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Why crypto currency legislations needs careful consideration

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much

Mains level : Paper 3- Regulating cryptocurrencies and challenges ahead

Context

The government has decided to introduce a bill that seeks to prohibit all private cryptocurrencies in India.

Background of the bill

  • In 2018, the three-judge bench of the Supreme Court set aside the RBI circular that prevented crypto exchanges from dealing with the formal financial system on grounds of proportionality.
  • Purpose of the bill: 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.

Issues involving cryptos

  • Issues involving cryptos can be seen at three levels, each of which is equally important.
  • The first is its impact on sovereignty.
  • The second is its interaction with financial markets.
  • Third is the value proposition that the entire concept of crypto brings to the economic debate.
  • Incorporation of price stability mechanism: 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.
  • Diluting the sovereign function of money creation: 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 cryptocurrencies.

Challenges in cryptocurrencies interaction 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?
  • Incompatible with the fractional system of banking: 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.
  • 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.
  • SEBI is yet to convey a position on various issues surrounding this idea.
  • Issues with making VCs medium of exchange: 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?
  • It will have impact on existing investments in mobile payment and UPI technology.
  • Impact on poor states: 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.
  • 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.
  • The issue of consumer protection needs to be addressed and the current laws may have to be reviewed considering this innovation.

Conclusion

The bill must meet many important objectives. 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.

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Back2Basics: About Stablecoin

  • Stablecoins bridge the worlds of cryptocurrency and everyday fiat currency because their prices are pegged to a reserve asset like the U.S. dollar or gold.
  • This dramatically reduces volatility compared to something like Bitcoin and results in a form of digital money that is better suited to everything from day-to-day commerce to making transfers between exchanges.

What is ICO?

  • ICO stands for “initial coin offering,” and refers to a formerly popular method of fundraising capital for early-stage cryptocurrency projects.
  • In an ICO, a blockchain-based startup mints a certain quantity of its own native digital token and offers them to early investors, normally in exchange for other cryptocurrencies such as bitcoin or ether.
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