Regulation of Cryptocurrencies

Context: In a joint report submitted by the International Monetary Fund (IMF) and the Financial Stability Board (FSB) to the Group of 20 nations, it recommended comprehensive regulation of cryptocurrencies instead of a blanket ban.

Key Recommendations by the Report

• Blanket Bans Ineffective: The report emphasizes that a blanket ban on cryptocurrencies would not be effective.
  • It suggests that such bans can be costly to enforce, increase incentives for circumvention, and create potential financial integrity risks.
• Risks of Widespread Adoption: It highlights the risks associated with the widespread adoption of cryptocurrencies. These risks include
  • undermining the effectiveness of monetary policy,
  • circumventing capital flow management measures,
  • exacerbating fiscal risks,
  • diverting resources away from the real economy, and
  • threatening global financial stability.
• Need for Comprehensive Regulatory Response: Instead of blanket bans, the report calls for a comprehensive policy and regulatory response. This approach aims to strike a balance between innovation and risk management.
• Anti-Money Laundering and Counter-Terrorist Financing Standards: To prevent misuse of cryptocurrencies, the paper recommends that jurisdictions implement the Financial Action Task Force (FATF) anti-money laundering and counter-terrorist financing standards that apply to virtual assets and virtual asset service providers.

About the International Monetary Fund (IMF)

• Established in 1944 at the Bretton Woods Conference with the goal of reconstructing the international monetary system.
• IMF fosters economic growth and employment by providing temporary financial assistance to countries to help ease the balance of payments adjustment and technical assistance.
• Headquarters: Washington, DC, USA.
• Currently, it has 190 member countries (including India).
• Important Reports: 
  • World Economic Outlook.
  • Global Financial Stability Report.

About the Financial Stability Board (FSB)

• FSB is an international body that monitors and makes recommendations about the global financial system.
• It was established in April 2009 after the G20 Summit in London as the successor to the Financial Stability Forum.
• Headquarters: Basel, Switzerland.
• The board includes all G20 major economies.

What are Cryptocurrencies?

• Cryptocurrencies are digital or virtual forms of money that use cryptography for secure and private transactions.
• They are decentralized and typically operate on a technology called blockchain, which is a distributed and immutable ledger that records all transactions in a transparent and tamper-proof manner.
• Examples of cryptocurrencies include Bitcoin (BTC), Ethereum (ETH), Tether (USDT), XRP (XRP) etc.

Key Features of Cryptocurrency

• Decentralization: Unlike traditional currencies issued by central banks, cryptocurrencies operate on decentralized networks. This means that no single entity or institution has complete control over the currency, making them immune to traditional financial systems and government regulations.
• Blockchain Technology: Most cryptocurrencies use blockchain technology, which is a digital ledger that records all transactions across a network of computers (nodes). This ledger is secured through cryptographic techniques, making it highly resistant to manipulation and fraud.
• Limited Supply: Many cryptocurrencies have a limited supply, which means there is a maximum number of units that can ever be created.
  • For instance, Bitcoin has a maximum supply of 21 million coins.
• Anonymity and Privacy: While transactions on a blockchain are transparent and visible to all participants, the identities of the users involved in those transactions are often pseudonymous.

Advantages of Cryptocurrencies

• Inherent Security: Cryptocurrencies use strong cryptographic techniques which makes them highly secure and resistant to fraud and counterfeiting. Transactions are also recorded on a transparent and tamper-proof blockchain.
• Low Transaction Costs: Cryptocurrency transactions typically involve lower fees compared to traditional financial systems, especially for international transfers. This can make cross-border transactions more efficient and cost-effective.
• Decentralization: Cryptocurrencies are not controlled by any central authority or government, providing greater financial autonomy and reducing the risk of government interference or censorship.
• Lower Entry Barriers: Cryptocurrencies are accessible to anyone with an internet connection, eliminating the need for traditional banking infrastructure and documentation.
• Global Accessibility: Cryptocurrencies can be used and accepted globally, making them ideal for borderless transactions and international commerce.
• Efficient Remittances: Cryptocurrencies can facilitate faster and cheaper remittances, allowing individuals to send money to their families across borders without high fees.
• Financial Inclusion: Cryptocurrencies have the potential to bring financial services to individuals who lack access to traditional banking systems, especially in regions with limited banking infrastructure.
• Innovation and Development: The underlying technology of cryptocurrencies, blockchain, has spurred a wave of innovation in various industries beyond finance, including supply chain management, healthcare, and more.

Challenges with Cryptocurrencies

• Price Volatility: The value of a cryptocurrency can fluctuate dramatically over short periods, which can make them risky as investment vehicles and hinder their use as stable stores of value.
• Misuse for Illicit Activities: Cryptocurrencies have been associated with money laundering, illegal transactions, and other illicit activities due to their pseudonymous nature.
  • Crypto crime accounted for a record-setting $20.6 billion worth of blockchain transactions in 2022, according to a new report from blockchain research firm Chainalysis.
  • According to Chainalysis, in 2021 alone, Indian users visited crypto scam websites over 9.6 million times.
• Security Concerns: The digital nature of cryptocurrencies makes them susceptible to various security risks, including hacking, phishing attacks, and malware.
  • The first major crypto hack occurred in 2011 when the crypto exchange Mt. Gox lost 25,000 bitcoins worth approximately $400,000.
• Regulatory Uncertainty: The regulatory landscape for cryptocurrencies is still evolving in many countries. Governments are grappling with how to classify and regulate cryptocurrencies, leading to uncertainty for users, businesses, and investors.
• Liquidity Challenges: While major cryptocurrencies like Bitcoin and Ethereum have good liquidity, many smaller or less-established cryptocurrencies can suffer from liquidity issues, making it difficult to buy or sell them without significantly impacting their price.
• Energy Consumption: Proof-of-work (PoW) consensus mechanisms, used by some cryptocurrencies, require significant computational power, leading to concerns about their environmental impact due to high energy consumption.

An Overview of Crypto Regulation in India

• Crypto assets in India: In India, they are identified as Virtual Digital Asset (VDA). Under Section 2 (47A) of the Income Tax Act (1961), VDAs are defined as
  • any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;
  • a non-fungible token or any other token of similar nature, by whatever name called.
  • any other digital asset, as the Central Government may, by notification in the Official Gazette specify.
• Trade in cryptocurrencies: Cryptocurrencies as a payment medium are not regulated or endorsed by the RBI. There are no clear guidelines dealing with cryptocurrency or its trade.
  • Even though crypto currencies have not been banned, their transactions in the country are very low. Majority of them buy cryptos as an investment.
• Taxation: During the Union Budget 2022-23, the finance minister announced a 30 per cent tax on gains from crypto assets and an additional 1 per cent TDS on the transfer of the said assets.
  • This marked Indian government’s official regulation of cryptocurrency in the country.
• Money laundering law: The government has brought crypto currencies and such other digital assets, trading, safe keeping and related financial services under the ambit of Prevention of Money Laundering Act (PMLA).
  • It means that entities dealing with crypto assets must follow similar reporting standards and KYC norms as the other regulated entities like banks, securities intermediaries, payment system operators, etc.

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