Over the past few years, cryptoassets have seen an exponential rise in their usage and adoption. As per the International Monetary Fund, there has been a ten-fold increase in the market value of cryptoassets since early 2020 with the value surpassing USD 2 trillion as of September 2021. While proponents of cryptoassets argue about the innovation potential of cryptoassets and their underlying technology (i.e. blockchain) for the financial system, this rise in cryptoassets along with its volatility has raised concerns about its risks to investors and the financial system. Therefore, designing an appropriate cryptoasset regulation has become a subject of intense policy debate.
While India’s initial policy response was towards a ban on dealing with such cryptoassets, policy direction (based on statements by government officials) now appears to be moving towards regulating cryptoassets. While the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 was sought to be introduced in the last two sessions of the Parliament, there is no clarity on the contours of the proposed law. As India continues to debate and deliberate on the nuances of the regulatory approach to cryptoassets, this report presents a blueprint of a standalone law to regulate cryptoassets in India that will promote responsible innovation in the crypto economy as well as counter the associated risks.
Understanding key concepts
Analysing certain key terms are necessary to understand the various regulatory frameworks:
Cryptoassets: It may be broadly defined as a digital representation of value or right issued by a private entity and that relies on cryptography, distributed ledger technology or similar technology as a part of its inherent value. Bitcoin (BTC) and Ether (ETH) are two of the most popular cryptoassets.
Stablecoins: It is a type of cryptoasset that seeks to maintain a stable value. This may be achieved by pegging its value to asset(s) such as a single fiat currency, basket of currencies or commodities or other cryptoassets. Tether (USDT) is one of the most popular stablecoins.
Distributed Ledger Technology (“DLT”): DLT is the underlying technology of cryptoassets. It refers to processes and related technologies that enable participants (nodes) in a network to securely propose, validate and record changes to a ledger that is distributed across the network’s participants. It does not rely on a centralized controller. Depending on their design and architecture, DLT systems may be of different types. Blockchain (that is the underlying technology of the popular cryptoasset Bitcoin) is a type of DLT which is based on verifying and adding transactions on a block.
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Global regulatory approaches
Across the globe, the regulatory response to cryptoassets has been varied. While there are countries such as China that has banned the use of cryptoassets, there is El Salvador which has recognized bitcoin as a legal tender. However, predominantly a balanced approach has been undertaken by most jurisdictions. This approach towards regulation has been categorised under three groups in the Report:
Reliance on existing laws: Regulators rely on existing laws (mostly securities law) to clarify their applicability to certain types of cryptoassets, primarily security tokens issued during an initial coin offering. Notable examples include clarifications issued by the US Securities and Exchange Commission in 2019 and Australian Securities and Investment Commission in 2021.
Amendment to existing laws: Regulators amend existing laws (mostly anti-money laundering laws) to bring cryptoasset related services within its ambit. A notable example is South Korea’s amendment to the Act on Reporting and Using Specified Financial Transaction Information Act 2001 in 2021. The amendment defines “virtual assets” and brings “virtual asset providers” within the ambit of the law.
Enacting a Standalone Law: A new standalone law is enacted to regulate cryptoassets. In 2021, the Council of European Union adopted its position on the draft Regulation on Markets in Crypto Assets (“MiCA”) – a framework governing issuance and provisions of cryptoasset related services. This will mark the beginning of negotiations on MiCA with the EU Parliament. Previously, Malta and Thailand have also enacted standalone frameworks for cryptoassets in 2018.
Some countries are also adopting a phased approach in regulation wherein they are focusing on regulating cryptoassets that are presently the dominant use case in such jurisdictions. Specifically, jurisdictions such as Hong Kong, the United States of America and the United Kingdom are focussing on developing regulations for stablecoins, which is the prevalent use case presently in such countries
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Recommendations: Blueprint of law to regulate cryptoassets
This Report examines how regulation over banning would be more effective in addressing the issues posed by cryptoassets. In regulating cryptoassets, the Report analyses two approaches: reliance on existing laws to regulate the cryptoasset sector, and enacting a standalone law. On the basis of this analysis, the Report recommends that the most viable and effective solution would be to formulate a standalone law to regulate cryptoassets. The key recommendations of the Report are set out below:
Enact a standalone law to regulate cryptoassets in India known as the “Regulation of the Cryptoasset Market Act” (Proposed Law). The Proposed Law should regulate issuers of cryptoassets and entities providing cryptoasset related services as defined under the law. The framework may distinguish between asset-backed / fiat currency-backed cryptoassets popularly referred to as ‘stablecoins’ and other types of cryptoassets. RBI will be responsible for regulating the former category of cryptoassets and SEBI will be responsible for the latter category.
SEBI will be responsible to regulate cryptoasset service providers. RBI will also be empowered to designate significant cryptoassets and significant cryptoasset service providers that may pose systemic risks. Once designated, such cryptoassets and service providers will be subject to stringent oversight of RBI.
The issuer of asset-backed / fiat-backed cryptoassets will be subject to authorisation requirements along with the requirement to file prospectus/whitepaper for issuing cryptoassets in India and for admission to trading on a trading platform. Issuers of other cryptoassets will only be subject to the requirement to file prospectus / white paper with the concerned regulator (SEBI). The Proposed Law also sets out other specific requirements that must be complied with by such issuers, more specifically issuers of asset-backed/fiat-backed cryptoassets.
Cryptoasset service providers will be required to obtain authorisation from SEBI to provide services. They will also be subject to requirements relating to communications with investors, customer due diligence, investor protection, prevention of market abuse, etc.
The Proposed Law also empowers the central government (in consultation with Reserve Bank of India (“RBI”) and Securities and Exchange Board of India (“SEBI”)) to notify a list of “Prohibited Cryptoassets” and also prohibit/restrict specific use cases of permissible cryptoassets. The Proposed Law also envisaged the creation of an Inter-Regulatory Council consisting of representatives of the Ministry of Finance, RBI and SEBI.
It also contemplates the setting up of a self-regulatory organisation of cryptoasset service providers to focus on issues such as cyber security.
Along with the Proposed Law, India must also focus on investment in creating a specialised task force consisting of skilled officers for enforcing the provisions of the law, investment in investor education and also fostering partnerships with other countries for effectively regulating cryptoassets.
Shehnaz Ahmed is Senior Resident Fellow and Lead, Fintech. Swarna Sengupta is a Research Fellow at Vidhi working in the area of Fintech. Views are personal.
This edited excerpt from a report published by Vidhi Centre for Legal Policy has been published with permission from the institute. You can read the full report here.