August 20, 2016
The purpose of this article is to highlight the issues of a consumer who wants to invest in digital currencies like bitcoin and how can the regulator achieve the twin objective of a cashless economy and regulating the cryptocurrencies.
The legal status of bitcoin varies substantially from country to country and is still undefined or changing in many of them. While some countries have explicitly allowed its use and trade, others have banned or restricted it. Likewise, various government agencies, departments, and courts have classified bitcoin differently. Indian regulators’ stance on bitcoin and cryptocurrencies has been muted.
In June 2013, the Reserve Bank of India (RBI) issued a notice acknowledging that virtual currencies posed legal, regulatory and operational challenges. On December 24, 2013, the Reserve Bank of India issued an advisory to the Indian public to be cautious in buying or selling of virtual currencies, including bitcoin. Following the announcement, bitcoin operators in the country began suspending operations.
Recently, the RBI has been changing stance on bitcoin and the RBI has come around to appreciate the strengths of the underlying 'blockchain' technology. However, we have seen new bitcoin exchanges coming up and are trading actively today. The transactions volumes are also increasing exponentially. However, the RBI’s approach towards bitcoin and other cryptocurrencies have been unknown even now. There are no clear guidelines from the RBI on bitcoin.
The inherent value of cryptocurrency as an alternative method to store and transmit units of value has gained acceptance from a critical mass of investors, technologists, regulators, merchants, entrepreneurs and consumers. It’s clear that cryptocurrencies are more than a passing phenomenon. In fact, cryptocurrencies represent the beginning of a new phase of technology-driven markets that have the potential to disrupt conventional market strategies, longstanding business practices, and established regulatory perspectives—all to the benefit of consumers and broader macroeconomic efficiency. Cryptocurrencies carry the groundbreaking potential to allow consumers access to a global payment system—anywhere, anytime—in which participation is restricted only by access to technology.
Growth within the cryptocurrency market has been driven largely by venture capitalists investing in technology infrastructure, and other investors seeking to profit from price fluctuations, rather than by consumers actually using cryptocurrency. This carries uncertainties with it: according to one estimate, the volatility of bitcoin against the dollar on a bitcoin exchange is about five to seven times the volatility of traditional foreign exchange trading. The full potential of cryptocurrency may be realized only when the market makes the leap from the hands of investors into the hands of consumers.
Despite the vast potential of cryptocurrencies, and its proven ability to survive several formidable tests of its legitimacy, the current state of the market remains fragile. This is due in large part to the serious threats exposed by Silk Road money laundering schemes, and the more recent cybertheft that swiftly drove the bitcoin exchange Mt. Gox into bankruptcy. The perception around cryptocurrencies encourage tax evasion, bribery payments, terrorist financing, and financing counterfeit products, is gaining ground. There have already been glimpses of interest from terrorist groups discussing its uses in chat rooms. Simply put, the technological innovation of cryptocurrency, with its positive attributes, has brought with it a dark side in which its most fundamental innovations—speed, secure transfer and store of value, and limited personal data exposure—are exploited by hackers and criminals. We need regulators to adopt an encouraging approach which facilitates the adoption of cryptocurrencies but also provides a fool-proof monitoring mechanism.
As mentioned earlier today cryptocurrencies are not widely adopted due to various reasons. One of the key reasons is the lack of awareness towards them and the volatility of cryptocurrencies. The volatility can also be attributed to the lack of wider adoption. However, one important aspect that potentially could impact consumer adoption is the way trading in cryptocurrencies happen today. The trading is predominantly done through an exchange which allows people to trade in cryptocurrencies. As per the last count available, there are more than 100 odd exchanges across the world. Some exchanges do support multiple currencies. However, to trade with an exchange, consumers have to open a wallet account and credit fiat currency into it. The cost of conversion of fiat to cryptocurrency and vice versa is substantial. One of the key challenges from a customer perspective is the risk associated with depositing fiat money with the exchange. More importantly, the process of depositing and withdrawal of fiat money is cumbersome.
Another important issue that customers are facing today is the interoperability of exchanges. While cryptocurrencies can easily be transferred from one exchange to another, the transfer of fiat money is rather impossible. This means that the customers have to have funds with each of the exchanges which add to the working capital cost and the process of transfer which is rather cumbersome.
One of the key incentives for investments in cryptocurrency is the anonymous nature of the transactions. Investors also look at the gains from investments as easy money and avoid paying taxes. Considering the challenge and risk of investing in each of the exchanges, can we consider a crypto-wallet which acts like a fiat wallet for every exchange and can easily be monitored by the regulator? This would be equivalent to something like share trading platform which allows us to trade with any exchange and also report the gains to the regulator. From an Indian perspective, the solution would integrate with all five exchanges and allow the easy transfer of money from wallet to fiat.
As explained in the solution above, there is definitely an opportunity for regulators to encourage and monitor cryptocurrencies. All that we need is cooperation from exchanges and regulators to facilitate customer adoption which also encourages proper monitoring of the transactions. Regulators cannot afford to be in denial mode anymore.
This would also provide an easy and effective solution for regulators and other authorities to monitor the movement of money from customer accounts and also remove the anonymity of people holding or trading in bitcoin/cryptocurrencies.