Navigating Cryptocurrency Regulations: An Overview
Recent Development
Indian cryptocurrency traders are grappling with a new challenge as Income Tax Return (ITR) forms now require disclosure of virtual digital assets (VDAs). This inclusion has left traders unsure about whether to reveal their crypto holdings abroad to tax authorities, particularly if their VDAs are on offshore exchanges like Binance. The lack of clear policy guidelines further complicates matters, necessitating a unified approach to regulate the cryptocurrency sector, as highlighted in the Economic Survey, 2023.
Prior to examining the regulatory frameworks of cryptocurrencies in India and other prominent nations, it is imperative to gain a comprehensive understanding of the fundamental aspects of cryptocurrency.
What is Cryptocurrency
Satoshi Nakamoto introduced the first cryptocurrency namely Bitcoin in 2009. A cryptocurrency is a type of digital currency based on cryptography, which ensures anonymity and security. It operates as a decentralized medium of exchange without the need for central banks, relying on blockchain technology. Transactions are recorded in a public ledger, and digital wallets are used for storing cryptocurrency. The system allows peer-to-peer payments from anywhere, with payments existing as digital entries in an online database rather than physical money exchanged in the real world.
Market Share of Cryptocurrency
India has emerged as the world's second-largest cryptocurrency market, following the United States, according to the 2021 Global Crypto Adoption Index. The report highlights a significant increase in cryptocurrency adoption in India in 2020, with the total value of cryptocurrency received by Indian users surging by over 600% to reach $40 billion. India's share of global cryptocurrency activity also saw a notable 12% rise during the same period, driven by a young and tech-savvy population, growing adoption by small and medium-sized businesses, and the government's favorable approach to cryptocurrency regulations.
Diverse Applications of Cryptocurrencies
Cryptocurrencies have diverse applications in the modern digital landscape:
They serve as a means for digital payments, allowing users to make online purchases, conduct transactions, and perform swift cross-border money transfers.
Many individuals also perceive cryptocurrencies as investment opportunities, hoping to gain returns through value fluctuations.
Cryptocurrencies play a significant role in decentralized finance (DeFi), enabling users to engage in lending, borrowing, and earning interest without relying on traditional financial intermediaries.
Facilitate fundraising for projects and startups through methods like Initial Coin Offerings (ICOs) or Token Sales.
Gaming platforms and applications utilize cryptocurrencies for in-game purchases and creating unique digital assets.
Benefits to startups:
Accepting cryptocurrency payments brings several benefits for businesses:
Direct transactions: By utilizing crypto, businesses can eliminate intermediaries, streamlining refund and chargeback processes while minimizing the chances of fraud and errors.
Reduced fees: Cryptocurrency transactions generally incur lower fees, typically less than 1% of the transaction amount, in contrast to the higher fees associated with credit card sales (up to 4%).
Protection against fraud: Cryptocurrency payments offer security against fraudulent chargebacks, like cash transactions, as there are no third-party intermediaries involved.
Enhanced customer convenience: Providing cryptocurrency payment options meets customers' preferences for secure and digital payment methods, enriching their overall shopping experience.
Expanded global sales potential: Embracing cryptocurrencies allows businesses to avoid foreign transaction fees and decrease the delay between payments, opening new markets and increasing sales opportunities.
Disadvantages of Cryptocurrency
High volatility and instability: Cryptocurrencies exhibit significant price fluctuations and lack stable value because of reliance on investor sentiment, making them prone to rapid changes.
Lack of government regulation: Cryptocurrencies are not governed by any central authority or official body, resulting in limited legal protections for users.
Irreversibility of transactions: Once a cryptocurrency transaction is executed, it cannot be reversed, and there are limited security measures because of user anonymity.
Dependency on private keys: Users who misplace or lose their private keys risk losing access to their cryptocurrency holdings permanently.
Limited acceptance: While gaining popularity, cryptocurrencies are not universally accepted as a form of payment, limiting their practicality in some situations.
