The G20 and Indias role in cryptocurrency regulation (GS Paper 2, International Organisation)
Context:
- During India’s presidency, the G20 has the opportunity to make significant progress on three critical issues. These issues include debt relief, regulation of cryptocurrencies, and climate finance.
- With no global consensus or frameworks in place, cryptocurrency regulation is one area where India can lead the way by leveraging the G20 presidency.
- The steep fall of several key crypto players in 2022 underscored cryptocurrency regulation to protect consumers and investors, and maintain the integrity of financial markets.
Takeaways from cryptocurrency’s fall in 2022
- Cryptocurrencies were designed to be decentralised, meaning a central authority does not control them.
- The independent nature of cryptocurrencies provided an alternative to traditional financial institutions, typically centralised and controlled by banks and NBFCs. However, despite decentralisation, the cryptocurrency industry has become increasingly centralised.
- Many major cryptocurrency exchanges, such as FTX, Binance, and Coinbase, are centralised and control a significant market share.
Centralised exchanges:
- There are several reasons why this move to centralisation has occurred. One reason is that it is generally easier to scale centralised entities than decentralised ones.
- Centralised exchanges can offer a wider range of features and services, such as margin trading and futures contracts, and process transactions more quickly and efficiently than decentralised exchanges. Decentralised exchanges, on the other hand, tend to be slower and more cumbersome to use, with higher transaction costs.
- Another reason is that centralised exchanges have been able to monetise their platforms more effectively than decentralised ones.
- Many centralised exchanges have attracted venture capital investment, which has allowed them to grow and expand. In contrast, decentralised exchanges have struggled to monetise their platforms, which has limited their growth.
Scams:
- Initially seen as a decentralised and trustworthy alternative to traditional financial systems, various controversies and failures, such as FTX, Mount Gox, and OneCoin have marred the cryptocurrency industry.
- These events share similarities with past financial and accounting crises like Satyam, Lehman Brothers, and South Sea Company, fuelled by greed and the desire to make fast profits through any means possible. These scandals often involved inflating balance sheets, manipulating the value of shares or tokens, and using misleading marketing to deceive investors.
- These recurring themes indicate that the root causes of financial scandals are often human-driven, irrespective of the specific details or industry.
The urgent need for regulation:
Reducing financial crimes:
- One of the main reasons is to protect consumers from fraud and other financial crimes. Cryptocurrencies, a relatively new and largely unregulated asset class, have been vulnerable to scams and other illicit activity.
- By establishing rules and standards for the use and trade of cryptocurrencies, regulators can help reduce the risk of such activities and protect consumers from financial harm.
Foster greater stability and reliability:
- Another reason for cryptocurrency regulation is to foster greater stability and reliability in the cryptocurrency market. Cryptocurrencies are highly volatile, and their value can fluctuate significantly over short periods.
- These intricacies make them risky for investors and make it difficult for businesses to use them as a form of payment. By regulating cryptocurrencies, authorities can help reduce volatility and promote greater confidence in their use as a means of exchange.
Economic Policies:
- Finally, cryptocurrency regulation can ensure that cryptocurrencies are used in a way that is consistent with broader financial and economic policies. This includes issues such as tax compliance and preventing money laundering and terrorist financing.
- By setting rules for the use of cryptocurrencies, authorities can help ensure that they are not used for illicit purposes and that they are integrated into the broader financial system in a way that is beneficial to all stakeholders.
A brief overview of crypto regulation in India:
- In 2013, the Reserve Bank of India (RBI), the country’s central bank, issued a statement cautioning users, holders, and traders of virtual currencies, including cryptocurrencies, about the potential risks associated with their use.
- In 2017, the RBI issued a circular prohibiting banks and other regulated entities from providing services to individuals or businesses dealing in cryptocurrencies. The circular effectively made it illegal for Indian residents to buy or sell cryptocurrencies.
- However, in March 2020, the Supreme Court of India overturned the RBI’s ban on cryptocurrencies, stating that it was “disproportionate” and that it violated the fundamental rights of citizens. This decision effectively legalised the use of cryptocurrencies in India and opened the door for their wider adoption.
Advancements in 2022:
- Since then, the Indian government has considered a regulatory framework for cryptocurrencies. In 2022, the Ministry of Finance released a report proposing the creation of a digital rupee, a state-backed cryptocurrency, as well as a framework for regulating private cryptocurrencies.
- The report also recommended the establishment of a Digital Currency Regulatory Authority (DCRA) to oversee the use of cryptocurrencies in India.
2022 Union budget:
- In the 2022 Union budget, Indian Finance Minister Nirmala Sitharaman announced significant changes to the treatment of virtual assets, including cryptocurrency.
- For the first time, the government officially classified digital assets, including cryptocurrency, as “virtual digital assets.” In the proposed tax regime, the government has announced a flat 30-percent income tax on the transfer of “crypto-assets”.
- This announcement is a significant step by the government in providing clarity to investors and entrepreneurs dealing with digital assets in India and a move towards regulating the cryptocurrency industry.
Leveraging the G20 for greater regulation:
- India will host 40 meetings across the country as part of the finance track of its G20 presidency. These meetings will involve various working groups and four minister-level meetings intended to contribute significantly to global economic discussions.
- The focus areas of the finance track include regulating crypto assets, managing debt vulnerabilities, and reorienting global financial institutions.
- Finance Minister Sitharaman and Reserve Bank of India Governor Shaktikanta Das will lead the overall finance track during India’s G20 presidency, with the first meeting of finance ministers and central bank governors scheduled in Bengaluru in early 2023.
- Consumer protection must be at the heart of all deliberations on cryptocurrency regulation. The decentralised nature of cryptocurrency and the lack of a central authority or intermediary make it particularly important to ensure consumer protection from fraud, financial loss, and other risks.
There are several ways regulators can ensure consumer protection in the cryptocurrency industry:
- One approach requires cryptocurrency exchanges and other platforms to implement strong Know Your Customer (KYC) and Anti-Money Laundering (AML) policies to prevent illicit activity. Regulators can also require exchanges to hold a minimum level of capital to ensure that they have sufficient resources to protect against losses.
- Another important aspect of consumer protection in cryptocurrency regulation is providing clear and concise information to consumers to make them aware of the risks associated with investing in cryptocurrency, as well as the potential benefits. It is also essential to provide consumers with information about their rights, the resources available to them for dispute resolution, and if they encounter problems or have questions.
Way Forward:
- Overall, consumer protection is an important consideration in regulating cryptocurrency and requires a combination of strong regulations and robust industry practices to prevent financial losses and other risks.
- India has the unique opportunity to set the global benchmark for crypto regulation and inform governments worldwide about the fundamental principles that must underscore their crypto regulatory framework.
