Ashutosh Singh, Saurabh Kumar
ABSTRACT
In the era of Artificial Intelligence, blockchain technology seems to be the future of the financial market. The use of blockchain technology by cryptocurrency highlights the enormous potential cryptocurrency carries. Originally built to replace conventional money and possessing features, such as low transfer cost, self-governed currency and lightning-fast transaction speed. It is perceived to have improved the efficacy of the financial system, but on the other side of the coin, its use for terror financing, money laundering, tax invasion, and fraud reveals its perilous nature, which ultimately questions its legal existence, while many countries have legalised crypto-transactions believing it to be a game-changer of future, whereas others view legalising it as playing with fire and thereby without proper analysis prohibited its use. When it comes to India, Supreme Court lifted the imposed ban by RBI, which barred financial institutions from dealing and providing services in cryptocurrency, on the ground of proportionality. As of now, the Government of India is, purportedly, planning to introduce a bill to illegalise the use of cryptocurrency. Through a comparative analysis, it can be summed up that nearly all the top economies have focused on regulating cryptocurrency rather than imposing a ban. Even, imposing a ban cannot be an appropriate solution as its use will continue illegally, therefore the only optimal solution is to regulate it which can be done through various measures, such as taxation of cryptocurrency, implementing KYC (know your customer policy), and many more. India, being a developing nation, should focus on exploring cryptocurrency by regulating it, rather than outrightly prohibiting it and the government should reconsider its proposed ban as it will not do any good. Keywords- Cryptocurrency, Blockchain technology, CBDC (Central Bank Digital Currency), RBI regulation.
1. INTRODUCTION
Cryptocurrency has always been an issue of skepticism as to its volatility and regulation since its inception in the global financial market. In a literal sense, cryptocurrency is an ungovernable encrypted digital currency with a massive fluctuating price. Its highly unstable price makes the government skeptical about its regulation and obligates it to place an embargo on the proliferation of its use. But the question that rings the bell is, how far banning cryptocurrency would be the solution?
In March 2020, the Apex Court struck down the impugned RBI circular of April 2018 wherein it proscribed banks and the financial institutions, regulated by RBI from providing services dealing with virtual currencies. The court noted, “RBI needs to show at least some semblance of any damage suffered by its regulated entities. But there is none.”[1]
The soaring trade volume of cryptocurrency, shortly after the lifting of the ban, exhibits the steady growth of its popularity in India. According to data[2],an estimated 1.7 million Indian nationals trade in digital assets. Since the removal of prohibition, many domestic and international cryptocurrency exchange platforms have set up their outlet within the country. All the efforts of the government to restrict its transactions seem to go in vain. Many foreign countries, too, started regulating virtual currencies instead of putting prohibition over their use.
Like any other technological innovation, Cryptocurrency can also be used for good or evil, depending upon its user. A serious concern that attaches to crypto-transactions is its anonymity which provides a foxhole for terrorists and criminals to make illicit transactions anonymously and effortlessly.
In this essay, the authors attempt to describe crypto technology, its inception, and how it functions, lucidly. Then, analyse the positive and negative impact of cryptocurrency on the economy of the country. After that, a comparative analysis of its implementation and prohibition in foreign countries will be presented which will be followed by the way forward suggested from the in-depth study.
2. WHAT IS CRYPTOCURRENCY?
Cryptocurrency is a decentralized digital currency that is based on a complex maths algorithm, is secured by cryptography and banks on keys which are an arrangement of numbers and letters to pass over its worth.[3] It is derived from “Crypto” which refers to the various encryption algorithms and cryptographic techniques. The purpose of cryptocurrency is to act as a source of exchange, a stock of value and as a unit of account, even though it rarely possesses legal tender status.[4] Even though it is embraced that technological advancement of cryptocurrency and crypto relating assets possess the prospective to revolutionize the whole banking and financial ecosystem thereby strengthening the economy as a whole, it also raises issues concerning investor and consumer protection, further, its use in activities such as money laundering, terror financing, and tax evasion seems to object its legal status. A sine qua non feature of cryptocurrency is that for recording any digital transaction it pivots on blockchain technology which is a computerized database with strong and formidable cryptography to safeguard transaction record entries, which is again used to verify the transfer of coin ownership and control the digital coin records[5]. This technology which is also known as Digital Ledger Technology (DLT) renders counterfeiting, double-spending almost impossible thereby immensely reducing the chance of fraud. Another distinguishing feature of cryptocurrency is that it is a decentralized virtual currency which means it is usually not distributed, issued, or backed by any central agency such as RBI, which renders any potential interception a herculean task for the government.