Cybersecurity concerns: Storing cryptocurrencies in cold storage wallets may expose users to potential cybersecurity risks, as these wallets can be vulnerable to hacking attempts.
Tax implications: The tax departments treat cryptocurrencies as property or investments, and transactions may be subject to capital gains or losses, requiring proper tax reporting.
Regulatory Challenges in Cryptocurrency Space
The dynamic and fast-changing nature of the cryptocurrency market poses significant hurdles in applying or developing already existing regulatory frameworks.
Regulatory authorities struggle to attract skilled personnel and acquire the necessary expertise, given their limited resources.
The decentralized and fragmented nature of crypto markets makes monitoring challenging, as regulators face difficulties in keeping track of numerous participants who may not adhere to conventional disclosure and reporting norms.
Cryptocurrency Regulation in India- A Timeline
Over the course of the past few years, the government's stance on digital assets has undergone significant shifts—from an outright ban on cryptocurrencies in 2016 to the forthcoming Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, aimed at regulation. As of now, there exists no explicit regulation or prohibition concerning the utilization of cryptocurrencies within the country.
2013-2017- Acceptance by banks
In 2013, the RBI warned the public about the risks of using virtual currencies. In 2017, the RBI clarified that virtual currencies were not legal tender, but there was no official ban, allowing most banks to continue facilitating transactions on cryptocurrency exchanges.
2017-2020- Beginning of Regulations by RBI
In April 2018, the RBI imposed restrictions on banks and financial institutions, prohibiting them from dealing with virtual currencies. This move significantly impacted the growth of the cryptocurrency industry in India.
2020-2022- Government’s Positive approach
The Supreme Court of India declared the restrictions on cryptocurrency transactions imposed by the RBI as unconstitutional in March 2020. Subsequently, in December 2020, the government introduced the Cryptocurrency and Regulation of Official Digital Currency Act, which seeks to restrict private cryptocurrencies and establish the digital rupee as the official digital currency. In January 2021, government displayed a positive approach, indicating the government's willingness to consider the use of cryptocurrencies and move towards regulation.
2022-Present- Taxing Cryptocurrency
In India, the Ministry of Corporate Affairs issued a notification on March 24, 2021, making it obligatory for cryptocurrency companies to divulge the gains or losses arising from transactions, the quantum of cryptocurrencies held, and any deposits or advances received from individuals.
The 2022-23 Union Budget in India introduced a 30% withholding tax on virtual currency transfers and imposed taxation on gifts in the form of virtual assets/cryptocurrencies. Concurrently, the RBI recommended implementing restrictions on cryptocurrencies in July 2022, citing concerns about their impact on the country's monetary and fiscal stability.
Further, the Economic Survey of 2023 highlighted the necessity for a unified approach to regulate cryptocurrencies is essential, as the unregulated crypto market poses significant challenges to financial systems worldwide.
Analyzing Present Regulations on Cryptocurrency
Cryptocurrencies are renowned for their robust security, achieved through complex mathematical encryption. Nevertheless, recent studies have uncovered vulnerabilities that expose them to hacking and theft. The current regulations concerning cryptocurrency are deficient in addressing its legal status, leading to potential confusion regarding the taxation of cryptocurrencies without explicit legalization. The government appears to be focused on maximizing its revenue by implementing a 30% tax on cryptocurrency profits until formal regulations are established. Further, accepting cryptocurrency payments benefits businesses with direct transactions, reduced fees, enhanced customer convenience, and expanded global sales potential.
India's incomplete regulations on cryptocurrency, and the potential move to ban it, could lead to the country's isolation from the globalized world where many nations have embraced cryptocurrency regulation as a means of fostering innovation and financial inclusion.
The proposal for creation of digital Rupee by Reserve Bank of India, grants more authority to RBI, despite concerns about the absence of robust data protection laws. The central bank has repeatedly expressed concerns about the potential impact of cryptocurrencies on macroeconomic and financial stability.
