Implementing Regulatory Framework for CryptoAssets in India

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India's Tech Force

India is home to 2.7 Million Tech Developers which is expected to grow to 5.2 Million in next 48 months. The overall services sector has contributed INR 92.26 Lakh Crores in FY 2018 -19 accounting for 54.4% of total India's Gross Value Added.

Needless to say that Services sector powered by Technology is the single major contributor to India's Gross Value Added. 

With ushering of new contemporary technologies like Blockchain the opportunity for India's Tech force to contribute to the world in the field of technology in a bigger and most inclusive manner is now and here ! 

What is Blockchain ?

Blockchain is a contemporary technology which, by design, is resistant to modification of the data. It is “an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way".

Blockchains are expected to power and disrupt future Industries of the world. 

  • 10% of total GDP of the world is expected to be stored on blockchain by 2027.
  • Overall Blockchain Market is expected to touch USD 28 Billion by 2025.
  • Blockchain is expected to add USD 176 Billion in Enterprise Value by 2025 and USD 3.1 Trillion by 2030.

A blockchain is a growing list of records, called blocks, which are linked using "cryptography". Each block contains a cryptographic hash of the previous block in a timestamp environment and transaction data generally represented as a Merkle tree.

The blockchain network has no central authority — it is the very definition of a democratised system. Since it is a shared and immutable ledger, the information in it is open for anyone and everyone to see. Hence, anything that is built on the blockchain is by its very nature transparent and everyone involved is accountable for their actions.

Indian Blockchain Scenario

With world's second largest tech fraternity, India is at a unique position to leverage the benefits of blockchain technology better than most nations of the world. 

However, as much as the Indian tech fraternity is excited about being part of the Global Blockchain Revolution, the regulatory framework in India seems to be crippling the growth of this technology, albeit not without reasons. 

Let's analyse it : 

  • On April 6, 2018 Reserve Bank of India issued a notification stating : In view of the associated risks, it has been decided that, with immediate effect, entities regulated by the Reserve Bank shall not deal in Virtual currencies (VCs) or provide services for facilitating any person or entity in dealing with or settling VCs. Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer / receipt of money in accounts relating to purchase/ sale of VCs.(RBI Prohibition on dealing in Virtual Currencies (VCs))
  • Ring-fencing regulated entities from virtual currencies : Reserve Bank of April 05, 2018 stated : Technological innovations, including those underlying virtual currencies, have the potential to improve the efficiency and inclusiveness of the financial system. However, Virtual Currencies (VCs), also variously referred to as crypto currencies and crypto assets, raise concerns of consumer protection, market integrity and money laundering, among others. (Ring-fencing regulated entities from virtual currencies)

I had filed a Right to Information (RTI) application to Reserve Bank of India, inquiring reasons for such ring fencing of Virtual currencies entities and it was revealed by the Responses of RTI that : 

  • RBI had not done any research before implementing such ring fencing restrictions;
  • No internal committee was set up before passing of such order;
  • No communication with any other International Central Bank was conducted to better understand the need and impact of blockchain technology;
  • Foreign Exchange Management Act does not apply to Virtual Currency transactions.

As a community response, several stakeholders had approached judiciary by filing petitions with the Hon. Supreme Court for obtaining clarity of stance by the Indian Government regarding this matter. 

Amongst others, two primary petitions Dalmia Petition (Civil Writ Petition 1071 of 2017) and Bhowmick Petition (Civil Writ Petition 1076 of 2017) were filed against Union of India, Ministry of Finance, Ministry of Home Affairs and Reserve Bank of India on matters covering : 

  • Possible Stance of Government : Anonymity of transactions in CryptoAssets environment / Generation of Virtual Assets for transaction between two parties disregarding legal tender / lack of KYC / potential risk of money laundering.
  • Possible Grounds of Appeal : Transaction log with miners for securing transaction trial / Widespread financial disruption if CryptoAssets are left unchecked / Conversion of one CryptoAsset with another doesn't fall under RBI and needs regulation.

