We need smart regulation to unlock the true potential of crypto assets

Regulation of crypto assets such as bitcoin and ethereum is a hot topic globally. Countries are in various stages of banning, un-banning, re-banning and regulating crypto assets. We may take some cues from other countries, but what we need is smart regulation thats made in India.

To understand why, lets take one oft touted benefit of crypto assetsthat they make finance more inclusive and decentralized. But India already has the worlds largest financial inclusion programme in Jan Dhan. In the past seven years, 430 million bank accounts have been created for the under-banked. A majority, 55%, of them are women. There are 45,000 chit funds (and many more unregistered ones). These chit funds are the worlds largest decentralized finance applications. Crypto cant match that scale. So, financial inclusion is not the main reason to embrace crypto assets in India. But there are three compelling India-specific reasons to embrace crypto assets.

Establish India as an integral part of the new financial ecosystem: Large global financial institutions and investors are adding crypto assets to their portfolios. Domestic crypto markets in India and the global opportunities are synergistic. Finance firms, banks, fintech and crypto startups can tap into the huge growth of the industry. Software technology parks (STPs) and special economic zones (SEZs) enabled the IT services boom. Creative crypto export zone schemes can incubate clusters of excellence and create world-class financial services firms and unicorns.

Capitalize on new technology and services opportunities: Banking, financial services and insurance customers form the biggest chunk of Indias IT services. Blockchain application development, its scalability, security and analytics are their next growth opportunities. To cater to this demand, there is a need for a large talent pool with expertise in the crypto tech stacks.

Gain optionality on financial innovation: There is a burst of technology innovation and business models around blockchains. There are several interesting applications, but new killer apps will emerge. The impact of new technologies is overestimated in the short term, but underestimated in the long term.

Next, lets consider the regulatory perspective. Indias financial sector regulation tends to be conservative, and thats a good thing. This same conservatism helped Indian financial institutions weather the Global Financial Crisis of 2008 better than many western firms. And, there are three key regulatory concerns about crypto assets.

Investor protections: Investor protection has been a top priority for Indian regulators. Crypto assets are seen as high-risk, speculative assets. Investor education, guidelines against misselling and other safeguards are needed.

Crypto assets are now better understood as digital assets, instead of as digital currencies. Regulating them like commodities and clarifying their tax treatment is a win-win. The governments tax revenues go up. It can also increase the number of tax filers (only 64 million in FY20) and the number of taxpayers (14 million).

Sidestepping current regulations: Some crypto assets may allow individuals to bypass securities issuance laws. Thats a potential risk to capital markets. Crypto assets may be used to avoid capital controls. Thats a potential risk to macroeconomic stability. If crypto holders have to declare their holdings above a particular level in their tax forms, such concerns can be mitigated.

Illicit transfers: Anonymous transfers of crypto assets may weaken anti-money laundering laws or combating the financing of terrorism rules. Thats a potential national security issue. Robust know-your-customer (KYC) norms are the solution here. Also, a blockchain may bring more transparency for financial transfers as all its transactions can be examined. India is a part of the G20 Financial Action Task Force (FATF), and the crypto industry players should adhere to FATFs recommendations.

In summary, a smart regulatory approach considers both the potential upside and downside. It fosters financial innovation, safeguards investors and unshackles the Indian crypto ecosystem.

Kashyap Kompella, CFA, is a technology industry analyst.

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