By Vipul Kharbanda and Aman Nair
December 2021 witnessed a number of reports revealing the possibility that the central government would introduce crypto-asset specific legislation in a bid to bring the space under regulatory control. While initial rumors posited that the government would adopt a complete ban on private crypto-assets, this was later modified – with the understanding that the government would look to regulate them instead. An integral part of this regulatory effort would be the classification of crypto-assets as assets and not as currencies.
However, many crypto-assets such as Bitcoin have been developed with the express purpose of functioning as an alternative method of payment to traditional fiat currencies. This raises an important question, how will the rumored categorisation of crypto-assets by the Indian government affect their use and functioning?
This post answers that question by contrasting the initial intent behind crypto-assets with their real-world behaviour, and examining how adopting a classification system under Indian law would affect them.
Crypto-assets: Theory vs reality
At the outset, it is essential to reiterate that crypto-assets do not exist as a monolith. Crypto-assets can be designed to serve a multitude of functions – as a method of payment and exchange, as a tool to access special goods or services, and as a tool of representing ownership of an asset or security.
Bitcoin’s – and all other crypto-assets that aim to act as a means of payment – reality have however been far from these original ambitions.
While the number of entities accepting bitcoin and other crypto-assets as a payment method has increased over the last decade, concerns remain over a key metric: the transaction volume of these crypto-assets. While transaction volume has seen a steady uptake, worries persist that these transactions are clustered around a small number of entities and users – thereby making it not nearly universal enough to function as a means of payment.
This leads to the most obvious distinction between crypto-assets’ proposed uses and their actual behaviour: speculation. Market behaviour has consistently pointed to the fact that consumers utilise crypto-assets like Bitcoin less as a means of exchange or store of value and far more as a source of speculative profits. It is this speculation that results in Bitcoin and other crypto-assets’ price volatility.
This is further evidenced with reports from El Salvador, where Bitcoin has been adopted as legal tender. Despite this, and despite numerous state-driven attempts at increasing its day to day usage, the number of transactions that have taken place using Bitcoin has remained incredibly low when compared to transactions using fiat currencies like the dollar (El Salvador uses the US dollar as its primary legal tender having dollarized in 2001).
What may happen if crypto-assets are classified as capital assets?
Given, therefore, what we see with how crypto-assets are utilised within the global financial system, the delineation of crypto-assets as capital assets and not currencies of payment systems would most likely lead to the following scenarios:
- A reduction in businesses accepting crypto-assets as a means of payment
- No significant drop in crypto-asset trading and speculation and continued price volatility for crypto-assets
Ultimately what this implies is that should the Indian government adopt a stance of clarifying that crypto-assets cannot be used as a means of payment, it is unlikely to cause a significant drop in either the price or trading volume of crypto-assets.
Stablecoins: A special case
There is, however, a significant set of crypto-assets that could be affected by the government’s proposed classification: Stablecoins.
Stablecoins differ from other crypto-assets in two clear ways. The first is that stablecoins, unlike other crypto-assets, do not derive their value from market forces but instead maintain a fixed value (often pegged to a currency). This value is maintained by either backing the stablecoin with other physical or financial assets or by affecting the available supply of the stablecoin using an algorithm. Second, stablecoins perform a unique function by acting as a mechanism of exchange within the crypto-marketplace. Stablecoins, because of their fixed value, act as a de facto alternative to fiat currencies for individuals looking to make trades within the crypto-ecosystem.
Since stablecoins could potentially be classified as performing the functions of a currency within the crypto-ecosystem, it is imperative that any effort by the government to delineate crypto-assets as being capital assets should take into consideration the intricacies of stablecoins.
To that end, while the wider ambit of stablecoin regulation is beyond the scope of this post, there are two questions that the government must look to answer:
- Given the special role that stablecoins play within the crypto-ecosystem, a loss of confidence by consumers in stablecoins could result in a significant crash of the wider crypto market. Therefore governments must look to understand whether an outright ban on stablecoins – should they be considered by the government as being currency – would be wise given the inevitable economic loss that would follow.
- Secondly, there exists a wider legal and economic question as to whether the mere functioning of an item as a means of exchange within one domain is sufficient to deem it to be a currency. For example, it is entirely possible to imagine a scenario wherein the government clarifies that no crypto-asset can be used as legal tender but still allow for stablecoins to be an acceptable means of exchange within the crypto-marketplace, similar to virtual currencies within a video game market.
Ultimately, the Indian government is faced with an important question as to how crypto-assets should be classified moving forward. Any attempt at doing so must be well thought out, and take into consideration the various nuances that exist within the space – rather than attempting to adopt a blanket policy for all scenarios.
Aman Nair is a policy officer at the Centre for Internet & Society, India, focusing on fintech, data governance, and digital cooperative research. Vipul Kharbanda is a non-resident fellow at CIS, focusing on the fintech research agenda of the organisation. Views expressed are personal and do not necessarily reflect the views of MediaNama.
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