Cryptocurrency (Representative image)
The listing of the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 in the winter session of Parliament was not unexpected given the statements made by the policy makers, and the growth of the industry. Policy makers have considered a range of options from a total prohibition on private cryptocurrencies to their recognition as a financial asset under the supervision of the regulator.
The Bill is anticipated to prohibit all private cryptocurrencies, but not the underlying technology, which can be used to improve the efficiency, and inclusiveness of the financial system. The crypto wave gripped India soon after the Supreme Court overturned the Reserve Bank of India (RBI) prohibition on cryptocurrencies. Thereafter, in a short span, we saw the birth of many cryptocurrency exchanges.
The courts in various jurisdiction across the world have considered virtual currencies to belong to different categories: from property to commodity, from non-traditional currency to payment instrument, and from money to funds. The Supreme Court of India considered that the use of cryptocurrencies as an activity over which the RBI does have power, and any activity that is a threat or has an impact on India’s financial system can be regulated or prohibited by the RBI despite the said activity not forming part of the credit system or payment system. That said the court found the prohibition as a response that was found wanting on the principle of ‘proportionality’.
Despite the court overturning the RBI-imposed ban on cryptocurrencies, the regulator has remained cautious. The main argument of policy makers against virtual currencies is that massive swing in their prices exposes investors to risks sans any protection, which portends trouble for the financial system. There should not be any reason to mislead ordinary people into believing that virtual currencies have the backing of an authority.
Additionally, the use of dark-net to promote illegal activities, and the use of digital identities to make payments remain legitimate concerns of the central bank. The RBI has repeatedly and expressly warned investors of the many pitfalls of unhinged trading in cryptocurrencies, without the intervention of a trusted regulator. Earlier this month, RBI governor Shaktikanta Das reiterated his fear saying cryptocurrencies are a serious macroeconomic, and financial stability threat.
However, the main challenge to regulate cryptocurrency lies in the fact that it is not classified as a legal tender. For the RBI to regulate cryptocurrencies, it must hold monetary value. As India’s banking regulator, the RBI will guard against any parallel currency which can challenge the strength of the Indian Rupee.
In its analysis of the character of virtual currencies, the apex court observed that there can be no quarrel with the proposition that the RBI has sufficient power to issue directions to its regulated entities in the interest of the depositors, in the interest of the banking policy, in the interest of the banking company, or in public interest. That said, the industry view has been that the activity is not regulated and prudent measures have been taken for compliance. The industry also considers this as a legitimate use of technology for creation of an asset class.
The report of the inter-ministerial body — set up on November 2, 2017 to study virtual currencies — has viewed cryptocurrency unfavourably, while dwelling on the benefits of distributed-ledger technology. It is this acknowledgment of the underlying technology that a framework for issuing CBDCs (central bank digital currency) is likely to be established.
The RBI recognises the role of the CBDCs in pushing financial inclusion, and financial literacy, and is aware that blockchain technology can be applied to foster innovations in this space. This outlook is in tandem with the approach of the regulators globally, wherein the CBDCs are being explored to study the feasibility of making faster and cheaper cross border payments while maintaining regulatory oversight by deploying blockchain technology.
Whatever be the destiny of cryptocurrencies, blockchain is here to stay. As technology marches ahead, governments, regulators, and legislatures will have to keep up pace to assess their impact on the overall regulatory, governance, and supervisory mechanism so that the controls that the government must have over the economy are respected, and maintained. Within these boundaries, it will be interesting to see to what extent technology plays a role in creating a new asset class whose intrinsic value does not disrupt or have a bearing on the financial markets that are otherwise subject to regulation, and supervision.
While disruption in money and financial markets may be warded off by a prohibition, one must keep alive the hope that the use of technology for improving efficiencies, and creation of new asset classes, along with improving financial inclusion, be encouraged.
The introduction of the Bill is only the first step. As technology evolves, the law will catch up. It is also hoped that the contours of the law will encourage innovation, and use of technology to expand financial markets. Else there is a risk of such technology being housed in other parts of the global financial markets that have chosen to regulate cryptocurrencies.L Viswanathan is Partner, Cyril Amarchand Mangaldas. Views are personal and do not represent the stand of this publication