Cryptocurrency Regulations

  • Cryptocurrencies are in news for many reasons. The price of bitcoins has been rising continuously for some time now. The price of cryptocurrency has surged rapidly, trespassing several thresholds one after the other. In recent years cryptocurrency is fastly becoming the part of global economic system.

What is cryptocurrency?

  • Cryptocurrency is an encrypted decentralized digital currency transferred between peers and confirmed in a public ledger via a process known as mining.

Some important cryptocurrencies

  • Bitcoins
  • Litecoin
  • Namecoin
  • Swiftcoin
  • Bytecoin
  • Gridcoin

India’s stand on cryptocurrencies :

  • In India the creation, trading or usage of cryptocurrencies including Bitcoins, as a medium for payment are not authorised by any central bank or monetary authority.
  • On December 5, 2017, the RBI reiterated its warnings in wake of significant spurt in valuation of bitcoins. RBI stated that “Attention of members of public is drawn cautioning users, holders and traders of Virtual Currencies including Bitcoins regarding the potential economic, financial, operational, legal, customer protection and security related risks associated in dealing with such currencies”.

Risks associated with the use of cryptocurrencies

  • Digital currencies, being in electronic format, are prone to losses arising out of hacking, loss of password etc.
  • lack of any authorized central agency to regulate the payments or to turn to for redressal of grievances.
  • There is no underlying of asset for Cryptocurrencies, making the value a matter of speculation.
  • The exchanges are located in various parts of the world, making the law enforcement a tricky thing for the multiple jurisdictions available.
  • Trading may subject the user to illicit and illegal activities since the cryptocurrencies, can easily be used for illegal activities anonymously.

Important terms related to cryptocurrency:

Blockchain technology

  • The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.

Public Ledgers

  • All confirmed transactions from the start of a cryptocurrency’s creation are stored in a public ledger. The identities of the coin owners are encrypted, and the system uses other cryptographic techniques to ensure the legitimacy of record keeping. The ledger ensures that corresponding digital wallets can calculate an accurate spendable balance.

Transactions

  • A transfer of funds between two digital wallets is called a transaction. That transaction gets submitted to a public ledger and awaits confirmation.

Mining

  • In simple terms, mining is the process of confirming transactions and adding them to a public ledger. In order to add a transaction to the ledger, the “miner” must solve an increasingly-complex computational problem (like a mathematical puzzle).

MCQ’s

1. Consider the following statements regarding cryptocurrencies.

  • Crypto Currency is an encrypted centralized digital currency.
  • These currencies are regulated by central monetary authority.

Which of the statement(s) given above is/are correct ?

  • 1 only
  • 2 only
  • 1 and 2 both
  • Neither 1 nor 2

2. Which of the following is not a type of cryptocurrency ?

A. Litecoin
B. Bitcoin
C. renminbi
D. Gridcoin

Answers

  1. D
  2. C

Recently, the Supreme Court struck down a circular of Reserve Bank of India, which bans financial institutions from enabling deals in digital or cryptocurrencies. The ban that came into force in April 2018, had crippled the Indian cryptocurrency industry.

This ban was challenged by the Internet & Mobile Association of India (IAMA) in the Supreme Court, the IAMA pleaded that dealing and trading in cryptocurrency was a legitimate business activity and that the RBI did not have jurisdiction over it as these assets could be classified as commodities rather than currency.

CryptoCurrency or Crypto-Assets

  • The money that we use (fiat currency) is a product of lending by institutions (commercial banks).

    • Its credibility comes from the backing given by the central bank of a country.
    • Its ubiquitous usage is because of a law passed by the legislature, which establishes that taxes can only be paid in state-issued fiat currency.
  • Although cryptocurrencies are intended to function as a means of payment, unlike fiat currencies, they lack a sovereign guarantee and their source of value is not quite clear.
  • They are more like investment instruments like shares in the equity market and that’s why they can be better-called Crypto-Assets.

