other cryptos like it, but also leading blockchain ecosystem and infrastructure cryptos.
It is important to note that while the government uses the term ‘private cryptocurrencies’ to describe Bitcoin, Ethereum and others, the definition is inexact. Crypto-currencies like Bitcoin and Ethereum were surely developed by private actors, but the utility of cryptos is far more public than private. In many ways, investing in crypto-currencies is easier and cheaper compared to everyday equity investing and the fees traditional stock brokerages charge. In some instances, there is more transparency on how these crypto-currencies work and what the companies’ behind them are doing with the money they raise, than compared to listed companies on stock exchanges.
The Indian government could treat each crypto-currency as per a defined use-case. This would mean Bitcoins are treated as investments while Ethereum and Ripple are treated as investments in digital blockchain-based infrastructure. The government could approach the question of regulation by declaring Bitcoins as an investment vehicle and not legal tender, which would not affect its CBDC or digital Rupee strategy. Therefore, it can give powers to Securities and Exchange Board of India to regulate crypto-exchanges and safeguard investor interest, while the RBI would be responsible for issuing rules to banks and payment companies on how to provide financial services to Indian crypto-firms.
If crypto-currencies gets banned, what recourse do crypto investors have?
If the government decides to ban crypto-currencies, hopefully it will provide a window for existing Indian investors to square their positions and exit their holdings. Hopefully, tax authorities will not hound investors who invested in crypto-currencies and made significant returns in the last few months. In the worst case scenario, Indian crypto-exchanges will need to move back to the Peer-2-Peer model if banks and payment companies cancel their partnerships and contracts, or they will need to shut shop till the government provides a legal framework for operating an exchange or crypto-firm.
From a tax perspective, any gains that investors have made over the course of the last year in crypto-currency trading have to be disclosed to the Income-Tax authorities even if there is legal ambiguity. If an investor holds on to their crypto-currencies for 36 months or more, the long-term capital gains (LTCG) tax would apply on their investment returns. If they hold onto it for less than 36 months, the short-term capital gains (STCG) tax would apply.
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