3. EMERGENCE OF CRYPTOCURRENCY
Cryptocurrency is an outcome of excavations carried out by data scientists at WWW (world wide web) which reveals that this technology is only 12 years old (at most 37 years old). The Emergence of cryptocurrency can be traced back to 1983 when David Lee Chaum, a Computer Scientist and Cryptographer, came up with digital cash through the company Digicash, which ended as soon as the company became bankrupt. After that, Adam Back, a British cryptographer, released a digital currency called hashcash, but again due to its shortcoming it was not long before it went obsolete and was replaced by Nick Szabo’s bitgold, which was further replaced by Wei Dei’s cryptocurrency b-money, but all these concepts and experiments lead to nowhere until the emergence of bitcoin, which is entitled as Adam of cryptocurrency, after a research study subjected “Bitcoin: A Peer to Peer Electronic Cash System” was published in 2008 by a pseudonymous developer named Satoshi Nakamoto which opened the door for other cryptocurrencies such as Litecoin, Peercoin, Name coin, etc.
The reason for the existence of cryptocurrency can be comprehended by Adam Back’s statement “What we want is fully anonymous, ultra-low transaction cost, transferable units of exchange. If we get that going… the banks will become the obsolete dinosaurs, they deserve to become.”[6]Even, Satoshi Nakamoto penned down the purpose of bitcoin, which was to act as an alternative to fiat currency and be free of intervention by government and its abuses “The problem with fiat currency is that trust is required to make it work. The Central Bank must be trusted not to devalue the currency, but the history of conventional currencies is full of breaches of that trust.”[7]
4. APPROVAL AND CRITICISM OF CRYPTOCURRENCY
Certainly, the Financial market got revolutionized with the emergence of cryptocurrency, an epitome of technological innovation that has taken the world economy by storm. Cryptocurrencies have several beneficial features as they can easily be exchanged for any currency like the Indian Rupee, US Dollar, etc. at cryptocurrency wallets and exchanges. Crypto-transactions are also claimed to be highly secured as it stores coded mathematical puzzles which are near impossible for a hacker to decode. Most Cryptocurrencies are pseudo-anonymous, which ensures the privacy of the user and his/her stored data. One of the most celebrated features of Crypto-transactions is transparency, it provides through blockchain technology, which also makes cryptocurrency self-governed and managed. A blockchain is a ledger account which records the transactions of cryptocurrencies that have ever been made and can be visible to anyone. It is also the most cost-effective way of making money transactions across the border, as it costs a very negligible or zero amount. It has been able to do that by eliminating the involvement of a third party like Visa and PayPal, which charges a high sum for even just verifying a transaction. As most of the barriers are absent, verification takes very little time, and makes transactions speed-light-fastening, whether domestic or international. But it was not so long when these boons owing to, their anonymous/pseudo-anonymous nature backfired as they began being using it for illegitimate purposes which included acts such as money laundering, terror financing, and tax evasion which was first highlighted by FATF in its report as “Cryptocurrency while having an ocean of opportunity for financial revolution through its brilliant innovation, have got an unwanted attention of various terrorist and criminal groups, who perceive it as a source of their funding[8] which emphasized the vulnerability of cryptocurrency towards money laundering/terrorism financing risks. The case of Ali Shukri Ameen is a paradigm of cryptocurrency used as finance by terrorists as in the case he was charged to have provided instruction to the public regarding the transfer of cryptocurrency to ISIL, a terrorist organization.[9] Another drawback of cryptocurrency is its unconscionable use for wheeling and dealing on the black market as criminals doing this know that cryptocurrencies are untraceable. For example, the “dark web” platform Silk Road used Bitcoin nefariously for promoting illegal drug sales.[10]Yet another problem is customer grievances as cryptocurrencies are decentralized there is no proper authority to look after complaints, which means there will be no refunds in case of fraud which indicates the risk involved. RBI in its annual report of 2017- 2018 mentioned another bane of cryptocurrency which included the detrimental effect on monetary policy as “The cryptocurrency eco-system may affect the existing payment and settlement system which could influence the transmission of monetary policy”.[11] Thus a large amount of cryptocurrency will eventually erode monetary stability and the last issue is its volatility and unpredictability which were accentuated by IDBRT’s report[12] and can even be observed from the price of bitcoin which went from 20000$/bitcoin to more than 40000/bitcoin in 25 days,[13] thus factors from money laundering, financing terrorism, tax evasion, the risk involved, to volatility add to its criticism.
