Why is it required to regulate crypto space?

Regulation of any product/industry/currency etc. is always in the interest of all participating parties who have their vested interest in the entire concerned ecosystem whether it is Government, company, community (public), Institutional investors, Crypto exchanges in India & abroad, inflow of foreign investments, Indian corporate sector, etc.

Cryptos is the new product line in the financial market across the world and is under its’ phases of development. Currently not even a single country has prescribed thorough regulations for cryptos across the globe.

Why regulations are required for all the participants having their vested interest in the crypto ecosystem :

Government : Govt. can frame laws to control the ecosystem of crypto world to provide safeguard to the economy by controlling bad guys through the use of KYC/AML policies, defining the crypto assets with their definitions, prescribing different nature of punishments to smoothen the way for enforcement agencies like ED, RBI, prescribing proper tax structure to lay down the principles/premises for various taxation authorities like Income tax, GST, sometimes land revenue authorities (in case NFTs for real estates) etc., laying down the conditions/barriers to the entry & exit to protect the interest of common public at large, and so on.

Company : Once regulations are in existence, the concerned company involved will be under the pressure of following the guidelines/conditions/principles regarding KYC/AML/FEMA etc. The participating company will be under the obligation to protect the interest of it’s customers base coming from the general public. Company will be under the obligation to prepare/show/maintain proper financial & non-financial records from the point of view of taxation and enforcement authorities. With the prescribed regulation of entry & exit, it will be difficult to enter/exit for the bad actors in the space. There will be ground level base for the company to decide upon rights & obligation of the company towards the general public in B2B & B2C segment.

Public/Community : It consists members of the community like depositors, traders, investors, etc. Such part of the community is always interested in regulations so that their interest can be protected under the proper law directly/indirectly related to the space in which public is performing its’ roles in different ways.

There can be lawful/enforceable relationship between public & company, public & Govt.

Community members are always interested in their rights/obligations whenever they deal in any space like in cryptos.

Relationship between Govt. & community members can be in the form of taxation of incomes/losses, violation of framed rules under different legislatures, etc. arising from the activities in the crypto space. Such relationships can be controlled through regulations.

Former RBI governor Mr. Raghuram Rajan said at Reuters Global Market Forums on August 25,2021 that some of cryptocurrencies may have “Potential Future” once the industry gets regulations and the crypto currency finds its real world implementation in various use cases of the technology. Mr. Rajan also said this with condition that he meant cryptocurrency here is for stable coins which have assets pegged values and not in volatile in nature. He also said cryptocurrencies will be helpful in cross-border payments where already cost & time involved is high.   He also emphasized the importance of Stable coins about their future if they have their implementation in proper real world use-cases and that too under regulated environment. Stable coins also have been termed as ‘Future of Money’. 

Please read more on report of importance of stable coins as future of money @ https://www.linkedin.com/posts/pankaj-kumar-6a759b207_stablecoins-and-the-future-of-money-activity-6832657007149895680- WFbT/

Mr. Rajan also stressed on the earlier regulations, especially for stable coins as the adoption of such technology continues to increase. Recently in 2021 Global Crypto Adoption Index made by Chain analysis, India ranked 2nd among 154 countries in global cryptocurrency adoption, even though in absence of regulations in the country. Mr. Rajan was not so confident about the valuation aspects of cryptocurrencies in the market specially for Bitcoin which is moving around $60000 currently. He also mentioned that it’s silly for those who talks about stability of cryptocurrency is more than fiat money.

You can read one of my articles on Crypto = Money ? @ https://www.facebook.com/110644834618198/posts/136897511992930/

How would regulation protect cryptocurrency investors?

Having Regulations in any industry in any country is always good for every participating entity in the respective space whether it is cryptocurrency or any other space.

Let’s understand, with one simple example of liquor industry, the importance of Regulations. There was time when there was no Regulation on liquor and anyone could produce / sell / consume liquor without any limitation which used to result in casualties like deaths, etc. But over a period of time, Regulations evolved and liquor’s production / selling came under the hands being controlled through the proper Regulation which resulted in implementation of good technology for production and selling through controlled network. Drinking / consumption also was controlled by Regulation by prescribing age limits to drink liquor which reduced number of deaths due to liquor consumption.

So, same way Regulations are important for the cryptocurrency investors to provide safeguard to the investors’ money by preventing frauds, to limit / stop the misuse of the crypto space by the enemy forces of the country, providing framework to the Govt. authorities to act in crypto space for different purposes like taxation, legal support / protection to investors etc.

