The blockchain technology underlying private cryptocurrencies is a source of useful innovation, but the currencies themselves are unstable, volatile and subject to bubbles. They have no sovereign or legal backing. Their value is derived only from demand for them. Sentiment can change.
Data-mining that creates cryptocurrencies is very energy intensive, but innovation is taking place here. That there are limits to expanding the amount is partly responsible for sharp jumps in their value.
Some favour such decentralised and ‘free’ systems. That blockchain uses many validators for a transaction, building on multiple expertise without a central regulator, makes it the mecca for those who dislike power and its sometimes arbitrary or ill-informed execution.
But financial stability and the value of the rupee must be preserved even as financial innovation is encouraged. Risky schemes that promise high short-term returns can attract a gullible and less than financially literate public. What are the alternatives?
Types of bans
A blanket ban with discretionary exemptions for specific purposes would discourage experimentation and innovation by individuals while subjecting them to potential harassment.
It is best to avoid invoking criminal law and imprisonment in commercial activities. This would add to the perception of excessive use of power.
Past criminal investigation of bankers, without making a distinction between a commercial loss and a fraud, has had a negative effect on lending and decision-making. The very few countries that impose a full ban on cryptocurreny are Algeria, Bolivia, Ecuador, Nepal and Macedonia. This is not good company to be in.
An alternative is to just ban its use as a medium of exchange, with heavy monetary penalties for individuals who use it in exchange or for financial institutions that facilitate its use or offer products based on such currencies.
Their auditors can be asked to certify that such institutions had no dealing in cryptocurrencies. The certification would be subject to Board and regulatory review.
Since values are unstable, the incentive to keep cryptocurrency as a pure store of value or unit of account will be low if it cannot be used as a medium of exchange, while allowing those who want to innovate with blockchain technology or collaborate with experiments abroad to be free to do so. Innovations often emerge as a side-effect of unstructured experiments. These would be discouraged by blanket bans with high transaction costs of getting permissions.
A 2018 RBI circular to its regulated entities had a similar aim but was set aside by the Supreme Court in March 2020, on grounds of proportionality. In its view, the RBI did not have the power to issue such a circular. But a Bill banning use as a medium of exchange will validate the restriction on all financial institutions and payment companies.
Countries which bar financial institutions within their borders from facilitating transactions involving cryptocurrencies are Bangladesh, Iran, Thailand, Lithuania, Lesotho, China, and Colombia ( https://www.loc.gov/law/help/ cryptocurrency/ world-survey.php).
The third alternative is to follow the many countries that have not banned cryptocurrencies but subject them to sophisticated and evolving regulation, with appropriate design features.
Regulators are willing to collaborate and share information, more so as part of global initiatives against terrorist finance and tax evasion. Since our markets are thin and less able to absorb shocks, we can choose to disallow the use of such currencies as a medium of exchange as an interim measure while we bring regulations up to speed.
Compliance with FATCA is a major issue. Criminal elements use cryptocurrency for money laundering or for exchange on the dark Net. These would continue to be subject to criminal law and investigation. Blanket bans increase the clout of criminals who become the only source of the banned object, encouraging a black market,…
Read More:Needed, a measured approach to cryptos