Crypto-Assets

September 9, 2023

GS Paper III Indian Economy

Context:

The International Monetary Fund (IMF) and the Financial Stability Board (FSB), released a policy paper, at the request of the Indian G20 Presidency, which recommended against an outright ban on crypto-assets.

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Financial Stability Board (FSB):

It is an international body that monitors and makes recommendations about the global financial system.
It succeeded the Financial Stability Forum in 2009 after the G20 Summit in London.
Mandate:
- Promote coordination and information exchange among authorities responsible for financial stability.
- Monitor and advise on market developments and their implications for regulatory policy.
Headquarters: Basel, Switzerland.
Its decisions are not legally binding on members.
India is a Member of the FSB

Earlier India’s Position: In 2018 the draft scheme of the Central Board of Direct Taxes called for banning virtual currencies , also the RBI restrained banks from dealing in cryptocurrencies, a decision that had to be reversed by the Supreme Court in 2020.
Suggestion from the paper: Introducing a licensing regime for crypto-asset platforms , bringing the asset under the fold of anti-money laundering and counter-terrorist financing standards.
It marks as the new beginning of the conversation on a global framework for regulating crypto-assets, with India acting as the main enabler.

What is Cryptocurrency?

Cryptocurrency is a bank-independent digital currency that uses a decentralized technology

International Monetary Fund (IMF):

The IMF was conceived in July 1944 at the United Nations Bretton Woods Conference.
Functions: Providing loans and concessional financial assistance to member countries experiencing actual or potential balance-of-payments problems.
Headquarters: Washington D.C, USA.

called blockchain to record and verify transactions in a digital ledger without any third-party interference or central authority monitoring the deal.
- For Example: Bitcoin, Etherum, Ripple and Litecoin

Implications of crypto-assets on the Financial Ecosystem:

Macroeconomic stability:
- Monetary policy: The widespread adoption of crypto-assets could threaten the effectiveness of monetary policy as Monetary policy effectiveness would be compromised since central banks lack the ability to adjust interest rates on a foreign currency.
- Fiscal Policy: The spread of crypto-assets can increase fiscal risks. New fiscal risks can arise from the financial sector’s exposure to the crypto-asset ecosystem, the lack of clarity of tax regimes, and the cross-border nature of crypto-assets.
Regulatory issues: Regulatory powers and coverage Crypto-assets can pose challenges to legal, regulatory, and enforcement frameworks.
- For Example: In some jurisdictions, crypto-asset activities are conducted in non-compliance with applicable domestic regulations and may lead to enforcement and supervisory challenges for authorities.
  - In some other jurisdictions, crypto-assets may fall outside of the existing regulatory perimeter, leading to regulatory gaps.
Legal risks: If crypto-assets are granted official currency or legal tender status, they could raise significant macro-critical legal issues as crypto assets are not recognised in countries.
- Countries where cryptos are recognised as legal tender: Central African Republic (CAR), El Salvador
- Countries where cryptos are not recognised as legal tender: Algeria, Bolivia
Financial integrity: Due to their claimed pseudonymous nature, speed, global reach, and evidence of weak implementation of relevant anti-money laundering/counter financing of terrorism (AML/CFT) requirements, crypto-assets can be attractive to criminals, raising financial integrity risks.
- According to the National Terrorist Financing Risk Assessment, U.S. authorities have identified several instances where terrorist groups and their financial supporters solicited funds in virtual assets. For example:
  - Terror Financing: the Islamic State of Iraq and Syria (ISIS) has received external donations for refugee camps through virtual assets, which are converted into cash via hawaladars, where they are subsequently sent to the camps.
  - Facilitating illicit activity: Cryptocurrencies are being used to facilitate payments for various forms of illicit activity which includes the trade in drugs and other illegal goods on the dark web, ransomware such as Rhysida or Abyss Locker, kidnapping and ransom payments, and cyber-crime.
Market integrity: Non-compliance with or lack of regulation for crypto-asset activities can impair market integrity and the interests of market participants.
Environmental risks: Two design elements of the supporting distributed ledger network have key implications for the energy consumption of crypto-assets.
- For Example:
  - Nearly 38 kilotons of electronic waste are annually produced as a byproduct of Bitcoin mining.
  - Ethereum, the second-largest cryptocurrency network, was estimated to use 62.77 Terawatt-hours of electricity per year, based on energy consumption through July 9, 2022.

Cryptocurrency regulation in India:

Payment Regulation: Cryptocurrencies as a payment medium in India are not regulated by any central authority.
Crypto Tax: 30% tax deduction on the transfer of virtual currency or cryptocurrency assets, including 1 % TDS at the time of transactions.
SC banning RBI circular: The Supreme Court of India lifted the curb on cryptocurrency imposed by RBI, which restricted banks and financial institutions from providing access to banking services to those engaged in transactions in crypto assets.

Way Forward:

Safeguarding monetary sovereignty and stability: Developing effective frameworks and policies is the best way to limit substitution into crypto-assets. Robust macroeconomic policies and credible institutional frameworks are fundamental to protecting monetary sovereignty.
Guard against excessive capital flow volatility: Policymakers should take steps to counter the potential erosion of counter financing of terrorism(CFMs) caused by the adoption of crypto-assets.
Address fiscal risks and adopt unambiguous tax treatment: Fiscal risks arising from the widespread adoption of crypto-assets including those resulting from granting legal-tender or official currency status should be identified, analysed, and disclosed.
Financial integrity regulation: Jurisdictions should implement the FATF Standards in the virtual-asset sector to protect their financial systems and the global economy from threats of money laundering, and the financing of terrorism and of proliferation of weapons of mass destruction.
Market integrity regulation: Jurisdictions should implement and apply the IOSCO Principles and Standards to economically equivalent crypto-assets and activities.

About International Organization of Securities Commissions (IOSCO):

IOSCO is the international body that brings together the world’s securities regulators and is recognized as the global standard setter for the securities sector.
It develops, implements and promotes adherence to internationally recognized standards for securities regulation.
It works intensively with the G20 and the Financial Stability Board (FSB) on the global regulatory reform agenda.
Headquarters: Madrid, Spain
It sets out 38 Principles of securities regulation, which are based upon three Objectives of securities regulation:
- protecting investors;
- ensuring that markets are fair, efficient and transparent;
- reducing systemic risk.