Has crypto adoption gotten too widespread to be ignored by policy?

    Has crypto adoption gotten too widespread to be ignored by policy?
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    By Latha Venkatesh   IST (Published)

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    Chainalysis, the blockchain data platform says crypto adoption grew by 881 percent as of August 2021, over the previous 12 months. And India along with Vietnam ranked as one of the fastest-growing markets.

    Anecdotal evidence suggests that cryptocurrency trading and investment is spreading fast in India. While numbers are unreliable, here's some evidence. The largest digital stockbroker Zerodha has 7 million accounts, while crypto exchange WazirX, has 8.5 million accounts and Coinswitch Kuber has 11 million accounts.
    Of course, equity accounts run into crores, and WazirX and Coinswitch may have overlapping members. But the pace of growth is important. Chainalysis, the blockchain data platform says crypto adoption grew by 881 percent as of August 2021, over the previous 12 months. And India along with Vietnam ranked as one of the fastest-growing markets.
    If adoption is widespread and growing, the question we need to ask is: Has crypto adoption gotten too widespread to be ignored by policy-makers? Now, this raises a couple of sub-questions:
    First:
    Are Indian policymakers ignoring the regulation of cryptocurrency exchanges, traders, and investors. The answer is yes. The CBDT does tax income or gains from cryptocurrencies. But there is little else by way of regulation. The RBI in 2018 told bank not to have any trucks with virtual currency exchanges or traders. That circular was struck down by the Supreme Court in 2020. Separately the government said in February this year, it is bringing a law to ban all private digital currencies and recognize only state-backed virtual currency, but nothing has been shared about the current status of that law. Hence, as of now, cryptocurrency exchanges, traders and apps are entirely unregulated. To the extent they use the banking system, banks do anti-money laundering checks. But the exchanges themselves are not regulated and don’t have any reporting obligations to any authority.
    Second: If cryptocurrencies are unregulated, can a crash in say bitcoins or other coins, and resultant defaults destabilize the financial system. Most Indian bankers say unlikely. Bankers aver that no bank in India accepts cryptos as collateral for loans, nor do they provide margin funding, given RBI's well-known anathema to this asset class. So hypothetically if bitcoin crashes to say $10,000, no bank in India would be hurt. A few youngsters who may have taken personal loans or borrowed on their credit cards to punt on these exchanges may default, but these are likely to be very small for the banking system. This argument appears convincing, but one can't be sure where some leverage may be lurking.
    This brings up the next question: How are other countries handling it? Many developed and emerging economies have proactively moved to regulate cryptocurrency players in their jurisdictions. An important point to note here is the trading itself can't be regulated because blockchain like the internet lies beyond and outside national governments. National governments can't regulate the internet itself. They can make rules on what websites may be blocked or how they may penalize people who use them for wrong ends.
    Coming to jurisdictions that have been more open to cryptocurrencies - Singapore, Japan, countries of the European Union and the United Kingdom, all have recognized cryptocurrency trading though most don't recognize it as legal tender. Regulation in these countries has the following elements:
    • Most require crypto exchanges to be registered with either the securities or commodities trading regulator.
    • These exchanges have to adhere to strict Know Your Customer (KYC), Anti-Money Laundering (AML) and Countering of Terror Financing (CFT) rules.
    • They are subject to taxation, as property, capital gains, or business income.
    • Importantly, most do not allow the exchanges or their financial entities to offer leverage or derivatives trading
    • For a bunch of countries that have recognized crypto trading, there is a significant bunch that remains ambivalent – US, China, and India, among them. The US Securities & Exchange Controller or SEC has penalized many crypto exchanges, brokers, and platforms for specific products which it says are securities, and hence have to follow securities law. But the SEC has not defined when or what it calls securities, with respect to cryptos.
      The US government came close to recognizing cryptocurrencies while passing the $1 trillion infrastructure bill when it said that taxes from these entities can yield $28 billion over the next 10 years to fund infra, but the bill finally didn't tax them.
      One reason policymakers in India, China, and the US, do not explicitly define, ban or allow crypto trading, could be a fear that the very act of regulation can vastly increase the number of investors, who believe their money is safe since the government is regulating; and then if there is a severe fall in these assets, a large number of investors may be hurt. Non-bank entities which are mostly lightly regulated may also be hit, engendering a systemic disruption.
      Ronit Ghose, Citibank's global head for banking, fintech, and digital assets says it is unlikely cryptocurrency crashes can have a systemic impact. He calculates that while the total value of cryptos in the world stands at about $2.5 trillion, total equity investments in the world amount to $130 trillion, total financial assets may by $400 trillion and including property, much more. So any threat to the financial system from this $2.5 trillion asset class is unlikely.
      But some central bankers are not so sure. Similar math would have been true of Lehman Brothers as well. Some veteran central bankers worry that cryptos have grown too big and can endanger the system. They also believe this asset class looks set to expand and it may not be possible to wish them away.
      For the moment the only fallback is to educate traders and investors about the volatile nature of the asset class even as financial regulators keep an eagle eye for any possible impact on banks and non-bank financial entities. Separately, maybe supranational bodies like the IMF, the BIS, and the FATF must swing into action and prepare some ground rules that all nations can follow. But that again maybe a catch-22. The more rules are written the more rapidly the numbers of crypto adherents may grow, the less likely national sovereigns may be able to regulate this supra-national asset-class.
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