The lack of proper regulation or outright bans on cryptocurrencies could lead to their exploitation for illicit activities. The unregulated crypto markets can become avenues for money laundering, fraud, and funding illegal activities.
The encryption technology employed makes it challenging for law enforcement to trace wrongdoers, creating additional complexities. In conclusion, while the strong encryption of cryptocurrencies offers notable security advantages, recent hacking incidents and the potential for misuse in unlawful activities highlight the urgent need for stronger legal frameworks and innovative security measures to safeguard the cryptocurrency ecosystem.
Consequences of Banning Cryptocurrency
It has been seen off late, an active Indian traders participation in cryptocurrency activities. Projections indicate huge growth, with the market expected to reach US$222.70 million by the end of 2023. Further, the India’s crypto ownership rate is almost double than global average of 15 percent. As of 2022 there were two crypto unicorns namely- Coindcx and CoinSwitch and nearly 350 startups blockchain related activities. The world has been shifting towards recognizing cryptocurrency as mode of payments. Like MasterCard and Visa now accept certain cryptocurrencies for payments. Tesla invested $1.5 billion in bitcoin and allowed bitcoin payments.
The Indian authorities have a chance to leverage cryptocurrencies by removing the obstacles related to traditional currencies and positioning the country as a global hub for cryptocurrency investment, thereby attracting substantial business and investment. However, to achieve this, they must meticulously devise fresh laws and regulations specific to cryptocurrencies, as existing laws fall short in regulation of cryptocurrency. Adopting well-crafted regulations that account for the intricacies of cryptocurrencies presents a more balanced approach, enabling India to attract investments and nurture a flourishing cryptocurrency industry while mitigating potential risks. Regulatory policies that are already in place like crypto exchanges required to provide transparent and comprehensive financial statements concerning their cryptocurrency dealings and customary practice for crypto exchanges in the country to retain general KYC information for all traders and investors who have registered on their platforms can help address the grey areas of cryptocurrency regulations.
Can Central Bank Digital Currency be an Option?
In February 2019, the Finance Ministry proposed the introduction of Digital Rupee. The rising global popularity of digital currencies, or cryptocurrencies, has prompted numerous central banks to consider launching their own digital currencies to address existing shortcomings and accelerate the transition towards a cashless society.
Central Bank Digital Currency (CBDC) refers to a digital form of legal tender and liability issued by a nation's central bank. It is denominated in the country's sovereign currency and is recorded on the central bank's balance sheet. CBDC operates as a digital currency that can be converted or exchanged at the same value as conventional cash and traditional central bank deposits of the nation.
CBDC differs from private cryptocurrencies as it operates on a permissioned blockchain, giving exclusive mining and control authority to the Central Government and authorized agencies. It is intended to be a Stablecoin, pegged to the Indian Rupee, offering a secure and convenient currency management solution unlike private cryptocurrency which has notional value.
Non-regulated crypto-backed transactions after ban by RBI: A possibility
It is imperative to acknowledge that the ban on private cryptocurrencies poses technological challenges due to their decentralized nature i.e., lacks a centralized entity or governing authority. Further, a ban on private cryptocurrencies may encounter considerable challenges as digital wallets established on decentralized exchanges (DEXs) that hold cryptocurrencies are not easily traceable. Consequently, complete ban or regulation from the source becomes unfeasible. Instead, the government should regulate and potentially prohibit specific elements such as usage, holding, and transactions within the cryptocurrency domain. Therefore, attempting to ban cryptocurrency as there are concerns related to volatility, consumer risks, power consumption, and potential criminal activities like money laundering and terrorism can have serious repercussions.
Views around the world on Cryptocurrency
European Union
Cryptocurrency legality in the European Union (EU) varies by member state, while taxation ranges from 0% to 50%. Recent directives like Fifth and Sixth Anti-Money Laundering Directives have strengthened KYC/CFT obligations and reporting requirements. The Markets in Crypto-Assets Regulation (MiCA) framework aims to enhance consumer protections and introduce licensing requirements. Additionally, Parliament approved measures requiring specific crypto service providers to obtain an operating license, providing regulators with tools to track crypto usage in money laundering and terrorism funding.