Currently Indian crypto space is relying on various regulatory standards which were enacted for different purposes. Such laws are including Know-Your-Customer (KYC) standards, Anti-Money-Laundering (AML) law, Prevention of Money Laundering Act (PMLA), and Foreign Exchange Management Act (FEMA) for overseas remittances. Problem of investors regarding taxation is also being solved by Indian Income Tax department in different ways using the methodology being applied / mentioned / enacted for investors of other spaces like shares/ commodities / properties etc. But still I will say that Indian investor is not fully protected in crypto space due to lack of regulations.

Let’s understand such importance of regulations with one more example of Money Exchange license in India which is regulated by central bank ‘RBI’ which has prescribed the conditions to acquire such license for carrying out the money exchange activities in India. Further RBI has prescribed various conditions to be fulfilled by the entity acquiring such license even after getting the license. Directly or indirectly it protects public in India. But to start crypto exchange in India, there are no regulations prescribed as yet because Govt. has not come with regulatory framework for crypto space in India.

Once regulations are there, investors can be protected from frauds, legal protection will be there for participating entities as per Indian Contract Act, taxation authorities can perform their assessment procedures easily with more clarity, law enforcement agencies also will be in comfort zone to perform their duties in crypto space. All these will affect investing  public to a large extent.

 

Future of Legislation

Do you know the ‘Biggest risk to cryptocurrency is what? 

Normally we talk about such risk factors are ‘Hacking, Price volatility, Faddism, Technology’, etc.

But I believe, biggest risk to cryptocurrencies is from ‘Legislature/Regulator’ or governments of respective countries. 

Why I am saying it a biggest risk is because sometimes people in cryptos and Establishments/States/Governments are not aligned with each other. For most of the governments, crypto is something like Godzilla (big animal) has entered in the city and government is trying to figure out how to deal with it. Trial & Error approach is being used to control this biggest animal i.e. Cryptos.

 

What is the government’s problem with cryptos?

Where this legislation is being headed?

Security Vs. Utility tokens: Here Security means stocks/bonds/shares etc. issued under proper established legislation like SEBI in India. Some of the entrepreneurs try to raise funds by issuing tokens which do not have any utility. It’s easy to raise funds through issuing tokens rather than issuing equity shares when crypto market is bullish and rules of equity can be bypassed, issues of boards and company setups can be overlooked. But this is detrimental to the crypto industry itself. Industry will definitely face pain in future in this area.

Consumer protection : Governments think that consumers can be taken for a ride in this new evolving environment of cryptos. Consumer protection is of utmost priority for governments. Big crypto players must educate the community about the cryptos like WazirX and CoinDCX are doing in India. Community must be educated & alerted about how to identify the fake crypto schemes. Crypto exchanges must help the government in tackling crypto issues and designing the policy framework to regulate the industry.

Taxation : I think with KYC norms, government is going to identify the points where cryptos must be taxed and crypto exchanges should be helpful to the government in this regard.

 Capital flight : Most of the Nations are concerned about the outward movements of their currencies from their countries. India is a good example of same. Govt. is worried that people may convert Indian rupees in to cryptocurrency and then cryptocurrency may move out of the country. Actually, already there are different laws in force to control flight of Indian rupees from India to outside. FEMA (Foreign Exchange Management Act) is the famous one of such laws.

Govt. is also worried about the inflow of foreign currency in the country from outside world. Govt. does not want such flow without coming it in to the notice of government. Again FEMA & other various laws are there in force to control such inflows. But again government thinks that through cryptos unaccounted inflow of foreign currency may come in the country and same may be used for illegitimate/criminal activities which may be detrimental to the economic/political/security of the Nation.  

Where this legislation is being headed? 

In India, prospects of legislation are bright because government is coming up with finding out the ways how to control such inflow/outflow of capital, how to tax cryptos, how to trace the movements of cryptos, how to control crypto exchanges, etc. Now, the fear of ‘Govt. Banning Cryptos’ is completely out of sight. 

One more major risk is that in different governments of various countries deal with cryptos differently, though cryptos is International issue. But again here, some good news was a few days ago. USA has formed a group of 30 countries (G20 & some more countries) to formalize some uniform policies to control cryptos worldwide something which can be compared with how banking works globally in uniform way.

 

Cryptos Vs. Reserve Bank of India

•  What RBI will do with Indian Crypto Industry ?
•  What Govt. Of India will do with Indian Crypto Industry ?
•  Who will win – Indian Crypto Industry or RBI ? 