Recent Media Reports about Blockchain

A recent Report by Bloomberg Quint suggesting that one to ten years of jail term to mine, hold or sell cryptoassets may be implemented by the government; has only added to the anxiety of the community. Though the complete report is not yet published by Bloomberg Quint, however there are evidences to believe that the policy being drafted by the Department of Economic Affairs, Ministry of Finance, perhaps in consultation with other government departments like Reserve Bank, Ministry of Corporate Affairs etc, may indeed have such provisions. 

Another Right to Information application filed by me in May 2019 suggested that : 

  • Reserve Bank of India has no information about any such policy being drafted  / Have not received or sent any communication from or to any other government department / No RBI officer is involved in any such drafting of policy for blockchain or cryptoassets.

This is despite the fact that RBI has pro actively cautioned users from dealing in Virtual Currencies / CryptoAssets and has played a very active role in investor education & protection in this matter since 2013. 

Though the Tech fraternity seems to have ignored the news terming it as clickbait / FUD (Fear uncertainty Doubt) and having no legal substance till a communication is issued by the authorised government in this matter, however other main stream media have shared the news deeming it to be true  : Draft law proposes 10-year jail term for dealing in cryptocurrency (Economic Times) 

What is World Governments doing for Blockchain entities

While every new contemporary technology comes with its own set of challenges yet any technology if left unregulated has potential to negatively disrupt industries and damage investor protection rights. 

Thereby efforts have been made by governments around the world to develop preliminary regulatory frameworks to better regulate and tap the potential of this technology. Some relevant regulations by Countries across the world :  

  • Japan - A study group and a working group on “sophistication of payment and settlement operations” were established in the Financial Services Agency (FSA) in 2014 and 2015. The working group’s final report recommended the introduction of a registration system for cryptocurrency exchange businesses, making cryptocurrency transactions subject to money laundering regulations, and the introduction of a system to protect cryptocurrency users. Later, the government submitted a bill to amend the Payment Services Act. 

     

    The Payment Services Act defines “cryptocurrency” as : 

    property value that can be used as payment for the purchase or rental of goods or provision of services by unspecified persons, that can be purchased from or sold to unspecified persons, and that is transferable via an electronic data processing system; or property value that can be mutually exchangeable for the above property value with unspecified persons and is transferable via an electronic data processing system.

  • Malta - Malta is considering three bills that would provide a regulatory framework for cryptocurrency and is following a principles-oriented approach to this legislation to help prevent the laws from becoming rapidly obsolete, or from stifling technological development. The three bills are as follows:

     

    The Malta Digital Innovation Authority Bill (MDIA Bill) would establish the Malta Digital Innovation Authority (MDIA), which would “focus on innovative technology arrangements and their uses such that Malta can take the greatest advantage of new technology arrangements while at the same time protect[ing] the public interest.”  One of the first objectives for the MDIA would be to promote government policies that favor technical innovation, particularly with reference to digital ledger technology and its adoption by the government in systems of public administration. Other objectives would include maintaining Malta’s reputation and protecting consumers. The MDIA would also bear responsibility for certifying technology arrangements and registering technology services providers under the “TAS Bill.” 
    ·The “TAS Bill” would establish a regime for the registration of technology service providers and provide for the certification of certain technology arrangements.  This regime will initially cover distributed ledger technology platforms and related contracts. The proposals would require technology service providers that provide services for any distributed ledger technology platform in or from Malta be certified by the MDIA. Those who provide these services in other specified cases may voluntary register with the MDIA.
    The Virtual Currency Bill would establish a framework for ICOs and a regulatory regime that would apply to certain services relating to cryptocurrencies, such as brokers, wallet providers, and virtual currency exchanges.  The bill will ensure that the offerings meet transparency requirements and will incorporate obligations that apply to initial public offerings that the issuer must follow.
  • Canada - According to the Government of Canada webpage on digital currencies, "you can use digital currencies to buy goods and services on the Internet and in stores that accept digital currencies. You may also buy and sell digital currency on open exchanges, called digital currency or cryptocurrency exchanges.” However, cryptocurrencies are not considered legal tender in Canada. According to the Financial Consumer Agency of Canada, “only the Canadian dollar is considered official currency in Canada.” 
  • Estonia - On November 27, 2017, Estonia enacted amendments to its anti-money laundering legislation  that define cryptocurrencies (virtual currencies) as value represented in digital form that is digitally transferable, preservable, or tradable and that natural persons or legal persons accept as a payment instrument, but that is not the legal tender of any country or funds (banknotes or coins, scriptural money held by banks, or electronic money). The anti-money laundering legislation now also applies to providers of a service for exchanging virtual currency with fiat currency and providers of a virtual currency wallet service, which is defined as a service in which keys are generated for customers or customers’ encrypted keys are kept, which can then be used for the purpose of keeping, storing, and transferring virtual currencies. Virtual currency service providers are required to have a license.
  • Germany - The German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) qualifies virtual currencies/cryptocurrencies as units of account and therefore financial instruments.Undertakings and persons that arrange the acquisition of tokens, sell or purchase tokens on a commercial basis, or carry out principal broking services in tokens via online trading platforms, among others, are generally required to obtain authorization from BaFin in advance. In February 2018, the German BaFin published information on the regulatory assessment of ICOs and the tokens, coins, and cryptocurrencies they are based on. It stated that firms involved in ICOs need to assess on a case-by-case basis whether the ICOs qualify as financial instruments (transferable securities, units in collective investment undertakings, or investments) or as securities and therefore trigger the need to comply with the relevant financial legislation.
  • Norway -The Norwegian Financial Supervisory Authority issued warnings against cryptocurrencies both in 2013 and 2018. It has also warned against initial coin offerings (ICOs).

