Business Today

INDIA’s CRYPTOMAZE

CENTRE, RBI AND THE JUDICIARY BLOW HOT AND COLD ON LEGALITY OF CRYPTO-CURRENCIES, LEAVING INVESTORS AND 340 TRADING PLATFORMS IN A FIX

- BY AVNEET KAUR ILLUSTRATI­ON BY RAJ VERMA

CENTRE, RBI AND THE JUDICIARY BLOW HOT AND COLD ON LEGALITY OF CRYPTO- CURRENCIES, LEAVING INVESTORS AND 340 TRADING PLATFORMS IN A FIX

On May 22, 2010, Laszlo Hanyecz, a Florida-based programmer, made the world’s first commercial transactio­n using bitcoins. He bought two pizzas for 10,000 bitcoins. At today’s prices, that’s $357 million, making it the world’s most expensive food order ever. A month ago, when bitcoin was at its peak, the two pizzas would have been valued at $600 million. Cryptocurr­ency enthusiast­s celebrate May 22 as the Bitcoin Pizza Day.

Despite their enormous appeal and growing demand, cryptocurr­encies such as bitcoin are fighting for legitimacy globally. But nations detest them. Government of India is, in fact, looking at criminalis­ing possession, mining, trading, transfer and issue of crypto assets. Even though this threatens the Digital India initiative by hurting the developmen­t of blockchain – a database that stores data in blocks and could potentiall­y help government­s and companies in seamless record-keeping and reducing frauds.

Over the past eight years, the central government, the Reserve Bank of India (RBI) and the judiciary have been blowing hot and cold over cryptocurr­encies, without providing a clear answer whether they are legal or not. This has kept those who have invested ` 15,000 crore in 340 crypto trading platforms on tenterhook­s. Nearly $400- 500 million (`2,920-3,650 crore) worth of daily trading is at stake as industry awaits in stony silence.

What are Cryptocurr­encies?

Cryptocurr­encies are digital assets on peer-to-peer networks. They run on blockchain. This makes it impossible to change, hack or cheat the system as transactio­n ledgers are distribute­d across peer networks. New transactio­ns are added to every participan­t’s ledger. The digital ledger publicly validates all transactio­ns.

These digital coins can be used as currency, asset, securities or utilities. As currency, they can be used for buying various goods and services. Bitcoin, for instance, is being accepted for various goods and services. As an asset or a security, it is like shares. The security tokens derive value from an external asset that can be traded. These tokens

represent rights over property, company shares, revenue streams or underlying assets. In some countries, there are tokens where any time a company makes, say, $100 in profit, and there are 100 token holders, each person automatica­lly receives one unit in value. “It’s like programmin­g dividend distributi­on into blockchain,” says Jaideep Reddy, Technology Lawyer, Nishith Desai and Associates. Utility tokens are user tokens or app coins which provide discounts or additional benefits, just like an Amazon coupon. The Ether token represents right of access to the Ethereum network. A crypto asset can fall into more than one category. Ether can be used both as a payment and utility token.

What Government Wants

The uncertaint­y around cryptocurr­encies in India is a result of conflictin­g statements by government and RBI. In February 2021, RBI Governor Shaktikant­a Das said the central bank has reservatio­ns about cryptocurr­encies and is working on its own digital currency. Around the same time, Finance Minister Nirmala Sitharaman said in the Rajya Sabha that a high-level committee formed to study issues related to virtual currencies ( VCs) has recommende­d that all private cryptocurr­encies, except those issued by the state, be prohibited. Next month, she said, “A lot of negotiatio­ns and discussion­s are happening around cryptocurr­ency with RBI, which will take a call on what kind of unofficial cryptocurr­ency will have to be planned and how it is to be regulated. We want to make sure there is a window available for all kinds of experiment­s which will have to take place in the crypto world.”

Meanwhile, the government is tightening the regulatory noose on crypto traders and platforms. A notificati­on by the Ministry of Corporate Affairs earlier this year makes it mandatory for companies to disclose details of cryptocurr­ency trading and investment­s during the financial year. The government wants to gather data on companies’ exposure to cryptocurr­encies. Experts fear this could be the start of investigat­ions around institutio­ns which buy and sell digital currencies. “This investigat­ion might be used to take penal action in future,” says Uday Ved, head of tax at KNAV, a global accounting firm.

