wordpress blog stats
Connect with us

Hi, what are you looking for?

Summary: Esya Centre-ORF report on regulation of crypto assets in India

Amid confusion on what approach the government will take to regulate cryptocurrency, this report pushes for a new framework.

“..the (crypto) industry should be regulated through exchanges. These entities account for the bulk of the volume of activity in most major crypto networks and provide a point of entry for most retail and institutional investors into the crypto market,” read the report drafted by Esya Centre and Observer Research Foundation. MediaNama has reviewed a copy of this report.

The report suggests that crypto assets are likely to form the basis for future forms of the internet and it would be unwise to place a ban on private crypto assets as these can result in significant revenue loss to the government and force nascent industries to operate illegally.

“Most regulatory formulae necessary to address policy concerns related to crypto-assets, such as investor protection, money-laundering and tax evasion, already exist in financial legislation. They just have to be adapted to accommodate an emerging technological paradigm,” Meghna Bal, one of the authors, said in a statement.

The report indicates that classifying crypto as a security, good or capital asset may lead to unintended restrictions on investment or leave regulatory gaps in key policy areas. It calls for a sui generis framework that accommodates the emerging trends in the crypto industry.

The report is significant because it comes at a time when the Union government is scheduled to introduce the crypto bill during the winter session of the Parliament.  It also lays down recommendations that may be useful for the government to consider while drafting the bill.

A summary of recommendations in the report

Investor Protection: “The principles underpinning SEBI’s investor protection framework are adequate for the crypto industry,” the report suggests. These include:

Advertisement. Scroll to continue reading.
  • Disclosures driving transparency: Disclosures must seek to address market manipulation and fraud concerns given that digital assets are different from existing financial instruments. The report cites the template for disclosures under the recently introduced Clarity for Digital Tokens Act which requires token issuers to make public disclosures about the ownership and rights of tokens by the team that develops them.
  • Transaction safety: Many of the transaction safety mechanisms under SEBI are inherent to crypto exchanges.
  • Address investor grievances: There should be a grievance redressal mechanism for investors that resolves disputes through arbitration.

Definition: The report bats for the creation of a definition for crypto assets. It explains that the definitions for existing asset classes leave out certain assets that do not meet the conceptual definition. It suggests the following definition:

“A digital asset means an asset that is created and conveyed using any distributed ledger technology and is not legal tender and may be used as a representation and/or of value, means of exchange, or a unit of account or be representative of financial interest and rights.”

Regulatory approach: The report proposes the adoption of a two-pronged co-regulatory approach in which “industry members and experts create codes and standards of conduct that are endorsed and guided by the regulator. The report calls for the following:

  • SEBI, the RBI, and the Finance Ministry should hold joint custody of supervision of crypto assets. These authorities, in consultation with law enforcement, can figure out regulatory concerns specific to them and include them in the framework.
  • These authorities then collaborate with industry players to develop codes of conduct for the Indian crypto market which are implemented and enforced by industry associations.
  • The report asserts that legislation to regulate the crypto industry must include a set of incentives for actors in the crypto market to act fairly and a strong set of disincentives against misconduct.

KYC/Anti-Money Laundering: The report calls for notifying crypto asset service providers as “Reporting Entities” under the Prevention of Money Laundering Act, 2002. “Our analysis indicates that the risk-based approach in the PMLA and the SEBI guidelines are suitable for the crypto industry,” the report says. It also says that the stakeholders can draft rules to bolster reporting requirements, as well as establish a mechanism for information sharing with the Financial Intelligence Unit and the Enforcement Directorate.

Safe harbour for crypto entities: “We recommend bringing in a safe harbour such as the one provided under Section 79 of the Information Technology Act, 2000 for all crypto asset service providers,” writes the report. It reasons that safe harbour is easier to implement than regulatory sandboxes. It says that crypto asset service providers should be protected from liability from the activities carried out by investors only if they carry out due diligence.

Taxation: The report concurs with other countries on treating earnings from crypto assets as capital gains. However, it was against a transaction tax for crypto assets because “it will reduce the ability of small exchanges to compete and operate as a deterrent for crypto-investors”.

Promotion of Crypto Assets: The authors advise against a ban on advertisements as they believe it will harm consumers and make it difficult for entities interested in developing competencies around crypto assets to raise funds. The report asks for advertisements to be regulated by “a framework similar to money market mutual funds as provided under the sixth schedule of the Mutual Fund Regulations”.

Competitive Fairness: The report recommends bringing certain regulatory interventions that uphold competitive fairness such as:

  • The report underscores how offline storage devices for crypto assets are non-standardised and non-interoperable. A regime of interoperability, according to the report, will enhance consumer convenience as it will make it possible for crypto assets owners to keep their crypto assets on fewer devices.
  • It also says that crypto exchanges must ensure they support a wide range of digital assets on their platforms.

Stable coins and FEMA: One of the recommendations calls for the RBI to issue a notification that exchanges and other crypto asset service providers comply with the reporting requirements under the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019. The draft suggests that crypto asset service providers should not be asked to obtain an authorised dealer license from the RBI because they are already registering with SEBI.

Security standards for exchanges: The government must also consider collaborating with industry to “understand the feasibility of imposing thresholds for security of their accounts and holdings”.

Advertisement. Scroll to continue reading.

Technological tools: India must undertake efforts to develop tools that help exchanges with AML/KYC compliance as is done in the US, according to the report.