    The Central Bank of Norway has not recognised cryptocurrencies, but it also does not prohibit its staff from owning or investing in them as per ethical guidelines from November 23, 2012.

    The Norwegian Tax Authority has issued a principle statement that bitcoins will be treated as capital property, at least for tax purposes. All Norwegian residents are required to report taxable income (including from capital gains such as those from cryptocurrencies) in accordance with the Norwegian Income Tax Act. Such income derived from cryptocurrencies should be filed as “other income.” Sales of cryptocurrencies are exempt from Norwegian value-added tax (VAT). 

Though there are also a set of countries that have totally restricted any use of cryptoassets like Nepal : On August 13, 2017, Nepal Rastra Bank issued a notice that “all transactions related to or regarding bitcoins are illegal.” In early October 2017, a police team from the Central Investigation Bureau (CIB) of the Nepal Police “for the first time arrested seven persons for allegedly running bitcoin exchange business from various parts of the country,” the Kathmandu Post reported.

What can be proposed regulatory framework in India ? 

Taking insights from the global regulatory frameworks being developed and customising it to the India needs may be a step ahead in this matter. 

Following suggestions may be included in the proposed Draft Bill Regulating CryptoAssets : 

  • Defining  terms like Blockchain, CrytoAssets / Virtual Assets / CryptoEntities, CryptoExchanges, CryptoWallets in lines of definitions drafted by policy makers: ECB, IMF, BIS, EBA, ESMA, World Bank and FATF ;
  • Providing a regulatory sandbox for CryptoAssets Entities to operate within the framework of RBI's FinTech SandBox;
  • Disallowing Initial Coin Offering by unregistered entities and allowing registered entities to offer STO / IEO based access to crowd funding with reporting and disclosure norms;
  • Setting out norms for Tangible or Intangible asset backed Security Token Offering in a registered environment with licence and access to public money coupled with public responsibility and reporting;
  • Updation of Foreign Exchange management act and Income Tax Act to report net flow of CryptoAssets cross borders and for taxation purposes;
  • Allowing companies to register with main object as blockchain / cryptography / cryptoassets under Ministry of Corporate Affairs;
  • Updation of Income Tax return forms to declare the current crypto Holding by tax payers perhaps on similar lines as Japan;
  • Laying out norms for KYC and AML for crypto entities especially Exchanges, FundHouses;
  • Levy of Taxation of registered entities for crypto transactions and levy of penalty on unregistered entities indulging in crypto transactions;
  • Engaging in democratic dialog with international organisations like World Economic Forums / G20 Summit to better understand potential method of implementation of such technology and leveraging its benefits;
  • Carve out and dedicate a specific team for Blockchain Implementation with representations from RBI, Ministry of Finance, Ministry of Corporate Affairs and selected representatives from Tech Fraternity for a better and democratic dialog;
  • Setting up international engagement group for Cross Country engagement with other international Crypto Entities in lines of Service Export Promotion Council;
  • Allowing of Blockchain and CryptoAsset Incubation centres in IIT and similar organisations;
  • Demarcating a physical area (Blockchain Zone)  within India for registration and / or experimentation in Blockchain and Cryptoasset space with banking access;
  • Separation of Fund Management / Wallet / custodian services from registered Crypto Exchange entities;
  • Registration of Miners and easing norms of Customs for import of ASIC / GPU miners or allowing development of the same, with strict recorded details of energy consumption;
  • Registration of CryptoAsset Fund houses to allow investing by individuals in a more structured manner into Global Blockchain Projects with clear reporting norms of such FundHouse;
  • Allowing investing of individuals to invest in Crypto projects in manner similar to Angel Funding norms with reporting similar to Form 2 reporting for investment in Private Limited Companies under Startup India Action Plan;
  • Initiation of a project similar to TITANIUM project by European Union to support law enforcement agencies charged with investigating criminal or terrorist activities involving virtual currencies;
  • Charting out a clear taxonomy for eligibility, registration, reporting for Crypto FundHouse, CryptoExchanges, Crypto Projects, Crypto Wallet Creators, Crypto Custodians, STOs, Cross Border Transaction & Taxation with lesser reporting burden on individual users involved with registered entities. With stricter penal norms for involvement in unregistered trade.