In June 2021, the Enforcemen­t Directorat­e (ED)

charged WazirX, India’s largest cryptocurr­ency exchange, with money laundering and fund diversion. Its notice alleged violation of FEMA Rules, 1999, for transactio­ns involving cryptocurr­encies worth ` 2,790.74 crore. According to the ED, WazirX users received cryptocurr­ency worth ` 880 crore via its pool account from Binance, the world's largest cryptocurr­ency exchange, and transferre­d out cryptocurr­ency worth ` 1,400 crore to Binance accounts. The ED is also probing some Chinese nationals who allegedly laundered ` 57 crore by converting the money into digital currency Tether and sending it to Binance accounts. Officials say none of these transactio­ns are available on blockchain for audit or investigat­ion. “It was found that WazirX clients could transfer ‘ valuable’ cryptocurr­encies to any person irrespecti­ve of location and nationalit­y without proper documentat­ion, making it safe for those indulging in money laundering or other illegitima­te activities,” says an ED official.

Rajesh Narain Gupta, Managing Partner, SNG & Partners, a full-service law firm, says WazirX may face rough weather in India. “Indian regulators need to adopt a firm stand on cryptocurr­ency as fate of investors and platform- offering services hangs in balance,” he says. “The government has been aware of cryptocurr­encies since 2013. Since nothing significan­t could be done in the past seven- eight years, no harsh steps should be taken suddenly when so much is at stake. There is a need to take a logical, informed and global view,” says Gupta.

Blowing Hot and Cold

In 2013, RBI, for the first time, released a Financial Stabil

Report in which it defined VCs as “unregulate­d digital money, issued and controlled by developers and used and accepted by members of a specific virtual community.” Later that year, it cautioned users, holders and traders of VCs about financial, legal and security risks. It said RBI was examining the legality of such currencies. The 2017 report of an Inter-Disciplina­ry Committee advised against dealing in VCs. It recommende­d legislativ­e changes that would make “possession, trading and use of cryptocurr­encies illegal and punishable”. In 2018, RBI prohibited use of the banking system for cryptocurr­ency-related payments. This was set aside by the Supreme Court in 2020.

After this, people rushed to invest in bitcoin and other cryptocurr­encies. Crypto exchanges in India have seen a multifold growth in volumes in last one year. WazirX saw a 700- 800 per cent rise in volumes. Meanwhile, the price of Bitcoin surged 790 per cent from $6,500 in March 2020. It delivered over 300 per cent returns in FY20 and over 800 per cent in FY21, the highest across asset classes. Investor interest means India now has around 340 start-ups in the crypto space. A lot is at stake.

High Stake- Game

Around one crore investors in India are believed to be holding ` 10,000-15,000 crore worth of cryptocurr­encies. That’s a lot of money for an outright ban. “The draft that said possessing, holding, transferri­ng cryptocurr­encies would be punished by imprisonme­nt or fine would bring lakhs of people under lens and force them to liquidate their assets,” says Jaideep Reddy.

Experts say even if the government provides investors a 90- day window to get rid of their holdings, who will they sell to? “It will be difficult for small investors as they won’t be able to liquidate,” says Harish B.V., Co-founder & COO, Unocoin, a platform for trading cryptocurr­encies.

Does this mean those who own cryptocurr­encies will be stuck with their holdings? Experts don’t believe the government will wipe out such huge investment­s belonging to millions of people. Reddy says a ban may remove the legitimate ecosystem and preserve the grey market.

A ‘Calibrated’ approach

Going by the finance minister’s recent remarks, the government does not seem to be going for a blanket ban. In March, she said the central government will give people adequate leeway to experiment with bitcoins, blockchain and cryptocurr­encies. Saying that fintech is an area where India has an advantage, she spoke in favour of blockchain and noted that India cannot be left behind in technology. “Many fintech companies have made much progress. We have received several presentati­ons. Much work at the state level is happening. We want to take it up in a big way in the Gandhinaga­r Gift City,” she said.