United States of America
The U.S. unveiled a fresh regulatory framework for cryptocurrencies in 2022, granting authority to established market regulators like the SEC and CFTC. The SEC's actions against Ripple and crypto exchanges indicate a trend towards tighter scrutiny. SEC Chairman emphasizes the importance of investor protection, and it is anticipated that stricter regulations will be imposed to manage the influx of new digital currencies. The outcome of ongoing legal cases and regulatory efforts will determine the classification of cryptocurrencies as securities in the future.
China
In China, cryptocurrencies are categorized as assets for inheritance determination. The People's Bank of China (PBOC) has imposed a ban on crypto exchanges. Furthermore, China enforced a prohibition on Bitcoin mining in May 2021, leading to the complete shutdown or relocation of mining operations to more lenient regulatory jurisdictions. Subsequently, in September 2021, cryptocurrencies were unequivocally banned in the country. Despite these stringent measures, China has been actively pursuing the development of its digital yuan (e-CNY) and officially initiated the subsequent phase of its central bank digital currency (CBDC) pilot test program in August 2022.
Brazil
In Brazil, Bitcoin may not have the status of legal tender, but a recent law has given cryptocurrencies the green light as acceptable payment methods across the country by including digital currencies and air mileage programs in its definition of payment methods. The government's executive branch will determine the responsible office for monitoring the law's implementation, while tokens considered securities will remain under the jurisdiction of the Brazilian Securities and Exchange Commission (CVM).
United Kingdom
In the UK, cryptocurrencies are treated as property and not recognized as legal tender. Crypto exchanges must register with the Financial Conduct Authority (FCA), and trading of crypto derivatives is not allowed. Specific reporting requirements are in place for Know Your Client (KYC) standards, Anti-Money Laundering (AML), and Combating the Financing of Terrorism (CFT). Taxation of crypto transactions depends on the nature of activities and the parties involved, with capital gains tax applicable to trading profits. As of August 2022, crypto firms must comply with reporting obligations to the Office of Financial Sanctions Implementation (OFSI) regarding financial sanctions and suspicious activities.
South Korea
South Korea enforces stringent rules for cryptocurrency exchanges and virtual asset service providers, mandating registration with the Korea Financial Intelligence Unit (KFIU), a division of the Financial Services Commission (FSC). Privacy coins were also banned from exchanges in 2021. Additionally, the implementation of a 20% tax on digital assets, initially scheduled for 2022, has been postponed to 2025.
El Salvador
In 2021 recognized Bitcoin as the legal tender, thus becoming 1st country to do so.
Common Thread
The global approach to cryptocurrencies involves continuous development and adaptation of legal, regulatory, and policy measures. In the United States, cryptocurrencies are taxed for exchange, use, and holding, but none are considered legal tender. The United Kingdom treats cryptocurrencies as capital assets, subjecting them to capital gains tax. Canada and Germany have more lenient tax approaches. In Canada, digital assets are regarded as virtual assets, and taxation is applied solely when they are sold. In contrast, Germany views cryptocurrencies as private currency and levies taxes if they are exchanged or sold within a one-year duration. Most countries choose to impose taxes, controlled recognition, and self-disclosure mechanisms to handle cryptocurrency users and investors, recognizing the diverse nature of the cryptocurrency ecosystem.
Way Forward
There is a need to establish comprehensive and consistent global standards for cryptocurrencies, relying on standardized taxonomies and reliable data. Regulatory responses should maintain flexibility to accommodate market developments and future international standards. The recent downfall of FTX, a cryptocurrency exchange, is a testament to the vulnerabilities in the crypto ecosystem. Hence, the lack of comprehensive global regulations for cryptocurrencies is a matter of global concern which must be addressed urgently.