Thoughts to takeaway : 

Cryptocurrencies run on ingenuous technology. From a law enforcement perspective, introducing mechanisms of accountability of crypto players should prevent this technology from being used largely for nefarious purposes, but at the same time not prevent technological innovation from happening. Therefore, legislative action should always be proportionate so that it addresses the illicit behaviour while at the same time not strangling technological innovation at birth. This is an aspect of particular relevance for this petition.

Cryptocurrencies run on blockchain. This technology is perfectly legitimate and offers many advantages for innovation in multiple legitimate sectors, including the business and public sector. It has for instance been suggested that blockchain technology could be an adequate defence mechanism against digital ransomware3. The idea is that through blockchain technology sensitive information can be kept in a decentralised manner instead of centralised. Keeping information in a decentralised manner makes it harder to link the information to the person it relates to. It is then also harder to know who to address for the ransom. Moreover, there would be numerous copies of the info, making it extremely difficult for criminals to hold them all to ransom. Another deterring factor could be that attacking a decentralised system of information would be easily visible to its participants.

Cryptoasset transactions and crypto players are not bound by borders. Therefore, it is certain that the national level may not the right level to address money laundering, terrorist financing and tax evasion via cryptocurrencies. From a regulatory perspective, a G20 initiative on a global framework for regulating and overseeing cryptocurrencies, to the extent necessary, would be welcomed.

The world of cryptoassets is a fast moving one and the network of acceptance of such assets can grow. If crypto assets effectively become widely accepted and used, there might come a point in time when there will no longer be a need to convert virtual currencies back into fiat currencies. In other words, with a growing network of acceptance, the need to "cash-out" of crypto currencies and exchange them for fiat currencies might decrease over time. This trend would, increase further if virtual currencies would become less volatile.

What does this petition seek to achieve ? 

This petition is neither sponsored by any specific Blockchain or CryptoAsset Company / Exchange / Group in any manner whatsoever nor has any compensation being received from any one to initiate such petition. 

The purpose of this petition is to engage the blockchain community and the government in a more democratic and engaging environment to accelerate the implementation of regulatory framework regarding blockchain and CryptoAssets in India and relinquish the ambiguity which has developed around it. 

I respect that as much as there is need for acceptance of contemporary technologies there is an equal and immediate need to regulate it in a manner to distinguish between genuine players from non genuine ones in a environment where investor protection as well as milking of benefits of contemporary technology are looked at on equal footings. 

The success of the petition shall be when the government issues guidelines for a democratic regulatory framework for blockchain and cryptoassets entities in India, perhaps on the suggestions stated above. 

Thank You

( Note : References from various research paper and regulatory statements have been drawn from across the world, to make the reader better understand the global scenario and participate in the campaign in an informed manner)