 “All these billion dollar questions”

For “REGULATION of Cryptos”,  RBI should assist Govt. in framing Regulations and frame a Law in such a way that Cryptos and blockchain eco system can be regulated & controlled to ensure contribution to the Govt. treasuries in form of taxes in various ways (Direct & Indirect taxes). I think RBI has a disbelief that crypto currencies can not be regulated, so let’s ban it. A huge marathon of brain storming is required to regulate such dynamic eco system. RBI should invite suggestions from the market leaders of this industry and arrange for round table meets to discuss measures to regulate the fastest growing industry of the current arena in this world. Even RBI officers should work hard little more and study the laws in foreign countries. This is also true that this industry is in the growing stage and under development. There is not an even single country which can say that they have fully developed mechanism to regulate the industry. 

Let the eco system grow and frame Laws simultaneously. There should be a body who can keep a watch on the development of the eco system, should advise the RBI & Govt. on the growth pattern so that sound proof mechanism can be developed to regulate the crypto & blockchain industry. 

Infact surprising trend was noticed in India when there was news of banning cryptos by RBI during few months back. More number of new entrants were there and for this you can refer to the news published in ET .

 

Banning the Cryptos is not the feasible solution. 

Like complete lockdown for ever is not the solution to control Corona virus.  

Latest news from Govt. circles as per news published in Economic Times:

https://economictimes.indiatimes.com/tech/technology/govt-may-set-up-new-panel-to-study-crypto-regulations/articleshow/82746324.cms

Indian Government to Set up Panel of Experts to Take a Fresh Look at Regulating Cryptocurrencies: Report

The Indian government is reportedly looking to form a new “panel of experts” to focus on ways to regulate the cryptocurrency industry in the country. “There is a view within the government that the recommendations made by Subhash Garg are dated and a fresh look is needed at use of cryptos rather than a total ban,” local media reported.

Indian Government Re-Examining Crypto Bill

The Indian government is considering forming a new “panel of experts to study the possibility of regulating cryptocurrency in India,” The Economic Times reported Wednesday, citing three sources privy of the discussions.

The committee could be exploring the use of blockchain technology and suggesting ways to regulate cryptos as digital assets instead of a currency. It may also study ways to operationalize the digital rupee to be created by the central bank, the Reserve Bank of India (RBI). An official familiar with the matter told the publication:

There is a view within the government that the recommendations made by Subhash Garg are outdated and a fresh look is needed at use of cryptos rather than a total ban.

The Garg committee drafted a cryptocurrency bill entitled “Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019.” It was published in July 2019. The draft bill recommends a blanket bank on cryptocurrencies except for state-issued ones.

Soon after the bill was published, Garg left his position in government. He recently explained that when his committee drafted the crypto bill, cryptocurrencies were mainly used as a currency. Now that they are widely used as assets, he has urged the government to regulate them as crypto assets.

Earlier this year, the Indian government planned to introduce a bill entitled “The Cryptocurrency and Regulation of Official Digital Currency Bill 2021.” While the content of the bill has not been made public, many suspect that it is based on the bill drafted by the Garg committed. The bill was scheduled to be introduced during the Budget session of parliament. However, the session ended and the crypto bill was not introduced.

Regarding the formation of the panel of experts, the discussions are at an early stage and the finance ministry is monitoring the growing volume of cryptocurrency trading in the country, sources told the publication. Among the people being considered to be part of the new committee is Minister of State for Finance and Corporate Affairs, Anurag Thakur. In February, the minister said that the crypto bill “is being finalized and would be sent to the Cabinet soon.” 

There was news in ET  during the beginning of Sept. 2021 that Indian Govt. is reworking on the Regulatory bill to redefine the clauses which were supposed to be there in regard to the ‘Ban’ earlier.  https://economictimes.indiatimes.com/markets/cryptocurrency/crypto-as-commodity-what-does-it-mean-for-you-and-the-industry/articleshow/85892934.cms 

 

Govt. may consider cryptos as Commodity / Asset / Currency depending upon actual utility case of cryptos. What does it mean for you?

Govt. is working on categorization of cryptocurrencies like treatment according to the usage / application of cryptocurrency will be decided. Govt. may treat cryptocurrency as commodity / asset class / currency for all purposes , including taxation, use cases like investments, payments or utility.

If crypto is used as an investment, crypto might be treated as an investment class assets like short-term or long-term.

