Why cryptocurrency laws need to be carefully considered

The government’s decision to introduce a bill to ban all private cryptocurrencies in India was not entirely unexpected. The issue of cryptocurrency (or virtual currencies / VCs) was first raised when the case was brought to the Supreme Court in 2018. During lengthy debates, the three-judge panel overturned the RBI circular which prevented crypto exchanges from dealing with the formal financial system for reasons of proportionality. However, the judgment recognized the role of the RBI in safeguarding the interests of financial stability. The moot point of the verdict was that there was no evidence that venture capital had a negative impact on RBI-regulated entities and that trading in such currencies was illegal.

The current bill now attempts to set the playing field so that the RBI, tax authorities, SEBI and other agencies have much better legal guidance in deciding how to proceed with VCs in their respective fields. Rules can therefore range from a ban to a controlled interaction with the formal financial system.

The crypto markets suddenly multiplied after the appearance of bitcoin on the scene. Since then, many such assets have emerged with varying degrees of financial engineering. Almost all crypto is blockchain-based, but not all blockchain is crypto. The fact that the RBI sandbox enables innovation in the blockchain only proves this point.

The issues involving cryptos can be seen on three levels, each of which is equally important. The first is its impact on sovereignty. The second is its interaction with financial markets and the third is the value proposition that the whole concept of crypto brings to the economic debate.

Commentators and experts who have observed trends in artificial intelligence have predicted that the algorithmic world that will emerge in the years to come will emphasize the very concept of the nation-state emerging from the Treaty of Westphalia. Blockchain technology and by extension cryptography are important components of this virtual world. Some of the variants of cryptos such as the stable coin make it clear that these are attempts to create monetary systems incorporating features of price stability involving a parallel monetary system. Thus, the unrestricted co-optation of CR clearly dilutes the sovereign function of money creation, clearly impacting the revenues of the RBI. Concerns about money laundering, terrorist threats and drug trafficking also fall into this category given the high value and anonymity offered by cryptocurrencies.

Once the decision has been taken to co-opt the supposed innovation, the question will arise as to how it interacts with the formal system. As of now, cryptos are recognized as assets or commodities and as a medium of exchange. Their role as units of account or as legal tender is rather limited. They can offer a store of value given their scarcity. From a banking point of view, certain problems arise. Since VCs are not legal tender, they cannot be used to pay off debt. Thus, banks cannot accept VCs to close a loan account. Second, can banks lend in trust by accepting VCs as collateral assuming the VC is an asset? If so, what should be the capital required if VCs are accepted as collateral? What will be the impact on the bank’s unmatured liabilities if there is a leakage of deposits to the RC?

On a deeper level, the very idea of ​​venture capital and the way it is designed is incompatible with fractional banking. Fluctuations in interbank liquidity require that the money supply adjusts to the requirements of the system. If the money supply undergoes a compositional change in favor of VCs, this capacity will be reduced, thus exacerbating the crisis.

In the financial markets, cryptos such as ICOs bring another set of issues that have not been discussed. The ICO is a creature that turns the very concept of limited liability in corporate finance upside down. ICOs are sometimes designed to conceal the identity of the beneficial owner. Other ICOs may not even confer any ownership rights. The SEBI has not yet taken a position on various issues surrounding this idea.

Regarding the value proposition, VCs have become a medium of exchange and many countries have allowed VC ATMs. But how does this proposal fare given that considerable progress has been made in the area of ​​payment systems in India. Is it worth it to introduce additional competition in a hyper-competitive market? What will be the impact on existing investments in mobile payment and UPI technology?

In short, the bill must meet many important objectives. The world of cryptocurrency straddles many areas. While there are obvious concerns regarding money laundering and Benami transactions, there are equal concerns regarding company laws, payment systems and banking laws, securities and other business laws. . The issue of consumer protection needs to be addressed and current laws may need to be reviewed taking this innovation into account.

Before concluding, a word of caution about “gullible” investments in venture capital firms that could threaten financial stability. It is well known that the Indian population shows significant differences in behavior in terms of savings and loans depending on the region. Such dramatic changes in behavior have profound implications for banking strategies and product design. State-by-state data shows that in states with per capita income below the national average, the preference is more for CASA deposits (current account and savings account). On the contrary, the percentage share of term deposits is higher mainly in states with a per capita income above the national average. In the past, there have been several instances where states with low per capita income were more inclined to invest in chit funds that negatively impacted the savings of many poor households. Do we have data to support the view that investments in CVs permeate all households, especially the most vulnerable?

This column first appeared in the print edition on December 13, 2021 under the title “The Myth and Attraction of Crypto”. The authors are the group’s chief economic adviser and economist at the State Bank of India. Views are personal

About Ruben V. Albin

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