Since the introduction of Bitcoin, various terms related to “crypto” have gained prominence over the past decade. The Bitcoin project aimed to be digital only, maintain privacy, and not be subject to “humiliation” by random issuance by its creators.
It is designed to alleviate the challenges faced by the creators of some globally accepted currencies, namely excessive issuance, absence of privacy, absence of robust or cheap payment systems, impediment to free flow over the internet and reliance on central players capable of user actions.
The Indian financial system is not facing the kind of challenges Bitcoin wanted to solve. The Indian system is robust, payment systems are extremely cheap and publicly available, the currency is well managed and most governments are fiscally responsible.
The trinity of JAM (Jan Dhan, Aadhaar, Mudra) and UPI (Unified Payments Interface) have made the case for a retail CBDC (central bank digital currency) in India limited to non-existent.
However, the revolutionary CBDC/DLT (distributed ledger technology) technologies are expected to provide groundbreaking technical advantages in the future. As such, India plans to experiment with the same to avoid lagging behind this technological trend, as announced by the finance minister during her recent speech on the Union budget.
India could consider using CBDC in closed loop wholesale situations, such as bulk settlements in securities, payments or foreign exchange. Alternatively, India could consider experimenting with DLT systems and smart contracts for the issuance of G-Secs (government securities) to controlled entities, automated interest payments, repayments, and so on.
Over the past decade, crypto assets have emerged as an important asset class for investors. India is no exception and there is a small but growing group of investors moving into this market which is currently unregulated. India may consider regulating crypto assets to ensure that:
1. Implementing KYC (know your customer) and AML (anti-money laundering) mandates to rid the country of nefarious activities
2. Investor protection in terms of deceptive asset sales and regulation of intermediaries
3. Staying at the forefront of DLT research to develop the web 3.0 ecosystem to benefit Indian engineers and companies; comparable to the rise of IT services (information technology) over the past four decades
It is possible to regulate the crypto industry as multiple regulators have the necessary experience in related fields – for example, the Securities and Exchange Board of India (SEBI) has expertise in regulating exchanges and stopping malpractice from securities issuers, brokers, commercial bankers and other intermediaries; Reserve Bank of India (RBI) has expertise in KYC, AML and concerns about malicious actions.
The RBI also has extensive experience in regulating the insatiable demand for gold from Indian citizens through authorized dealers.
The regulators of RBI, SEBI and the Ministry of Finance are rightly concerned about the nature of crypto assets and their potential to disrupt the pursuit of monetary policy and, ultimately, financial stability. This is understandable as global experience in regulating this asset class is limited. The risk of regulatory failure, and its consequences, can be quite high. As such, proceeding cautiously might be the best way forward.
India has slowly reduced capital controls and allowed Indian citizens to invest or spend abroad through schemes such as LRS (Liberalized Remittance Scheme), which imposes an annual cap on funds citizens can send out of India and their end use.
One way to proceed with caution in the crypto-asset industry could be to use the LRS/GIFT City route to enable citizens to invest in crypto-assets in a safe and controlled environment.
The government could explore the possibility of banning crypto assets in mainland India while buying, selling or trading GIFT City by KYC-ed customers on regulated exchanges within a small LRS sub-limit outside the annual LRS limits that are currently allowed will be allowed.
The Indian Financial System Code (IFSC) could be the only regulatory body (which could attract experienced resources from RBI, SEBI and IRDAI if necessary) to license exchanges, intermediaries and issuers.
Strict KYC/AML regulations may be required for exchanges to operate in GIFT City. Exchanges may be forced to partner with regulated banks that oversee and are responsible for actions by exchanges.
Capital adequacy standards could be defined for exchanges or custodians to ensure that well-capitalized agencies operate, and minimum equity criteria could be defined for investors to ensure investors understand the risks to which they are exposed.
A transition date could be provided for the declaration of crypto assets by citizens so that all possession in India after this date would become illegal. After this date, all crypto-asset related activities could be conducted in GIFT City, which can act as a limited sandbox completely isolating the mainland financial system.
Detailed regulations can be prepared after considering individual concerns and leveraging the knowledge of other Indian and global regulators in related fields.
Such an approach would enable India to understand the emerging asset class, take advantage of the potential technology services opportunities that Web 3.0 could bring to Indian service providers, maintain financial stability, protect investors and create a regulated and well-behaved enabling market forces, while enhancing resource mobilization through GST (goods and services tax), capital gains, taxes and other fees.
It will advance India’s long-term plan to move towards capital account convertibility in the coming decades. It will also bolster GIFT City’s reputation as an offshore hub, while enabling its regulators to gain experience in brokering financial transactions between India and the rest of the world that are currently irretrievably lost as they are affected by inaccessible foreign jurisdictions go.