Crypto as a commodity : when crypto is used to describe a tradable or fungible or non-fungible asset that may represent a commodity, utility, or a contract in the real or virtual world through exclusive tokens on a blockchain network. These digitised tokens can be used to represent any kind of virtual or real world asset like in-game objects, rewards points, or real world commodities.   https://www.investopedia.com/terms/c/crypto-commodity.asp

 

Let’s understand a little more about regulatory aspects with the help of certain valuable frequently asked questions by the communities involved :

Important connected & participating parties in crypto space are : 

–   Any resident/citizen/corporate/institution of India involved in trading/investments of crypto assets/currencies 

–   Crypto exchanges involved in providing platform for conducting crypto transactions 

–   Government bodies like Income tax, GST, Enforcement agencies, Reserve bank of India, Government itself

 

Questions commonly asked by the crypto users are following :

 1.       Under Income Tax Act : 

How the income/loses arising from the transactions of crypto assets/currencies will be treated in the hands of the person/s doing such transactions, under various heads like :

a.     Income from business or profession

b.     Income from Capital gains/loses

c.     Income from speculation

d.     Income from other sources

e.       Income from salary

Income from Profit / Gains from Business : If it’s your regular business of buying /selling/trading/mining cryptos, then income from cryptos will be taxed under this head.

Income from Capital Gains : If you are buying/selling/trading like an investor for short term or long term, then such income/loses will be treated under this head.

Income from Other Sources : Due to lack of regulations for cryptos, sometimes income/loses from cryptos are also taxed under this head for a transaction like once a while like maybe one in a year.

Income from salary : This is very interesting fact. Why crypto should be taxed under this head? Now-a-days most of the crypto companies in India or abroad are paying regular remunerations in the form of cryptocurrencies and such receipts may be taxed as salary income in the hands of recipients and valued at rate in fiat prevailing on the date of receipt.

When Crypto transactions can be considered as speculative transactions ?

Definition of speculative transaction : Speculative transaction is a transaction in which a contract for the purchase or sale of any commodity, including stock and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scripts. As per definition, investing in crypto will not fall under speculative transactions as it covers only for transactions commodity, stock or shares and crypto is neither commodity not stocks/shares or securities. So, income/loses from crypto will always be taxed under the heads of business or profession, Capital gains/loses at the prescribed rates of tax as applicable.

Intraday trading /derivatives/ in equity market is considered as speculative, hence income arising from there is taxed under the head ‘Speculation income’. Accordingly, in crypto income arising from intraday trading/ derivatives/ is taxed as speculative income at rates prescribed under same head.

This is also true that different heads according to applicable circumstances will be decided upon.

Do we have to pay taxes only when profit is there on crypto transactions ?

Taxable events arise whenever there is conversion from :

o  cryptocurrency to fiat currency

o  cryptocurrency to cryptocurrency

o  cryptocurrency to goods/services

How the losses from Crypto transactions will be treated under Income Tax Act in India ?

How receipt of crypto as gift treated under Indian Income Tax Act ?

 

Under Goods & Services Act :

• How the crypto incomes/payments/receipts will be taxed under various provisions of GST Act?
• How & how much % of GST will be levied on the trading fee & other fees charged by the crypto exchanges  from the users of the such respective exchanges?
• How the provisions of ITC (Input Tax Credit) will be applicable in case of B2B transactions in the space of crypto world?
• How much GST should be levied on commissions receivable/payable  in the crypto space among various parties?

 

General category questions :

Ø  Can Corporates or Financial Institutions deal in cryptos in India ? What are the rules, if any prescribed by the regulatory bodies ?

Ø  Whether Bitcoin mining is treated as business or something else in the Indian Income Tax Act ?

Ø  What are the cases when I can accept cryptos as payments for my services / products sold ? Do I have to pay taxes for such cases ?

 

 Various Enforcement – agencies/laws :

•  If any crypto transaction is found against the rules of FEMA/AML/KYC laws, how the steps will be taken by various enforcement agencies to enforce the prevailing laws?
•  Who will be the designated authority to enforce the laws to prevent the criminal activities in the crypto space?
•  What kind of punitive actions will be taken either under prevailing laws or new law/s will be enacted?

Existing FOREX Regulations :

In the following words, let me give a little more understanding about existing FEMA regulations when any crypto user deals with foreign exchange in his/her/its cross border crypto transactions.

Few months back one Indian bank ICICI had started asking it’s users not to remit any forex under the LRS scheme framed by RBI for dealing with foreign exchange transactions by the Indian residents/companies / individuals. Already I have written on this at Linkedin & other social medias. I am sharing here link for same and contents.

https://www.linkedin.com/pulse/what-icici-bank-has-done-indian-blocks-use-rbis-remittance-kumar

ICICI has started asking it’s customers not to use RBI’s scheme of LRS for buying / making investments in cryptocurrencies. 