What did the judgment hold?

  • Economic Dimension: The judgment holds that while the RBI had the power to take note of and deal with virtual currencies, the prohibition was excessive since it cut off the lifeline of otherwise legitimate trade.

    • It also holds the RBI did not show any harm to its regulated entities as a result of their facilitating virtual currency trade or any defects in the functioning of virtual currency exchanges.
  • Administrative Aspect: The Supreme Court held that an outright ban on virtual currencies would be a disproportionate measure by the government since ma­ny less intrusive measures are available.

    • It is worth remembering that virtual currency transactions do not operate in a complete regulatory vacuum.
    • Several existing laws such as the Consumer Protection Act, Information Technology Act, Foreign Exchange Management Act, PMLA, besides tax, deposit-related and criminal laws apply to the virtual currency domain just as they apply to any other economic activity.
    • In fact, action has already been taken in India under many of these laws against errant persons and entities operating in the virtual currency domain.
  • Constitutional Aspect: The Supreme Court also held that the ban was unconstitutional. It is in violation of the freedom to carry on trade guaranteed by Article 19(1)(g) of the Indian Constitution.

Why had RBI banned cryptocurrencies in 2018?

  • Cryptocurrencies are a poor unit of account, as demonstrated by their frequent and high fluctuation in value.
  • They pose several risks, including anti-money laundering and terrorism financing concerns (AML/CFT) for the state and liquidity, credit, and operational risks for users.
  • On the perspective of consumers, issues linked to cryptocurrencies are heightened by the striking paucity of information on their design, use and operation and indications of market manipulation.
  • It is possible that the business models of commercial banks may be seriously disrupted.

Effects of lifting this ban on Cryptocurrency

  • This lifting of the ban will help in incorporation of blockchain technology.

    • Blockchain technology is the underpinning technology behind many cryptocurrencies.
    • Blockchain, which was conceptualised for the verification of anonymous peer-to-peer transactions in bitcoin, has since been adapted for many other purposes.
    • It creates electronic ledgers, where every transaction is recorded and is open to verification by many persons while maintaining confidentiality.
    • It quickly detects fakes and disallows duplicate transactions.
    • Blockchain technology forms a crucial part of Industrial revolution 4.0.
    • It is also estimated that blockchain will generate $3.1 trillion in new business value by 2030.
  • Cryptocurrencies act as alternative investments.

    • These currencies may enable savvy traders to hedge global volatility, as it did during the financial turmoil of 2012-13.
  • There is a worldwide proposal for central-bank digital currencies, which could allow for money to be transferred between users without the involvement of a third-party (commercial bank).

    • Allowing cryptocurrency will enable India to be part of this global deal.
  • For India, aiming to be a digital economy powerhouse, embracing emerging technologies like cryptocurrency and blockchain is a must.

Way Forward

Rather than impose bans, it would be more pragmatic to institute awareness campaigns to alert investors to specific risks, and to monitor trades for fraud and scams. Fintech industry needs to jointly with the RBI and the government on a constructive policy framework for cryptocurrencies in India. In this context:

  • There is a need for RBI to formulate a detailed regulatory framework to license virtual currency intermediaries like exchanges.
  • These local cryptocurrency exchanges could be asked to adhere to the KYC norms followed by stock exchanges.
  • There is a need for the Fintech Industry to show that virtual currency trade can be carried on in a safe and responsible ma­nner with self-imposed safeguards, such as adequate customer due diligence.
  • One im­mediate step that could be taken by the government is to designate virtual currency intermediaries as reporting en­tities under the Prevention of Mo­ney Laundering Act (PMLA).
  • These steps should ideally be done by a new expert regulatory body with capability in technology, economics and fi­nance.

A vibrant cryptocurrency segment could add value to India’s financial sector. Thus, in the face of growing technological innovation in the financial sector, it is critical to strengthen the supporting regulatory frameworks of India that operate regardless of the nature of an instrument.

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