5. STATUS QUO OF CRYPTOCURRENCY IN INDIA
The arrival of bitcoin lead to the proliferation of cryptocurrency in India, although, cryptocurrency was perceived to have been carrying enormous potential, RBI realized its double-edged sword nature and through a circular dated 06 April 2018 prohibited entities modulated by it from dealing in any virtual currency or facilitating assistance to any person or entity settling payments or trading in virtual currency[14], citing its perilous nature and risk associated as the principal ground for the ban. But soon the circular was challenged in two separate writs in the Supreme court, one by IAMIA (Internet and Mobile Association of India), an industrial body and the other by a group of companies that own online crypto-exchange platforms and a few cryptocurrency traders impugning the circular on several grounds from questioning the RBI’s authority to deal with cryptocurrency, that the decision of ban was taken in a hurry to that the circular was arbitrary and the decision of ban was disproportional. The Apex court clubbed both the writs in Internet and Mobile Association of India vs Reserve Bank of India[15] and on 4th March 2020, the three-judge bench came up with a landmark judgment in which it struck down the curb imposed by RBI thus legalizing cryptocurrency and its exchange in India. The sole ground for the verdict in the petitioner’s favour was the test of proportionality and the availability of alternatives and in the end, the court relied upon European Union Parliament’s research paper[16](subjected ‘Cryptocurrencies and Blockchain’) in which it was asserted that “We do not favour a complete ban on cryptocurrencies such as in China. That is an extreme step which would do no good. Till the time proper safeguards are there such as rules against money laundering, terrorism financing, tax evasion and maybe a set of more understandable regulation accompanying rules it should be more than enough”.[17] Concurring to the report the apex court held the ban to be disproportional and that RBI should have considered different alternatives before coming up with the challenged circular. Thereby, legalizing cryptocurrency in India, but the government of India is now planning to introduce a bill proscribing cryptocurrency and its trade in India.
6. COMPARATIVE ANALYSIS
Since cryptocurrencies have become ubiquitous, it stimulated countries to acknowledge their existence and formulate their regulations accordingly. Not every country perceived it as a revolutionary technological innovation, rather some identified it as a virtual threat, that endangers their economy. Therefore, few countries have laid down the prohibition, directly or indirectly, on its use, but, at the same time, plenty of them have amended their laws to regulate cryptocurrencies. In terms of economy, as of now, none of the top five largest economies has put a blanket ban on crypto-transaction, including India. In the United States, every state has its own definition and regulation as to cryptocurrencies, but it is not prohibited in any part of the USA, rather they have enacted laws to regulate it.[18] China, 2nd largest economy, has not banned crypto-transactions, however, it has restricted its financial institutions from facilitating transactions of cryptocurrency just like how the RBI once did in India.[19] Japan has legalized cryptocurrency and its transactions since 17th April 2017. Japan brought forth strict regulations to make registration compulsory for cryptocurrency exchanges and to protect investors from malpractices. In Germany, The German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) has qualified cryptocurrency as a basic measure of account and as a financial and banking instrument.[20] Through legislation in November 2019, Germany allowed its financial institutions to sell and store cryptocurrencies.[21] There is no prohibition in the United Kingdom as to the use of cryptocurrencies. U.K govt. treats cryptocurrencies as a foreign currency for taxing and other purposes, also brought several laws to curb money laundering, terrorist funding, and all menace attached to virtual currencies. Very recently, the Financial conduct authority(FCA) which regulates the financial market of the UK has prohibited the trade of crypto-derivatives to retailers to protect retail investors from sudden and unexpected losses.[22] Although none of the great economies have accepted cryptocurrency as legal tender till now, most of them are regulating or making effort to regulate it, ensuring the highest possible safety of investors and the economy of the country. It could be drawn that all of them have recognized the potential of virtual currencies in the tech-growing world. It is the reason why China after restricting its financial institutions from facilitating crypto-transactions, is still trying to formulate its government-backed cryptocurrency.[23] Being the 6th largest economy, India must consider the regulatory steps taken by other top five largest economies as to cryptocurrency regulation. Cryptocurrencies are not banned in any of these countries; however, China is on its way to launching its government-backed cryptocurrency but did not ban all cryptocurrencies technology inside its territory. Cryptocurrency and blockchain technology have immense potential and India, being the fastest developing economy, cannot afford to completely isolate itself from such fin-tech. It can easily be understood that the world sees its future with cryptocurrency-bitcoin technology that has revolutionised the financial world just by its emergence.