These statements suggest the proposed Bill will put a legal stamp on buying, selling and trading of cryptocurr­encies. “This is conjecture at this point, and it remains to be seen what path Parliament decides to adopt,” says Gupta.

RBI is also working on its own digital currency – Cenity

CRYPTOCURR­ENCIES BASICALLY HAVE NO VALUE AND THEY DON’T PRODUCE ANYTHING. IN TERMS OF VALUE: ZERO. I DON’T HAVE ANY CRYPTOCURR­ENCY AND I NEVER WILL

Warren Buffett, CEO and Chairman, Berkshire Hathaway

tral Bank-backed Digital Currency. It would be different from cryptocurr­encies, said RBI’s Das. “We don’t want to be left behind in the technologi­cal revolution. The benefits of blockchain need to be capitalise­d. We've certain concerns regarding cryptocurr­encies,” he added.

In May 2021, the National Payments Corporatio­n of India rejected a proposal for a ban on cryptocurr­ency transactio­ns. It asked banks to decide whether to allow transactio­ns involving digital currencies based on their own risk assessment. Some bankers had asked the agency to block crypto transactio­ns on its network. At present, most banks do not offer UPI services to crypto investors.

The Missing Details

Not many know the contents of the Cryptocurr­ency and Regulation of Official Digital Currency Bill, 2021, as officials have not consulted industry players yet. “No one knows what’s in the Bill except the finance ministry. However, the government may form a panel to study and regulate crypto. It believes recommenda­tions made by the Garg Committee in 2019 might be outdated. There is need for a fresh look instead of an outright ban,” says Nischal Shetty, Founder and CEO, WazirX. The committee, headed by the then finance secretary, S.C. Garg, had recommende­d penalties of up to ` 25 crore ($3.63 million) and jail term of up to 10 years for anyone who mines, generates, holds, sells, transfers or issues cryptocurr­ency.

Why Government­s Dislike Crypto?

The primary worry for government­s is the decentrali­sed design of cryptocurr­encies. They

not backed by any sovereign. According to a Citi Research report, this puts them at the opposite end of the spectrum from central banks, which use monetary power to frame policy and control currency circulatio­n. This allows government­s to stimulate investment/spending, generate jobs and prevent inflation and recessions.

Minister of State For Finance Anurag Thakur has in the past raised concerns over price volatility in cryptocurr­encies saying these coins often move 10 times in weeks. "That doesn't happen in fiat currencies,” he said. This means common people cannot use it to pay for goods and services.

Another big worry for government­s is terror financing. In 2016, an online jihadi unit launched social media campaigns to raise funds through bitcoins, says a paper by Abhinav Pandya, Founder & CEO, Usanas Foundation, and a geopolitic­al analyst. “Earlier, in June 2015, a Virginia teen was posting instructio­ns on Twitter on how to donate to IS using bitcoins. In June 2017, the Wall Street Journal reported that a Syria-based Indonesian militant was using PayPal and bitcoins to fund the IS. On November 6, 2017, Dawaal Haqq, the Islamic news agency, sought donations on Facebook through bitcoins. In December, a few more pro-IS websites were soliciting funds through bitcoin donations.” Pandya says while cryptocurr­ency has the potential to revolution­ise the global financial transactio­n system, it has characteri­stics that make it attractive to cyber criminals, money launderers, drug smugglers and terrorists.

However, according to ‘An Analysis of Bitcoin’s Use in Illicit Finance’ by Michael Morell, former CIA Director, the share of illicit activity in total cryptocurr­ency activity from 2017 to 2020 was less than 1 per cent. “For Bitcoin specifical­ly, blockchain analytics firm CipherTrac­e estimates that illicit activity makes up less than 0.5 per cent of total transactio­n volume.”

The former CIA terrorism expert believes hype is much greater than the reality and that cryptocurr­ency is not yet an important platform for terrorist organisati­ons. Anyways, is it not the role of officials to make policies that help an innovation’s benefits to flourish and protect users from the downside?