ICICI, a leading private bank in India, has updated its retail outward remittance application to include cryptocurrency. 

By doing so, the bank indirectly is asking its customers to declare under India’s Foreign Exchange Management ACT 1999 (FEMA) that they will not use the Reserve Bank of India’s Liberalised Remittance Scheme (LRS) for any crypto related investments.

The bank’s declaration states :

“The above remittance is not for investment / purchase of bitcoin / cryptocurrencies / virtual currencies (such as ethereum, ripple, litecoin, dash, peercoin, dogecoin, primecoin, chinacoin, ven, bitcoin or any other virtual currency / cryptocurrency / bitcoin).” 

Customers must also declare that the remittance is not for any investments in a “company dealing in bitcoins / cryptocurrency / virtual currencies.”

It’s not only ICICI has stopped, it is asking its customers about the sources of funds also in the declaration that “The source of funds for the proposed remittance is not proceeds from redemption of investment in cryptocurrencies / bitcoins / virtual currencies and also end use of.” 

If you remember the time of 2018 when RBI had banned banks from providing services to crypto business, it was ICICI bank among front leading banks who stopped services to their customers for cryptos.  

In May, RBI issued a letter to all banks in India with clarification on it’s 2018 ban that such circular of 2018 is not binding / valid from the Supreme court judgement of March 2020, and therefore can not be cited or quoted from. In March,2018 Supreme court has quashed the RBI’s imposed ban on banks.  

It’s also important to discuss about certain regulations of LRS & FEMA,1999 : 

RBI regulate LRS scheme through it’s Master Circular no. RBI/FED/2017-18/3 FED Master Direction No. 7/2015-16 latest updated on June 20, 2018, link to this circular also shared herewith :  

https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10192 

This LRS scheme is applicable for all Indian resident individuals as per following extracts taken from RBI’s “Master Direction – Liberalised Remittance Scheme (LRS)” :

“A. Liberalised Remittance Scheme (LRS) of USD 2,50,000 for resident individuals 

1. Under the Liberalised Remittance Scheme, Authorised Dealers may freely allow remittances by resident individuals up to USD 2,50,000 per Financial Year (April-March) for any permitted current or capital account transaction or a combination of both. The Scheme is not available to corporates, partnership firms, HUF, Trusts, etc.”  

“5. All other transactions which are otherwise not permissible under FEMA and those in the nature of remittance for margins or margin calls to overseas exchanges/ overseas counterparty are not allowed under the Scheme.” 

If ICICI bank is acting under this provision, then investing in cryptocurrencies is different from margins or margin calls which falls under derivatives. ICICI should have asked its customers to declare that forex under LRS is not being used for margins or margin calls. 

Point no.6 of the master circular also can be used sometimes to mark crypto investments as under asset class, unrated debt securities etc. 

Point no. 8 of the master circular also can be used to mark our crypto investments like in NFTs etc. 

 “8. Remittances under the Scheme can be used for purchasing objects of art subject to the provisions of other applicable laws such as the extant Foreign Trade Policy of the Government of India.”  

Point no. 12 of the circular also can be checked which mentions about prohibitory transactions mentioned in the certain schedules of FEMA, as amended from time to time. Nowhere in FEMA anything mentioned about cryptocurrencies as prohibited transaction. 

“12. The Scheme is not available for remittances for any purpose specifically prohibited under Schedule I or any item restricted under Schedule II of Foreign Exchange Management (Current Account Transaction) Rules, 2000, dated May 3, 2000, as amended from time to time.”  

Under LRS master circular, RBI has issued operational instructions to Authorised persons (Banks one of them) : 

Extracs from circular :  

“B. Operational instructions to Authorised Persons 

 2. The Reserve Bank will not, generally, prescribe the documents which should be verified by the Authorised Persons while releasing foreign exchange for current account transactions. In this connection, attention of authorized persons is drawn to sub-section (5) of Section 10 of the FEMA, 1999 which provides that an authorised person shall require any person desiring to transact in foreign exchange to make such a declaration and to give such information as will reasonably satisfy him that the transaction will not involve and is not designed for the purpose of any contravention or evasion of the provisions of the FEMA or any rule, regulation, notification, direction or order issued there under.”

This is the point which covers about the declaration kind of thing. Sub-section 5 of section 10 of the FEMA,1999 clearly mentions that any person (individual resident in India) has to make such a declaration and to give such information that the transaction will not involve any evasion of the provisions of the FEMA.

I will be obliged if someone can tell me whether dealing in cryptocurrencies is prohibited in FEMA’1999.