Context

Recently, the Reserve Bank of India has confirmed that there is no longer any banking ban on crypto exchanges, companies, or traders.

• Following the decision of the Central Bank of India, the Supreme Court quashed the circular of the Reserve Bank of India dated April 6, 2018 which had stopped crypto currency’s traders and exchanges from accessing the banking system.

Network of Cryptocurrencies around the World

• Some of the terms used by countries to reference cryptocurrency such as digital currency (Argentina, Thailand, and Australia), virtual commodity (Canada, China, Taiwan), crypto-token (Germany), payment token (Switzerland), cyber currency (Italy and Lebanon), electronic currency (Colombia and Lebanon), and virtual asset (Honduras and Mexico).
• Australia, Canada, and the Isle of Man recently enacted laws to bring cryptocurrency transactions and institutions that facilitate them under the ambit of money laundering and counter-terrorist financing laws.
• Algeria, Bolivia, Morocco, Nepal, Pakistan, and Vietnam ban any and all activities involving cryptocurrencies.
• Qatar and Bahrain have a slightly different approach in that they bar their citizens from engaging in any kind of activities involving cryptocurrencies locally, but allow citizens to do so outside their borders.

Why Cryptocurrency exchanges need regulations?

• The decentralised exchanges enable trades or exchanges on a peer-to-peer basis through an automatic process involving smart contracts.
• The presence anonymity of users and lack of central presence makes the regulation of crypto exchanges impossible.
• Crypto exchanges have now grown as a key market infrastructure within the crypto-ecosystem.
• In its heyday, MT Gox crypto exchange accounted for nearly 70 per cent of all Bitcoin transactions and its hacking had led to losses estimated in billions of dollars today.
• The sudden death of the CEO of Canada’s largest exchange in India left millions of investors’ money inaccessible in offline wallets because he was the only one who knew all the passwords.
• Sometimes the Cryptocurrency exchange platforms are known to co-mingle client and proprietary funds or assets but without adequate internal checks and controls, these extra functions could lead to conflicts of interest, micro-prudential and consumer protection risks.
• Crypto exchanges are also known to enable circumvention of capital controls and commission of financial crime including money laundering and terrorism financing.

Advantages of Cryptocurrency Exchanges to India

• Being similar to stock exchanges, the crypto exchanges provide an online platform or marketplace, albeit for cryptocurrencies.
• By enabling trade or exchange of cryptocurrencies for fiat money, the crypto exchanges connect the crypto and traditional financial systems.
• Unlike initial coin offerings where the issue of coins or tokens is made directly to investors which is responsible to assess the project’s credibility, crypto exchanges intermediate and vet an IEO through due diligence of projects and KYC scrutiny of issuers.
• Unlike traditional securities markets, crypto exchanges perform additional functions like custody of assets or funds, clearing and settlement.

Viewpoints on Cryptocurrency

• The Indian government has so far been quiet about whether it plans to regulate or ban cryptocurrencies.
• A draft bill has been prepared for the regulation of cryptocurrencies in India but the discussions related to it are at a nascent stage.
• There is a possibility that the digital currencies may be notified or approved by the RBI, and cryptocurrency exchanges could be recognized and regulated by the Securities and Exchange Board of India.
• The central bank is worried that the anonymous nature of cryptocurrencies could pose a threat to India’s banking system.

Drawbacks of Cryptocurrencies to India

• There is lack of clear legal and regulatory framework which can be used to govern the network of cryptocurrencies in India.
• The safety and security of cryptocurrencies and lack of investor/consumer protection in the form of recourse, and quick and orderly access to their own funds/assets are some of the key issues associated with the cryptocurrencies.
• The borderless nature of cryptocurrencies and service providers (like wallets and payment processing) weaken the ability to enforce investors’ rights and recover their assets.
• A complete ban on cryptocurrencies would not only be difficult to implement but also lead to underground cryptocurrency trading.

Measures to be adopted in order to regulate Cryptocurrencies

• There should be categorization of cryptocurrencies as securities or other financial instruments and licensed crypto exchanges have emerged as a point of regulation, including for the implementation of anti-money laundering (AML) and terrorism financing (CFT) laws.
• The recognition of cryptocurrencies require the application of existing securities laws as in the case of the US, UK, Japan or Hong Kong, or laws specifically designed for cryptocurrencies like Malta.
• International standard setting bodies like Financial Action Task Force (FATF) and International Organization of Securities Commissions (IOSCO) too have provided guidance from time to time for the regulation of cryptocurrencies.
• A legal and regulatory framework must first define cryptocurrencies as securities or other financial instruments under the relevant national laws and identify the regulatory authority in charge.
• The regulation must define the entry points such as who can carry out crypto exchange and intermediary functions, who can trade and what can be traded.
• The operation of crypto exchanges or intermediaries like brokers or custodians can be subject to receiving regulatory licenses.
• The regulatory licenses should be based on compliance with eligibility requirements and a detailed scrutiny of operational policies and procedures on internal governance, risk management and financial resources.
• The regulations can also require the performance of stringent Know Your Customer (KYC) checks and independent verification by exchanges before onboarding investors.
• The professional advisors of crypto exchanges can prohibit or intermediate any access to retail or unsophisticated investors.

Way Forward

• The regulation of crypto exchanges must provide for ongoing supervision on matters concerning safety and security of assets and funds, transparency of operations including trading and price discovery, comprehensive and timely disclosures on the cryptocurrencies traded including risks and suitability for retail investors, and compliance with AML/CFT requirements.
• The record keeping, inspections, independent audits, investor grievance redressal and dispute resolution may also be considered to address concerns around transparency, information availability and consumer protection related to crypto exchanges
• Cryptocurrencies are borderless and often transcend regulatory classifications (as security, commodity or payment mechanism for example). Therefore, creating robust information sharing and coordination mechanisms between regulators and enforcement agencies within the country, and with relevant foreign agencies would be important.

Source: The Indian Express