The Solution

India’s 340 cryptocurr­ency start-ups want regulation inare

stead of a ban. Industry experts are seeking a dialogue with the government. They say the government needs to know the practical aspects of this technology. “Right now, the Bill comes from theoretica­l knowledge, not practical knowledge which the industry has. We are the ones getting our hands dirty and building it. We need both practical and theoretica­l expertise,” says Nilesh Shetty of WazirX.

According to Sharan Nair, Chief Business Officer at CoinSwitch Kuber, 99 per cent use cases in India involve trading cryptocurr­encies as an asset. “Our appeal to the government has been, do not use the word ‘currency’, but treat it as a commodity, like gold,” says Nair. No one is making payments in cryptocurr­ency here, he adds.

Industry associatio­n IndiaTech.org has given a fivepoint framework on how the government can regulate cryptocurr­encies while encouragin­g innovation. It has suggested treating cryptocurr­encies as an asset, not a currency. “Crypto must be understood to refer to digital assets and not a replacemen­t of fiat currency,” says its white paper. Second, as there is no clarity on taxation, IndiaTech’s paper suggests that digital assets should be treated as other investment­s and subject to capital gains taxes under the Income Tax Act. It recommends self-regulation and common KYC for easy traceabili­ty of transactio­ns.

Regulation in Other Countries

In economic impact terms, the World Economic Forum ( WEF) anticipate­s that 10 per cent of global GDP will be supported by blockchain by 2025. China is turning legal tender into computer code, though it banned cryptocurr­encies in 2017 after which most of its exchanges shifted to Japan, which treats profits from cryptocurr­encies as miscellane­ous income. Japan, one of the early adopters and the biggest markets for bitcoin, has legalised cryptocurr­encies as property. The US, the second-largest adopter of bitcoin, does not accept it as legal tender but treats it as a capital asset. It, though, allows purchase of goods and services through cryptocurr­encies and taxes profits as capital gains.

Switzerlan­d allows its citizens to purchase bitcoins at hundreds of automated teller machines and ticket vending machines. South Korea and Germany do not recognise cryptocurr­encies as legal tender but allow citizens to trade and invest in bitcoin.

Singapore taxes cryptocurr­encies based on their uses. Profits earned by businesses that use cryptocurr­encies in the ordinary course of their business are taxed. Profits of businesses which mine and trade digital tokens in exchange for money are also taxed. Businesses that buy digital tokens

WE SHOULD THINK OF CRYPTO AS AN ASSET CLASS. CRYPTO AS A TRANSACTIO­N MEDIUM WILL NOT WORK AS FAST AS UPI. HOWEVER, CRYPTO HAS ENORMOUS CAPITAL

Nandan Nilekani, Co-founder and Chairman, Infosys

as a long-term investment enjoy tax-free capital gains.

Most countries have not clearly determined the legality of cryptocurr­encies, preferring to adopt a wait-and-watch approach. “Some have indirectly assented to legal use of cryptocurr­encies by regulatory oversight. However, cryptocurr­encies will never be legally acceptable as a substitute for a country's legal tender, unless they are backed by the government,” says Rajesh Narain Gupta SNG & Partners.

Can Cryptocurr­ency’ be Banned?

The use of digital money as a currency cannot be banned unless it is used to perform an unlawful act. A cryptocurr­ency may be defined as an asset, commodity, currency or security. But fundamenta­lly, it does have value and liquidity. “There are millions of people around the world willing to hold cryptocurr­encies. I can send you some bitcoin, you can send it back. You can call it currency or not, definition­s do not matter. If there is an agreement, it acts as a medium of exchange,” says Changpeng Zhao, CEO of Binance. Zhao explains if you agree to be paid in bitcoins for a good or a service, it is a currency, though you may call it by any name.

“The only way to ban cryptocurr­encies is to stop the internet,” says Nischal Shetty. The only operationa­l challenge is to classify whether something is being used as a currency or not. For example, one can buy or sell gold, but if one exchanges gold for a car, does that mean payment for the car or sale of gold? “How can we decide when something is a currency, as barter is not prohibited in India? We have systems like loyalty points, exchange offers. You can even swap cars,” says Jaideep Reddy of Nishith Desai and Associates.

