We need smart regulation to unlock the true potential of crypto assets

To understand this, let’s take an over and over again advantage of crypto assets- that they make finance more inclusive and decentralized. But India already has the world’s largest financial inclusion program in Jan Dhan. In the last seven years, 430 million bank accounts have been created for under-banking. The majority of them, 55%, are women. There are 45,000 chit funds (and many are unregistered). These chit funds are the largest decentralized finance application in the world. Crypto can’t match that scale. Hence, financial inclusion is not the main reason for the adoption of crypto assets in India. But there are three India-specific reasons for the adoption of crypto assets.

Establish India as an integral part of the new financial ecosystem: Large global financial institutions and investors are adding crypto assets to their portfolios. The domestic crypto market in India and the global opportunity are synergistic. Finance firms, banks, fintech and crypto startups can take advantage of the huge growth of the industry. Software Technology Parks (STPs) and Special Economic Zones (SEZs) enabled the boom in IT services. Creative ‘crypto export sector’ schemes can develop clusters of excellence and create world-class financial services firms and unicorns.

Take advantage of opportunities in new technology and services: Banking, financial services and insurance customers constitute the largest segment of India’s IT services. Blockchain application development, its scalability, security and analytics are the next opportunities for their development. To meet this demand, there is a need for a large talent pool with expertise in the crypto tech stack.

Get Optionality on Financial Innovation: There is an explosion of technology innovation and business models around blockchain. There are many interesting applications, but new killer apps will emerge. The impact of new technologies is underestimated in the short term, but underestimated in the long term.

Next, let’s consider the regulatory perspective. India’s financial sector regulation is conservative, and that is a good thing. This same conservatism helped Indian financial institutions in the face of the 2008 global financial crisis compared to many western firms. And, there are three major regulatory concerns regarding crypto assets.

Investor Protection: Investor safety has been a top priority for Indian regulators. Crypto assets are viewed as high-risk, speculative assets. Investor education, guidelines against misselling and other safeguards are needed.

Crypto assets are now better understood as digital assets rather than digital currencies. Regulating them like commodities and clarifying their tax treatment is a win-win. The tax revenue of the government increases. It could also increase the number of tax filers (only 64 million in FY20) and the number of taxpayers (14 million).

Bypassing existing rules: Certain crypto assets may allow individuals to bypass securities issuance laws. This is a potential risk to the capital markets. Crypto assets can be used to evade capital controls. This is a potential risk to macroeconomic stability. Such concerns can be mitigated if crypto holders have to declare their holdings above a particular level in their tax forms.

Illegal Transfers: Anonymous transfers of crypto assets can undermine anti-money laundering laws or combat terrorism financing regulations. This is a potential national security issue. Know Your Customer (KYC) norms are the solution here. Furthermore, a blockchain can bring more transparency to financial transfers as all its transactions can be traced. India is a part of the G20 Financial Action Task Force (FATF), and players in the crypto industry should follow the recommendations of the FATF.

In short, a smart regulatory approach considers both potential upside and downside. It promotes financial innovation, protects investors and opens up the Indian crypto ecosystem.

Kashyap Kompela, CFA, is a Technology Industry Analyst.