7. WAY FORWARD
After examining the status quo of cryptocurrency in India and its comparative analysis with other giant economies it can very well be observed that banning cryptocurrency is going to lead nowhere and even if a ban is imposed its use would go underground and it will become unfathomable for government to trace its transactions like it is happening in China where traders trade cryptocurrency using VPN(Virtual Access Point).[24] Therefore putting a ban will not be much fruitful and hence regulating cryptocurrency should be preferred. The Government may consider a few measures, given below, that would be instrumental in the regulation of cryptocurrency in the country:
Prohibition of Anonymous cryptocurrency
It is a myth that cryptocurrencies are only anonymous rather it is both anonymous and pseudo-anonymous. Cryptocurrency such as Bitcoin and Ethereum are pseudo-anonymous and being pseudo-anonymous they can be traced while cryptocurrency such as Dash and Zcash are anonymous[25] and they cannot be tracked therefore proscribing only anonymous cryptocurrency rather than banning the whole cryptocurrency can be a key solution.
Know your customer (KYC) Policy.
KYC of all crypto transactions should be mandated. KYC is a compliance process in which any banks and financial institutions ask for identification credentials from their customer before making any transaction. It helps in determining the parties to financial transaction and prevent anonymity in the business. It is very helpful to clamp down on illegal activities such as money laundering as it unveils the true identity of anyone making transactions.
Generation of CBDC
CBDC (Central Bank Digital Currency), centralized virtual money furnished by the apex monetary institution of a particular country[26] can act as a panacea to the problem of regulation, as it possesses all the positives of cryptocurrency such as low transaction cost and use of blockchain technology. Being backed by a central authority such as RBI in India CBDC will addresses all the cons of cryptocurrency thereby curbing tax evasion, money laundering, frauds, and terrorism financing as these transactions could be traced. Also, CBDC in due course will help India move towards a more cashless economy. Countries such as China, the USA, and Canada are already racing for the first CBDC with China being the front runner with its DCEP (Digital Yuan) which is already in its testing phase. A futuristic approach from India is needed by developing its own CBDC. An update to this need was provided during the Union Budget speech which was conveyed on 1st February 2022, where it was revealed by the finance minister of the country that The government of India is planning to introduce its own CBDC with the assistance of RBI. Reports suggest that India’s very own official digital currency can debut as early as 2023.[27]
Mandatory Registration
The Government should have a proper check on the functioning of the cryptocurrency exchanges within its territory. It should be mandatory for all cryptocurrency exchanges to register themselves and should have the license to deal with cryptocurrencies and assets. The mandatory registration should not be only for crypto-fiat exchanges and crypto custodians; rather crypto-to-crypto exchanges too must get themselves registered. It would deter money Laundering as it brings obligation on crypto-exchanges to ensure Anti Money Laundry (AML) compliance and must have to implement customer due diligence requirements during the customer onboarding phase. As of now, few countries already have rules for mandatory registration of crypto exchanges like Japan, Estonia, and Canada.
Taxation of Cryptocurrencies
The government may consider levying taxes on crypto transactions as it would bring double benefits, first, it will be used legally and can easily be traceable, and second, it will generate income and bestow immense financial support to the countries’ economy. The kind of taxes to implement, direct or indirect, depends upon how government characterizes it, as a commodity or coin. Recently, the government of India, backtracking from its earlier stance, has levied a 30% tax which means that all the income from cryptocurrency and crypto assets in the fiscal 2022-2023 will be taxed atthe rate of thirty per cent (30% plus cess and surcharges).[28] Being the most volatile digital assets, no doubt, cryptocurrencies would continue to bring up momentary risks to the economy, but those risks escort numerous and multifarious opportunities to explore the fin-tech world. Letting this opportunity slip out of hand would be the most regrettable decision one may make. The Government of India should reconsider its policy and should make an effort to regulate cryptocurrency in the country.
