How to regulate crypto, minus a crypto-specific law

In previous columns, I have written about the futility of prohibiting Bitcoin trade, arguing that a ban is rarely an effective solution. I pointed out that, at the end of the day, the “only people who abide by the terms of a ban are those who always intended to use the service for legitimate purposes. Everyone else simply takes their already nefarious activities deeper underground.”

That said, there are other complexities that the proposed cryptocurrency regulation will have to address. In the first place, since anonymity is a widely touted feature of cryptocurrencies and given that most of them are relatively freely exchangeable with fiat currency, there is a concern that they might be used for money laundering. Many countries have addressed this by requiring cryptocurrency exchanges—the platforms that convert cryptos into real money and vice-versa—to carry out customer verification checks and by requiring them to retain transaction records for a stipulated period of time. In some jurisdictions, regulators have gone so far as to require exchanges to employ personnel trained to detect suspicious transactions.

Another concern has to do with how crypto transactions are taxed. While the capital appreciation resulting from crypto sales is obviously subject to capital gains, it is somewhat harder to determine how services that have been paid for using cryptocurrencies should be taxed under indirect tax regimes such as GST. One can argue that any service, regardless of whether it was paid for in fiat or crypto currency, should be subject to GST, but what is not immediately clear is how tax should be computed on such a volatile payment mechanism. One possible approach could be to base the actual tax payable on the fair market value of the cryptocurrency as on the date of payment or receipt.

And then there is the question of how to tax incomes that are specifically generated through cryptocurrency technologies, such as mining operations (in the context of proof-of-work based cryptocurrencies like Bitcoin). Given that crypto mining income has no real world equivalent, it might be necessary to amend the tax code so that income earned from this activity is treated as a novel category of income.

We will also have to decide on how we regulate crypto exchanges. Given that they are central to the regulation of this sector, we could require them to be registered in India in order to bring them unequivocally within the purview of Indian regulation. Some countries also impose licensing obligations on these exchange platforms, so that their continued operations are subject to compliance with specified conditions.

And then, finally, there is the question of how to regulate other crypto assets (new kinds of crypto tokens, initial coin offers,and the like) that have all the characteristics of a security but which operate on a blockchain. Most countries have brought crypto assets under the ambit of securities regulation, requiring issuers to comply with specific disclosure requirements at the time of issue as well as abide by insider trading and market manipulation regulations while trading in these crypto assets.

All of this seems to suggest that rather than introducing a brand new cryptocurrency legislation, as is currently being proposed, the government should simply amend existing anti-money laundering, taxation and securities regulations to ensure that they additionally cover the cryptocurrencies and assets discussed above. This would make sure that our existing regulatory frameworks, along with the associated enforcement apparatus that we have already put in place, are extended to regulate cryptos as yet another class of assets.

Having said that, this approach leaves out all those transactions that take place entirely in the cryptocurrency realm, those that never enter into the ‘real world’ because certain goods and services can be directly purchased using cryptocurrencies. At present, most governments have chosen to ignore this category of transactions, relying on the fact that these ‘currencies’ are still not widely accepted, and, as a result, most people who want to spend the cryptocurrencies in their possession would have to first convert them into regular fiat currency.

As much as this is true as of now, it is bound to change sooner than later. Mainstream businesses have already begun to accept cryptocurrencies as payment for goods and services, and, in time, I can see us being able to buy everything we need directly using cryptocurrency. Similarly, an ever-increasing number of entrepreneurs are choosing to raise funds by issuing crypto tokens and voluntarily submitting their organizations to decentralized blockchain-based systems of governance. This has given rise to a veritable explosion of decentralized autonomous organizations.

All these developments will be indicative of a more fundamental societal shift towards the widespread use of crypto. But it is not until that actually happens that we should think of enacting bespoke cryptocurrency regulation.

Rahul Matthan is a partner at Trilegal and also has a podcast by the name Ex Machina. His Twitter handle is @matthan