CRYPTO-LEGALITY : INDIA TUGS BETWEEN BAN AND REGULARISATION

While the states around the world have been finding ways to understand and regulate the new financial assets which have emerged in the form of cryptocurrencies, India has found a quick and efficient way to beat other states in the race for regulations - by banning them all.

This paper is made in light of the “Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies” (“Report”) and the Cryptocurrency and Regulation of Official Digital Currency Bill (“Bill”). Though this paper comes 2 years after the publication of the Report, it holds more relevance today than it did at the time of the Report’s publication due the latest news of the Bill being tabled for discussions at the Parliament. The Bill proposes to ban the holding, trading, and mining of cryptocurrencies in India, making the offence punishable by imprisonment and fine. It maybe helpful to revisit some of the observations made and course of action to be adopted as per the Report and the Bill in light of what is happening around the world today.

During the big bull rally of the cryptocurrencies in 2017, which informed the world about words such as Blockchain, mining, cryptocurrencies and of course Bitcoin (“BTC”), the general public and its consensus was split between two opinion - future and bubble. Alas, like all bull runs, this run too came to a screeching halt when bitcoin crashed over 70% in market cap and pulling along with it all other altcoins (cryptocurrencies that aren’t BTC), solidifying the bubble beliefs of some followed by a train of “I told you so”. The crypto-market stayed dormant for about two years showing no serious signs of restarting another bull run, until mid-2020, due to the catalyst provided by the Covid-19 pandemic. This brief context is relevant to understand the backdrop on which the Report was made. The Committee was set up in 2017, at the height of the Crypto hype and the Report was published in 2019, right after the end of the first bull run and before the covid-19 pandemic and the second bull run. Therefore, a large portion of report has viewed and declared cryptocurrencies as an unreliable store of value (in other words F&Os), without intrinsic value (in other words CDOs) and volatile (in other words the entire capital market of 2020). However, BTC in the last one year has grown 10x, pulling along with it various other Altcoins. But between the two big bull runs came huge innovation in the field of Blockchain and its product -cryptocurrencies, which the Report had missed, to not fault of its own.

The first generation of cryptocurrencies can be summed up by BTC and the bitcoin network which established a peer to peer direct transacting system. The second generation of cryptocurrencies can be largely summed up by Ether and the Etherium network that introduced smart contracts that now allowed the system to undertake more complex financial transactions. The third generation of cryptocurrencies is currently on going and no single network or currency can be used to define the nature of the third generation, but some examples can be taken such as IOTA, Cardano, and Polkadot. The Report was made when the third generation of cryptocurrencies was in its infancy. Therefore, numerous observations and conclusion made in the Report are redundant and outdated. For instance, on numerous occasion the issue of scalability of cryptocurrencies was raised in the Report. While it is true that the First generation and second generation blockchain network could only handle tens of transaction per second, the third generation blockchain network has shown to process tens of thousand transactions per second, putting them in direct competition with the likes of master card and western union. Another issue raised by the Report is the misuse of the pseudo-anonymity provided by the decentralised ledger, thus, allowing for untraceable illicit activities such as money laundering and terror funding. Again, Ripple (another blockchain network) has overcome this issue and now transaction involving money laundering and such can be tracked and reported to concerned authorities. Further, the Report stated that the verification of the distributed ledger or “proof of work” requires large amount of storage and processing power, which can have unfavourable consequences on country’s energy resources. Though this is true for some of the blockchain networks, the issue however has been addressed by networks such as Cardano, Chia and more who are now choosing far more sustainable manners to reach consensus on their network. Therefore, a large number of issues raised in the Report have been in actuality addressed by the third generation of Cryptocurrencies and blockchain.

