Cryptocurrency is a virtual currency or a form of digital asset based on a network that allows securing payments online. It is a decentralized structure that is denominated in terms of virtual ‘tokens’ represented by ledger entries internal to the system. It works on decentralized technology with a typical database used to store transactions and maintain the integrity of transactional data known as a blockchain. These blockchains are immutable which means data entered can’t be reversed back. The first valuable blockchain-based cryptocurrency was Bitcoin, which is currently the most dominant in the financial market. The word ‘crypto’ refers to the various encryption algorithms and cryptographic techniques that protect these entries and hence provide a secure network for payments.
Today, the aggregate value of all the cryptocurrencies in existence is estimated to be around $1.5 trillion with Bitcoin representing more than 60% of the total value. Cryptocurrencies have been praised for their transparency, portability, availability, security and ease to transfer funds. Fund transfers are completed with minimal processing charges, allowing users to avoid the unreasonable fees charged by banks and financial institutions for wire transfers. In modern cryptocurrency systems, a key system is used where two distinct keys- a public key and a private key is used to sign transactions with different algorithms and techniques used at the back-end to safeguard transactions. One of the most sought after and distinguishing characteristic of cryptocurrencies is that it is not issued by a central authority which makes them theoretically immune to government interference (or, manipulation).
Regulation of Cryptocurrency market- Is it required?
The popularity of the cryptocurrency market is increasing every day. With the astronomical rise of cryptocurrencies like Bitcoin, Ethereum, Dogecoin there seems to be a sudden influx of tech-savvy netizens into the market. The traffic is so high that many cryptocurrency exchanges cannot even afford to have their account creation feature open all the time. The average daily trading volume of the cryptocurrency market is around trillions of dollars. The total market cap of the entire market stands at more than half a trillion dollars which is an astonishing feat considering the proper functioning of the market started less than a decade ago. However, to use these numbers solely as an appraisal index of the state of the market would present a false narrative. Certain structural and functional issues affect the stability and security of the market. These problems stem from a variety of reasons some of them includes the infant nature of the blockchain market, lack of understanding of the cryptocurrency space, peculiar nature of the economics of cryptocurrency also known as tokenomics, and the untraceable nature of the virtual currency market.
The high-level Inter-Ministerial Committee (IMC) constituted under the Chairmanship of Secretary of Ministry of Economic Affair to study the issues related to virtual currencies and to propose specific actions to be taken in the matter, recommended in its report that all private cryptocurrencies, except any issued by the state, should be prohibited in India. It also gave two major reasons as to why regulation of cryptocurrency is required- firstly, the excessive volatility of the cryptocurrency market; secondly, the use of cryptocurrency for terror funding and other illegal activities.
The prices of cryptocurrencies on exchange platforms rise and fall dramatically over a very short period. Several reasons contribute to the excessive volatility in the market but perhaps the biggest contributor is the activities of ‘whales.’ Whales are those individuals who have large cryptocurrency holdings. These massive cryptocurrencies holding allows them to swing the market by manipulating the price of a cryptocurrency. They do this by utilizing ‘buy and sell walls.’ A buy wall is a situation when a ‘buy position’ worth millions of dollars is opened on a crypto trading platform. When the big buy position is opened due to the actions of the whales, the regular investors who trade in small amounts will interpret it to mean an imminent price increase. Whenever such a situation arises the price of the cryptocurrency goes up inevitably. The biggest problem with this regular market strategy is that the whales can fraudulently drive up the price without actually investing in the market. The actual trade that boosts the price of the cryptocurrency comes from the smaller traders. When the price is at a level that favours the whales, they can adjust their buy and sell walls, cash in on the price spike and once they do so, the price of the cryptocurrency falls dramatically. This process gets repeated over and over with only the whales benefitting. Since there is no regulating authority they are never caught or held responsible for the act committed. Putting adequate limits or fees in place along with a strong regulatory body will discourage the movement of large buy and sell market positions.
The cryptocurrency market has since its inception been beset by the activities of hackers and cybercriminals. There have been several high-profile cryptocurrency hacks and heists that have resulted in millions of dollars being stolen or misappropriated. One of the most important features of cryptocurrency is that its transaction leaves no track that can be accessed to reach a starting person, thus the person who made the demand for the initial payment is not traceable. This feature can be successfully harnessed by the terrorists and criminal especially drug mafias to avoid their tracts and to complete the payment. In a bid to counter the activities of these cybercriminals, cryptocurrency traders and platform operators have to take several basic precautionary measures including identifying malicious activities through its decentralised ledger and blacklisting any similar transactions. Cryptocurrency trading platforms constantly have to improve their security framework to stay ahead of hackers and thieves. Many of these upgrades also make the trading process a lot more cumbersome; while some of these measures have proven to be helpful but they create bottlenecks that hamper the process of cryptocurrency trading. Ultimately creating a trade-off between security and efficiency of the system.
