Soumya Kanti Ghosh, Saket Hishikar write: While there are obvious concerns of money laundering and benami transactions, there are equal concerns with respect to company laws, payment systems and banking, securities and other commercial laws, and consumer protection
In a nutshell, the bill must meet many important objectives. The entire universe of crypto currency overlaps with many domains. (Reuters/File)
The decision of the government to introduce a bill that seeks to prohibit all private cryptocurrencies in India was not entirely unexpected. The issue of crypto currency (or virtual currencies/VCs) first came to the limelight when the matter went to the Supreme Court in 2018. In the course of lengthy arguments, the three-judge bench set aside the RBI circular that prevented crypto exchanges from dealing with the formal financial system on grounds of proportionality. However, the judgment recognised the role of the RBI in safeguarding the interest of financial stability. The moot point of the verdict was that there was nothing to show that VC adversely impacted RBI regulated entities and trading in such currencies was illegal.
The current bill now attempts to define the rules of the game so that the RBI, tax authorities, SEBI and other agencies have much better legal guidance in deciding the course of action with respect to VCs in their respective domains. The rules can, therefore, range from a ban to controlled interaction with the formal financial system.
Crypto markets have suddenly mushroomed after bitcoin emerged on the scene. Since then, many such assets have emerged with varying degrees of financial engineering. Nearly all cryptos are based on blockchain, but all blockchain is not crypto. The fact that the RBI sandbox permits innovation in blockchain only proves this point.
Issues involving cryptos can be seen at three levels, each of which is equally important. The first is its impact on sovereignty. Second is its interaction with financial markets and third is the value proposition that the entire concept of crypto brings to the economic debate.
Commentators and experts who have observed trends in artificial intelligence have predicted that the algorithmic world that will emerge in coming years will stress the very concept of the nation state that emerged from the Treaty of Westphalia. Blockchain technology and by extension crypto are important components of this virtual world. Some of the variants of cryptos such as the stable coin clearly indicate that these are attempts to create systems of money that incorporate features of price stability that imply a parallel monetary system. Thus, unrestricted co-opting of VC clearly dilutes the sovereign function of money creation, clearly impacting the revenues of RBI. Concerns pertaining to money laundering, terrorist threats and narco-trading also come under this category given the high value and anonymity offered by crypto currencies.
Once any decision is taken to co-opt the supposed innovation, the question will arise on how it interacts with the formal system. As of now cryptos have been recognised as assets or commodities and as a medium of exchange. Their role as units of account or legal tender is rather limited. They may offer a store of value given their short supply. From a banking point of view, certain issues do arise. Since VCs are not legal tenders, they cannot be used in the discharge of debt. Thus, banks cannot accept VCs to close a loan account. Second, can banks lend in fiat by accepting VCs as collateral assuming the VC is an asset? If this is so, what should be the capital requirement if VCs are accepted as collateral? What will be the impact on the bank’s non-maturing liabilities if there isa flight of deposits towards VC?
At a deeper level, the very idea of VCs and the way they are designed are incompatible with the fractional system of banking. The fluctuations in interbank liquidity require that money supply adjusts to system requirements. If money supply undergoes compositional change in favour of VCs, this ability will be curtailed thus accentuating the crisis.
In financial markets, crypto such as ICOs bring another set of issues which have not been discussed. The ICO is a creature that disrupts the very concept of limited liability in corporate finance. ICOs are, at times, designed in such a way that the beneficial owner identity is concealed. Further ICOs may not even confer ownership rights. SEBI is yet to convey a position on various issues surrounding this idea.
Coming to the value proposition, VCs have emerged as a medium of exchange and many countries have permitted VC ATMs. But how does this proposition fare given that considerable advances have been made in the payment systems domain in India. Is it worthwhile that additional competition is introduced in a market that is hyper-competitive? What will be the impact on existing investments in mobile payment and UPI technology?
In a nutshell, the bill must meet many important objectives. The universe of cryptocurrency overlaps with many domains. While there are obvious concerns of money laundering and benami transactions, there are equal concerns with respect to company laws, payment systems and banking, securities and other commercial laws. The issue of consumer protection needs to be addressed and the current laws may have to be reviewed considering this innovation.
Before we conclude, a word of caution on “gullible” investments in VCs that could threaten financial stability. It is well known that the Indian population exhibits significant behavioural divergences in their savings and credit behaviour across regions. Such wide behavioural changes have profound implications on bank strategies and product designs. State-wise data show that in the states with lower per capita income than the national average, the preference is more towards CASA (current account and saving account) deposits. On the contrary, the percentage share of term deposits is higher mainly in the states with a per capita income higher than the national average. In the past, there have been several instances of states having low per capita income being more prone to chit fund investments that have negatively impacted the savings of many poor households. Do we have data to support the view that investments in VCs are permeating all households, specifically the vulnerable ones?