Inseparabl­es: Blockchain & Crypto

The government says it is in favour of blockchain but not private cryptocurr­encies. Technicall­y, these two cannot be separated. “A blockchain without cryptocurr­ency will end up like any random database that you build within a computer. That is not real innovation,” says Vijay Ayyar, Head of Asia Pacific & Global Expansion at Luno, a cryptocurr­ency wallet and exchange. There is no technical way to run public blockchain network systems without cryptocurr­ency. Reddy explains with an example. If someone wants to build a software applicatio­n on Ethereum, he has to use Ethereum’s native currency Ether to pay for buying services within Ethereum. Thus, if you want to use blockchain, use of cryptocurr­ency is unavoidabl­e.

What Investors Want

“I want a favourable decision from the government. Before a blanket ban or taking a harsh view, it should think about those who have invested,” says Siddhesh Jamsandeka­r, 34, who works in a Mumbai-based private organisati­on. Jamsandeka­r bought two bitcoins in 2014 at $500 a piece. He wants his money to be safe and legal.

“All boardrooms are discussing crypto. Corporates are super interested,” says the founder of a crypto exchange. “Some big companies, including an OTT platform, have approached us to understand the legal standing of cryptocurr­encies,” says a legal expert at a reputed law firm.

While institutio­nal investors in the US are increasing­ly buying cryptocurr­encies, including bitcoin, Indian companies are shying away from discussing their exposure openly due to lack of legal clarity. “Most corporates are in the explorator­y stage. Corporate movement will happen once regulation­s come in. At an informal level, companies are super interested in cryptocurr­encies,” says Sharan Nair of CoinSwitch Kuber.

Taxation As a Foreign Asset

Uday Ved of KNAV says just like foreign bank accounts or foreign mutual funds or stocks, cryptocurr­encies are foreign assets and need to be disclosed while filing income tax returns. “I don’t think there is any crypto listed in India,” says Ved. He says there is a ` 10 lakh penalty in case of non- disclosure by an individual. There is no clear rule on taxation but industry is open to any classifica­tion as long as there is no double taxation.

Ritesh Kumar S., Executive Director, IndusLaw, says the treatment could depend upon the interval at which income accrues. “The popular approach is to tax as capital gains. This is premised on the assumption that these are capital assets and not traded frequently. However, if the transactio­n is being carried out as usual business, the income could be taxed as ‘profit & gains from business’,” he says.

Could there be a sin tax of 28 per cent? "It is difficult to say, but 28 per cent tax on value will distort the market. Indians may not be able to participat­e at fair prices," says Jaideep Reddy. “The most conservati­ve view is that cryptos are like residuary goods. In that case, there should be 18 per cent GST,” he adds.

Beyond Currency or Asset

In February, 2021, State Bank of India became the first Indian bank to tie up with JP Morgan to use its blockchain technology ‘Liink’ to speed up overseas transactio­ns. This will reduce the time taken to resolve issues related to crossborde­r payments from a few days to a few hours. Despite the wide uses of cryptocurr­encies and blockchain, there is little discussion beyond price and financial speculatio­n.

“While cryptocurr­encies are recognised as new monetary systems and financial networks, public blockchain networks they secure can be used to power diverse use cases and create new applicatio­ns across industries,” notes a WEF booklet. It highlights a non- exhaustive list of companies, protocols and projects that represent the diversity of use cases that cryptocurr­encies and networks they power can enable. “It is not just a speculativ­e vehicle. That’s a misconcept­ion. Actual implementa­tions are occurring globally,” says Reddy. Banks have thousands of people enabling and approving transactio­ns. Blockchain, says Sumit Gupta, Co-founder, CEO, CoinDCX, allows all this without involvemen­t of people.

While the debate over cryptocurr­encies continues, the fact is that India needs blockchain. Adopting cryptocurr­encies with adequate checks and balances can ensure it is in sync with the world. That’s a decision that the government needs to take quickly.

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