Bitcoin, Blockchain And The Policy Confusion

The monsoon session of Parliament is long over, but we do not have the much anticipated cryptocurrency policy. After RBI curbs were struck down by Supreme Court in March 2020, the central bank has been reluctant to step in. So, in essence, the only ‘regulation’ today is the Supreme Court judgement about cryptocurrencies.

What is making matters worse is the uninformed public debate on the issue. An op-ed co-authored by Shashi Tharoor, who heads the Standing Committee on IT, confuses cryptocurrencies and blockchains.

Before Shashi Tharoor, Andy Mukherjee, in his Bloomberg piece also links bitcoin regulations to blockchain innovation — cryptocurrency policy (or absence of the same) is leading to “paroxysm of anxiety” among blockchain firms.

Again, this confuses the anxiety among crypto investors and platforms that facilitate that, with the anxiety among blockchain start-ups, which are diverse and cover a whole gamut of industries.

So, instead of distinguishing between regulation of cryptocurrency investments, use of digital currencies as a medium of exchange and other blockchain technology use cases, we have ended up with an ill-informed public discourse confusing one with another.

Among others, China has made a clear distinction between the blockchain, the technology, and cryptocurrency trading, which is a specific use case of the technology (albeit the first and the most prominent one).

So, the first thing the government should do in its policy note is to start treating blockchain simply as a technology.

Then, regulations should take care of each use case separately, through and under regulators, who are responsible for regulating that area, irrespective of the technology. Some of these would be:

Bitcoin and other crypto currencies – This involves two areas of regulation – cryptocurrencies as a medium of exchange and cryptocurrencies as speculative assets.

Different countries are dealing with it differently. China has gone for a blanket ban while US is treating it like a commodity investment.

Blanket bans could work in China but are unlikely to work in India, even if it was a noble goal. We will most likely create shady, unregulated markets as alcohol has in prohibition states like Gujarat.

But, can the government be indifferent to the exposure the common public may have to a high risk instrument?

My suggestion would be to implement rigorous KYC guidelines and set an Income Tax return linked income threshold for investment. Whether it is Rs 20 lakh or Rs 50 lakh of annual income or it is linked to the income tax department’s silver and gold tax certificate can be debated.

This will ensure those who can manage the risks of a highly speculative instrument as part of a broader portfolio have access to it while the general public is protected.

My friends in the crypto industry do not like the idea because as per them, “Most small business owners and independent professionals who are investing in bitcoin have a far lesser disclosed income”.

Central Bank Digital Currency (CBDC) – Many central banks rushed into the CBDC rollout because of the fear of their currencies losing out to ‘private’ (better term would be ‘non-government’ as Bitcoin is anything but ‘private’) cryptocurrencies as a medium of exchange.

With UPI and cross-border linkages of UPI, as has been done with Singapore, we will start achieving some of the ease and cost of payment benefits of digital currencies anyways.

Further, NPCI is already working on the CBDC, so all that we need is a clearly articulated roadmap. In fact, India may benefit by the fact that the agency with a good record in building a world class payment infrastructure is leading a CBDC initiative.

China is far ahead of everyone with their phased rollout reaching the masses now and you can even use a digital Yuan at a Mcdonald’s. So we will benefit from learnings elsewhere.

Digital Assets and Digital Securities – Blockchain allows for creating small units of assets like real estate (fractionalization) and trading them without involving intermediaries.

Same principle extends to digital securities like bonds. This is one of the more complex areas to regulate, as the use of blockchain has allowed for issuances and trading of tokens (digital units of these assets or securities) and many new types of instruments are coming to the market.

Even the US blockchain industry is struggling to anticipate what will be considered a security by the SEC. This is because it is not that easy to apply the Howey Test (US Supreme Court defined criteria for what constitutes a security) when new things are being tokenized and traded.

Every SEC ruling is being keenly followed. As a regulator, this will be under SEBI’s mandate which may need additional skills to understand and regulate. The principles should be consistent whether it is an instrument issued and traded on blockchain or otherwise.

In US, there is soft touch regulation with Reg D, under which blockchain companies can innovate as long as digital tokens issued by them are restricted to Accredited Investors (investors with income above a certain threshold) and Rule 144 for a lock-in period before secondary market access.

Same approach can be adopted in India so that blockchain can facilitate HNI investments in digital assets and securities, creating private markets with trust and liquidity facilitated by blockchain.

Yes, this will also penalize those whose disclosed income doesn’t reflect their earnings.

Blockchain Beyond Payments and Investments – From supply chains to trade finance, there are many other areas where blockchain will play a critical role — As it would in areas like land records.

None of this needs a separate regulation. No one needed a separate regulation when vendor management moved from paper to ERP systems. Similarly, no one needs a regulation as some business processes move to blockchain or related technologies.

In a recent presentation to a group of chartered accounts (CAs), I presented three pictures — barebones reinforced cement concrete (RCC) structure, a multistoried casino and a multistoried hospital — to illustrate the difference between blockchain and its use cases.

Regulations are about regulating a casino or a hospital by their respective departments and regulators, not regulating RCC.