Kazim Rizvi and Gautam Kathuria
The financial services sector in India has been characterised by exponential growth, coupled with significant innovation and disruption over the past few years. The burgeoning adoption of cryptocurrencies and the larger blockchain ecosystem in India is one such example.
With a rapidly-growing investor base, and multiple crypto unicorns, there is a bullish sentiment around this sector. This ishighlighted by estimatesthat peg the possible contribution of digital assets to be at $1.1 trillion by 2032. It is also being looked at as a major source of FDI, as well as a driving force for the creation of thousands of direct and ancillary jobs in India.
Despite these factors, there is regulatory ambiguity regarding the way forward for this sector. The upcoming Union Budget is expected to bring some clarity in this regard.
Initial highlights of the proposed cryptocurrency Bill point towards the role of SEBI in regulating cryptocurrency as an investment asset in capital markets, with the RBI at the helm of the broader monetary and foreign exchange aspects. Jurisdictional clarity in this respect is important, considering that a Reuters report pegs thenumber of cryptocurrency investorsin India to be at 15-20 million, with a holding size of nearly Rs 400 billion.
Crypto Assets and Taxation
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Recognising cryptocurrency as a legitimate tradable asset under SEBI’s oversight would bring in greater stability, not just in terms of institutional regulation, but also through better understanding of digital assets. Treating it as an investment instrument will also allow investors greater diversity in their asset portfolios, benefitting retail investors in the medium-term.
Additionally, encouraging public-ledger-based crypto-assets (vis-a-vis private cryptocurrencies) to be registered for trading, would lead to greater competitiveness, and a more reliable valuation of crypto-assets. Such a regulatory framework could also help central bank digital currencies (CBDCs) co-exist with crypto assets, and foster greater trust and stability in cryptocurrencies. These measures could, over time, help in on-boarding educated and informed investors, rather than encourage short-term, speculative investments.
In addition to setting the foundation for cryptocurrency as a tradable asset, the Budget could create more certainty around its taxation. Asnoted by the government, there are plans to makechanges in the Income Tax Act to bring gains made from transactions in cryptocurrencies under the tax net.While there is already an element of taxation, in that investors have treated cryptocurrencies as assets and paid capital gains tax, the proposed tweaks in the law would bring about greater certainty in this aspect. This would also clarify the applicability of GST on trading, and brokerage activities.
Additionally, the Budget, and the cryptocurrency Bill may functionally classify various operators in the cryptocurreny space (exchanges, wallet providers, brokerage, token issuers), and accordingly impose differential tax liabilities on the supply side. This is in line with global practices ofdifferential taxation, where different stages of cryptocurrency operations (from mining, trading, inheriting, or liquidation) are taxed differently.
Accountability and Investor Protection
Given the nascent nature of crypto-assets, investor protection, and education are significant concerns that must be incorporated via regulation around advertising and outreach. The need for responsible marketing has also been echoed by Finance Minister Nirmala Sitharaman, where last month shehinted at government regulation of cryptocurrency advertising, reviewing the guidelines provided by the Advertising Standards Council of India. These guidelines encompass risk disclosure, distinguishing between cryptocurrency and legal tender, and differentiating cryptocurrency trading from trading of regulated asset classes.
Investor protection contributes significantly to a stable cryptocurrency ecosystem due to its potential to promote informed investments, and deter casual investors. This would enable a less volatile method of price discovery for crypto-assets, in addition to making sure that investors understand the difference between conventional assets and digital assets.
The accountability of cryptocurrency intermediaries is another crucial aspect to consider for transitioning cryptocurrency towards the mainstream macroeconomic framework. Over the last few years, the major overarching concern of the government has been the possibility of illicit use of crypto funds and transactions to the detriment of investors and national interests.
In this context, the Budget may emphasise the need for better standards for verification of investors, and reporting mechanisms from cryptocurrency operators. Stricter regulation in terms of including monitoring and reporting of suspicious transactions, additional authentication mechanisms, and periodic audits of transactions are also plausible.
These regulations may also reflect therecent FATF guidelinescirculated to countries, regarding the applicability of these standards for all virtual assets, virtual asset activities, and virtual asset service providers (including licensing, registration, and reporting frameworks). Regulation is also likely to focus on customer and trader verification with exchanges and anti-money laundering authorities, as well as developing co-ordination channels between them.
Conclusion
Previous budgets have often sought to widen the fiscal vision towards financial inclusion, and the current climate provides an opportunity for Budget ’22 to employ newer tools to move closer towards this vision. Regulation of cryptocurrency, and the underlying blockchain technology could provide an impetus to this, with the strengthening of peer-to-peer financial networks, faster transactions, reduced transaction intermediaries, and greater transparency in information and liabilities.
The 2022 Budget assumes greater importance in light of the overarching economic recovery it will aim to herald. Considering its imminent implementation, establishing an enabling and forward-thinking regulation for cryptocurrencies can help play an important role in this recovery.
Kazim Rizvi is Founding Director, and Gautam Kathuria is Senior Research Associate, The Dialogue. Views are personal and do not represent the stand of this publication.