Tax incentive for whistleblower entities: The report says that tax incentives should be introduced for entities that give relevant and verified information on any other crypto asset service provider that may be acting in contravention of any law in force.

Prohibit crypto assets centred around anonymity: Crypto assets that afford their holders’ anonymity by using “stealth signatures” to obfuscate transaction details should be banned from being listed on the platforms.

Will existing regulation be insufficient for crypto assets?

Esya Centre and ORF have also explored the regulatory implications for the crypto asset industry if crypto assets are accommodated under existing definitions and the challenges it will face in such an exercise. The report deems the exercise “problematic” because:

Crypto Assets as Securities: The report writes that if crypto is treated as a security then the Securities Contract (Regulation) Act 1956 (SCRA) will be applicable. However, the report notes that there is no specific guidance on its application to crypto assets so it is unclear whether they can be treated as securities.

  • Challenges: The authors think that it will lead to a cap on Foreign Direct Investment (FDI) in exchanges and crypto wallets at 49 percent as per FDI Policy 2020. There are also uncertainties regarding the application of the FEMA and tax implications.

Crypto Assets as Commodities: The report says that it is possible to consider crypto assets as “goods” under the SCRA because “they can be considered intangible movable property”. It writes that there are a few areas in which the regulatory outcome could differ from regulation of securities because KYC/anti-money laundering and investor protection mechanisms are specific for the commodity derivatives segment. They could also be subjected to Goods and Services Tax (GST) under the Indian framework.

  • Challenges: The authors say that notified commodities falling under the purview of the SEBI must meet certain criteria which are not suited for emerging technologies like crypto assets. It also raised concerns regarding double taxation and the application of India’s equalisation levy to crypto.

Crypto assets as capital assets: “There is no specific law on exchanging assets but general laws on sale of goods will apply,” the report writes in case crypto assets are classified as capital assets. The report predicts that the law will treat a crypto exchange like an e-commerce entity in such a scenario. “This regulatory approach would attract both e-commerce regulation and PPI regulation and crypto exchanges would have to comply with the extant framework under both,” the report adds.

  • Challenges: The authors say that the 2020 E-Commerce Rules require entities to obtain, publish and make information available on sellers on its platform which will be onerous for crypto exchanges. “E-commerce entities comply with consumer protection requirements instead of investor protection requirements, which is inadequate in some ways but onerous in other ways,” the report explains. It also adds that there are too many disconnected regulators that have oversight.

Why should crypto be regulated and not banned?

The report was not in favour of a ban saying that “a flourishing domestic crypto market gives India leverage in global conversations surrounding crypto governance”. Here are some of the reasons why the authors want crypto to be regulated:

  • Crypto assets provide guidance on how to deal with future financial markets where assets and currencies will be increasingly digitised.
  • It will have unintended consequences as they are “generally unenforceable” and only serve to hinder the prospects of the development of a new industry in the country. “A ban on crypto assets/exchanges would also be unconstitutional,” the report writes.
  • The authors outlined that research suggests only three percent of the volume of Bitcoins are used in illegal activity which can be dealt with through regulatory interventions related to money laundering, etc.
  • Mining activity on the Bitcoin network is significantly concentrated which raises concerns about the financial welfare of the country if a large percentage of the population relies on Bitcoin as a store of value.
  • Crypto assets are generally traceable stores of value as crypto accounts have a public address.
  • The opacity of crypto holdings and the activity in crypto networks is steadily being addressed through the efforts of academics, law enforcement authorities, and analysis tools such as Chainanalysis, etc.
  • Regulation is necessary to instil trust in crypto markets and safeguard the interests of the more than 15 million Indians that have invested in crypto.
  • Regulators must identify points of centralisation within crypto markets to regulate them effectively.

Also read:

Have something to add? Post your comment and gift someone a MediaNama subscription.

Advertisement. Scroll to continue reading.
Written By

MediaNama’s mission is to help build a digital ecosystem which is open, fair, global and competitive.

Views

News

While the market reality of popular crypto-assets like Bitcoin may undergo little change, the same can't be said for stablecoins.

News

Bringing transactions related to crypto-assets within the tax net could make matters less fuzzy.

News

Loopholes in FEMA and the decentralised nature of crypto-assets point to a need for effective regulations.

News

The need of the hour is for lawmakers to understand the systems that are amplifying harmful content.

News

For drone delivery to become a reality, a permissive regulatory regime is a prerequisite.

You May Also Like

News

Google has released a Google Travel Trends Report which states that branded budget hotel search queries grew 179% year over year (YOY) in India, in...

Advert

135 job openings in over 60 companies are listed at our free Digital and Mobile Job Board: If you’re looking for a job, or...

News

Rajesh Kumar* doesn’t have many enemies in life. But, Uber, for which he drives a cab everyday, is starting to look like one, he...

News

By Aroon Deep and Aditya Chunduru You’re reading it here first: Twitter has complied with government requests to censor 52 tweets that mostly criticised...

MediaNama is the premier source of information and analysis on Technology Policy in India. More about MediaNama, and contact information, here.

© 2008-2021 Mixed Bag Media Pvt. Ltd. Developed By PixelVJ

Subscribe to our daily newsletter
Name:*
Your email address:*
*
Please enter all required fields Click to hide
Correct invalid entries Click to hide

© 2008-2021 Mixed Bag Media Pvt. Ltd. Developed By PixelVJ