Banning Cryptocurrency – a Regression
According to a recent estimate, over one crore Indians are already earning and investing in this thriving global crypto economy. On April 5, 2018, the Reserve Bank of India (RBI) issued a circular titled ‘Statement on Developmental and Regulatory Policies’ concerning the activities of cryptocurrency in India. According to which the entities governed by RBI were asked not to deal with, or give services to any person or business organizations that carry out transactions in digital currencies. Even though this circular did not explicitly ban cryptocurrency, it was successful in making it completely irrelevant. This circular was challenged before the Supreme Court in the case of Internet and Mobile Association of India v. Reserve Bank of India (RBI) and after almost two years a historical judgment was delivered striking down RBI’s April 2018 circular which banned regulated financial institutions from providing services to crypto businesses. The court held that the circular was unconstitutional because it restricted the business opportunities of cryptocurrency exchanges, taking away the fundamental rights guaranteed under Article 19 (1) (g) of the Constitution. The key reason according to the court in determining the unconstitutional status of the circular was that the RBI was neither able to prove the harm of cryptocurrency trading nor was able to explore an ideal alternative to ban imposed (such as rules and regulation).
Although the SC struck down the order the intent of the central government is not very positive in this matter. The Subash Chandra Garg committee formed to give advice on the issue of cryptocurrency and to draft the regulation of virtual currency bill explicitly stated that all private cryptocurrencies should be banned in India and only those issued by the RBI should be allowed. The committee also suggested a jail term of up to 10 years as well as heavy penalties for anyone dealing in digital currencies. The government plans to introduce ‘The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021’ before the parliament, the essence of the bill is the prohibition of all private cryptocurrencies in India, with certain exceptions i.e., only the State-owned, ‘National Digital Currency’. Looking at the current infrastructure available with the RBI the possibility of it launching a virtual currency is far away. If this bill becomes an act and all private virtual currencies are banned in India, it will be a regressive step. Also instead of imposing a blanket ban on all private cryptocurrencies the government could have streamlined and regulated the cryptocurrency industry by bringing supporting rules and regulations including strict KYC norms, reporting and taxability. The Internal Revenue Service (IRS) of the USA has classified crypto assets as the ones with value and property, making cryptocurrencies taxable entities in the USA. This serves two purpose- allows collection of tax for gains made and acts as a regulatory mechanism where any illegal payment can be traced to some extent. Similar steps are being taken by several developed countries including UK, Switzerland, Japan, New Zealand to understand and regulate crypto assets. In the UK a self-regulatory trade association called CryptoUK seeks to enhance the existing industry standards around cryptocurrencies especially Bitcoin by executing a code of conduct that consists of provisions related to data security, privacy, and money laundering. Moreover, any possible gains made by an investor concerning his/her crypto-assets are subject to capital gain tax.
India has already missed the first and second industrial revolution due to colonisation and this step of banning could make us lose the race to the fourth industrial revolution which is entirely based on information economics. There is an urgent requirement for a clear classification of all the digital currencies in India. These virtual currencies are not legal tenders backed by the central government or the RBI. The Indian crypto traders and investors are also asking for treating crypto assets on grounds similar to that of other financial assets like debt, equity or a commodity. Although the SC reaffirmed RBI’s power to regulate such currencies, it said that any restraint or regulation on trading in cryptocurrencies must be exercised with proportionality and responsibility, which must be backed by adequate empirical evidence. This has set the stage for the regulation of cryptocurrency. Most cryptocurrencies are not backed by substantial assets or other securities and may have no clear anticipated value. This results in weakened price discovery and ultimately increases the risk of market manipulation. The lack of comparable information on such products, together with anticipated technological complexities, warrants regulatory attention on consumer protection, and adequate disclosure and transparency. Proper regulation of the virtual currency will also support anti-money laundering (AML) and combating the funding of terrorism (CFT) which was recognized as a risk by the Financial Action Task Force (FATF) in 2014.
Positive steps towards regulation will give a big boost to the adoption of crypto assets, thereby helping to increase tax revenues for the government and to create more jobs. It will also allow both the government and private sector to innovate and come out with plans to integrate digital currencies into the mainstream economy.
CoinMarketCap. "Global Charts."
Internet and Mobile Association of India v. Reserve Bank of India, Writ Petition (Civil) No.528 of 2018
Jonathan Chiu & Thorsten Koeppl, The Economics of Cryptocurrencies- Bitcoin and Beyond
By: Harsh Raj, first-year law student at NALSAR University of Law, Hyderabad, Telangana