However, no system in the world is foolproof, and neither is this technology, however, blockchain and its technology in practice is only 12 years old and has been evolving at a pace which is incomprehensible. Therefore, the difference between the Bitcoin Network and a third generation cryptocurrency such as Cardano is fairly comparable to the difference between a landline phone and a Nokia 3310. There still exists a massive space for innovation and solving a lot of other problems and issues that come along with this technology, however, it is absolutely non sensical to determine the prospects and applicability of blockchain technology through a microscopic vision of mere Bitcoin or Etherium network. Non-fungible tokens(NFT) for instance is a product that was made popular through a rather hilarious concept of crypto-kitties. If the concept of crypto-kitties and its trade volumes were informed to an old fashioned businessperson, it is sure to surprise and most likely annoy them, reinstating their beliefs that the world is taking a turn for the worse. However, NFT has shown potential to shift the dynamics and our understanding of traditional markets and traditional ownership, and it is here to stay. NBA, Luis Vuitton, Formula 1, Nike, Vodafone are some of the global companies/associations that have already or are in the process of creating NFTs as or for their products.

There are a lot of positive implications of cryptocurrencies and the blockchain technology and India would largely benefit from spreading awareness of this technology and implementing it in its governance system, which even the Report agrees with. But the agreement between the Report and this paper ends with the above statement. While the Report claims that cryptocurrencies are evil, but the underlying technology is ground breaking and needs implementation, it overlooks or fails to understand the correlation between the two : incentive to nodes/verifiers. Unless the Report expects every Indian blockchain network developer to pay every nodes/verifiers on the network in INR, no one is going to run the network and maintain the ledgers which is at the heart of the blockchain without cryptocurrencies incentivising such work. And if you make the entire blockchain centralised, then you expose the data to huge cybersecurity risks which is one of the larger issue already solved by the Decentralised ledgers. Therefore, without the incentive provided by the cryptocurrency, a network will not be able to attract any nodes/verifiers to run the verification process, or maintain and update the blockchain. Further, if the Indian Government plans to launch its own cryptocurrency (presumably will be the only legal form of cryptocurrency) and blockchain network, effectively then the only choice any Indian developer has when to develop Decentralised Applications (“Dapps”), is on the government platform. This hinders the evolution of blockchain technology as a whole as it creates a central monopoly of the blockchain network which in effect restricts competition and innovation in its field. Lastly, the concept of Central bank digital currency (“CBDC”) is not even worth discussing, as the idea of CBDC only puts the old wine in a new bottle.

Therefore, the Report, on the basis of which the Bill is drafted, is largely outdated, its observation are obsolete and it needs to be revisited, perhaps, by industry experts this time. This is not the time to ban cryptocurrencies, but find ways to regulate it. Regulation does take away one of the central and crucial aspect of the entire blockchain theory - decentralisation. However unfortunately humans have a stellar record of defrauding unregulated systems, and the blockchain network has already have had its fair share of controversies in that regard. Regulations provide for a safe environment for all the players within the market, even the playing field and restricts the use of arbitrary power. And if history has taught us anything it is that power corrupts and absolute power corrupts absolutely. For this reason, and only this should a central authority task itself in setting the regulations that promote the growth of the the technology and the safety of its users. Regulations, thus, pose more benefits than harm to the blockchain community. Further, the pump and dump schemes that resulted in scams worth millions of dollars during the ICO (Initial Coin Offering) hype is also a good reminder that healthy regulations will protect the community and ensure that resources are utilised in its growth rather than to maliciously benefit few.

As rightly claimed by Nischal Shetty in his Financial Times article - ‘Banning cryptocurrencies would be like banning Internet in 1990s and will set India back by years’. People who understand how the blockchain technology works are few, however, are aware that they are witnessing history the way an industrialist was during the period of Industrialisation, or a software engineer at the advent of the internet. We are, potentially, at the brink of a society that could decentralise power and redistribute it back to the people, where it ought to belong, leading to true democracy.

Finally, even though the Hon’ble Finance Minister and the Minister of State have on separate occasions expressed their intent to positively welcome and accept the growing technology, there still exists a need for our law makers to understand the technology and its massive implications, before they table a bill to regularise or supervises these new financial assets and smart contracts. The regulations should look to promote the core ideologies of the technology, while providing assurance to its users, rather than restricting or controlling its implications. Under the protection and guidance of the Government, this technology can effectively change the dynamics of traditional markets and make India an economic powerhouse on the world platform.