[1] Internet and Mobile Association of India v. RBI, 2020 SCC Online SC 275. [2] Archana Chaudhary and Siddhartha Singh, India plans to introduce law to ban cryptocurrency trading, The Economic Times, September 17, 2020, available at https://economictimes.indiatimes.com/news/economy/policy/government-plans-to-introduce-law-to-ban-cryptocurrency-trading/articleshow/78132596.cms (January 16, 2021). [3] FATF, “Virtual Currencies Key Definitions and Potential AML/CFT Risks” Pg. 5 (2014). [4] Internet and Mobile Association of India v. RBI, 2020 SCC Online SC 275. [5]Andy Greenberg, Crypto Currency, Forbes, April 20, 2011, available at https://www.forbes.com/forbes/2011/0509/technology-psilocybin-bitcoins-gavin-andresen-crypto-currency.html?sh=5beaf144353e (January16, 2021). [6] Internet and Mobile Association of India v. RBI, 2020 SCC Online SC 275. [7] Id. at 6 [8] Financial Action Task Force, “Virtual Currencies Key Definitions and Potential AML/CFT Risks” Pg. 9 (2014). [9]Julie Carey, Virginia Teen Sentenced to More Than 11 Years for Helping ISIS, NBC4 Washington, August 28, 2015, available at https://www.nbcwashington.com/news/local/teen-to-be-sentenced-for-helping-isis/1988769/ (last visited on January 16, 2021). [10]Marie Claire Van Hout and Tim Bingham, Responsible vendors, intelligent consumers: Silk Road, the online revolution in drug trading, National library of medicine, March ,2014, available at https://pubmed.ncbi.nlm.nih.gov/24268875/ (Last visited on January 17,2021). [11] Reserve Bank of India, “Annual report 2017-18”, 48 (June 2018). [12] Institute for Development and Research in Banking Technology, “Applications of blockchain technology to banking and financial sector in India”, (January 2017). [13] Anchalee worrachate, Bitcoin ends a choppy week of trading with prices below $40,000, The Economic Times, January 15, 2021, available at https://economictimes.indiatimes.com/markets/stocks/news/bitcoin-ends-a-choppy-week-of-trading-with-prices-below-40000/articleshow/80289272.cms (January 17, 2021). [14] Internet and Mobile Association of India v. RBI, 2020 SCC Online SC 275. [15] Id. at 15. [16] European Parliament /Prof. Dr. Robby Houben and Alexander Snyers, “Cryptocurrencies and blockchain” (July 2018). [17] Id. at 17. [18] Kyle Torpey, U.S. Lawmakers Are Realizing They Can’t Ban Bitcoin, Forbes, July 30, 2019, available at https://www.forbes.com/sites/ktorpey/2019/07/30/us-lawmakers-are-realizing-they-cant-ban-bitcoin/?sh=2612fe543e31 (last visited on January 16, 2021). [19]Gerry Mullany, China Restricts Banks’ Use of Bitcoin, The New York Times, December 5, 2013, available at https://www.nytimes.com/2013/12/06/business/international/china-bars-banks-from-using-bitcoin.html (Last visited on January 16,2021). [20] European Parliament /Eddie Gerb and Margarita Rubio, Virtual Money: How Much Do Cryptocurrencies Alter the Fundamental Functions of Money? (November 2019). [21] Id. at 21. [22] Financial Conduct Authority, available at: https://www.fca.org.uk/news/press-releases/fca-bans-sale-crypto-derivatives-retail-consumers (last visited on January 17, 2021). [23] Jonathan Cheng, China Rolls Out Pilot Test of Digital Currency, The Wall Street Journal, April 20, 2020, available at https://www.wsj.com/articles/china-rolls-out-pilot-test-of-digital-currency-11587385339 (last visited on January 17,2021). [24] Shen Wenhao, Cryptocurrency laws and regulations in China, Law Asia business journal, July 12, 2018, available at https://law.asia/cryptocurrency-law-china/ (Last visited on January 17, 2021). [25]Shehan Chandrasekera, IRS Is Trying To Deanonymize Privacy Coins Like Monero And Zcash, Forbes, July 6, 2020, available at https://www.forbes.com/sites/shehanchandrasekera/2020/07/06/irs-is-trying-to-deanonymize-privacy-coins-like-monero-and-zcash/?sh=60891e404174 (Last visited on January 17, 2021). [26] Orla Ward and Sabrina Rochemont, “Understanding Central Bank Digital Currencies (CBDC)” The Institute and Faculty of Actuaries 5 (March 2019). [27] PTI, India's digital rupee to debut by early 2023, The Economic Times, February 03, 2022, available at https://economictimes.indiatimes.com/news/economy/policy/indias-digital-currency-to-debut-by-early-2023/articleshow/89379626.cms (Last visited on February 10, 2022). [28] Sneha Kulkarni, Budget 2022 levies 30% tax and TDS on cryptocurrency assets, The Economic Times, February 03, 2022, available at https://economictimes.indiatimes.com/wealth/tax/budget-2022-levies-30-tax-and-tds-on-crypto-assets/articleshow/89267756.cms?from=mdr (Last visited on February 10, 2022).
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