The Bipolar Nature of Cryptocurrencies in India

CryptoX
Aug 23, 2018
5 min read

In February 2018, Indian Finance Minister Arun Jaitley’s Budget speech caused unrest in the national press and among investors, followed by the fall of bitcoin to $8,800, from an all-time high of $19,343 barely two months earlier.

Why do legalities matter and what is the status quo?

Jurisdiction: RBI or SEBI?

The Reserve Bank of India (RBI) handles policy formulation and enforcement of payment systems regulations in India. Hence, Virtual Currencies (VCs) may soon come under the purview of the RBI, and not, as some had predicted, the Securities and Exchange Board of India (SEBI).

The ‘Speech’ and What it Implies

Thi 2018 Budget Speech by Mr. Jaitley was the first time the legality of VCs had been formally addressed, barring repetitive RBI warnings against digital currency investments, labeling them as “Ponzi schemes” that offer unusually high returns to early investors.

Mr. Jaitley announced that “The Government does not consider crypto-currencies legal tender or coin and will take all measures to eliminate use of these crypto-assets in financing illegitimate activities or as part of the payment system.”

Contrary to popular belief, this doesn’t mean crypto trading is illegal, but that it comes with its own risks, like any other investment asset in the market. In other words, they’re not legal, but they’re not illegal either. Classic case of Bipolar Disorder.

The Status Quo

In April 2018, RBI asked all the regulated entities, including banks, to withhold services provided to any individual or business dealing in digital currencies. RBI provided a three-month window to Banks to end all existing relationships with the aforementioned players. It was this near-ban announcement that left investors and businesses scrambling.

This led to an increase in trading on P2P Platforms, which appear to give a solution to those who want to exit or enter the crypto world as they eliminate the need for third-party intermediaries like banks and financial institutions.

Though the mechanism is fraught with risk, the exchanges claim they have fool-proofed it. One important aspect is that both the exchanges are allowing the transactions only between KYC-verified users, which includes Aadhaar and permanent account number (PAN) disclosure.

A high-level committee headed by Subhash Chandra Garg, Secretary, Department of Economic Affairs of the Ministry of Finance, is expected to firm up some recommendations for Crypto Regulations soon.

The Discourse: Why Cryptocurrency is Unpopular among State Actors

Many governments around the world (with the notable exception of Japan) do not recognize cryptocurrencies as legal currency or tender. Initial Coin Offerings (ICOs), where companies raise funds by selling a new digital currency, build on the Blockchain technology and enhance it further. They threaten to disrupt the venture capital industry by slashing the cost of fundraising — and opening up the possibility of investing in start-ups to anyone with a smartphone.

In his speech, Mr. Jaitley expressed the Government’s desire to enhance and embrace blockchain while eliminating VCs. However, it will be hard to separate the two.

Mining is the process that develops and enhances Blockchain technology, and Miners are incentivized with VCs. There are two different ways to run a distributed system—public and private.

Let’s assume X wants to use blockchain for Supply Chain Management. X enters data in a system for everyone to view, and has the power to modify it. It is thus a private blockchain and X will have full control over it. X is essentially using decentralization technology to create another centralized system, which proves to be counterproductive. Public blockchain systems are required for transparency and those who guard it need to be paid in the form of cryptocurrency.

Blockchain Technology could also disrupt the Banking, Real Estate and Cyber Security Sector; which is why States are hesitant to embrace this technology.

Politicians all over the world express concern about the cryptocurrency craze, citing worries about security, regulations, volatility and a speculative bubble (the bursting of which could be catastrophic, very much like that of the Real Estate Bubble that triggered the 2008 Financial Crisis).

Taxes: A Catch-22 Situation

VC remains an unexplored source of revenue in the form of taxes since the accounting and taxation treatment for the same is not regulated properly. The need of the hour is to bring in an effective rather than a regressive framework. Levy of tax on bitcoins cannot be ruled out because Indian Income Tax Laws have always sought to tax income received irrespective of the form in which it is received.

Cryptocurrencies are neither money nor a foreign currency, nor a financial supply for goods and services tax (GST) purposes, which makes taxation complicated.

In the case of VC acquired through mining, there is a possibility that the Department of Taxation may not consider it as a capital asset and the provisions of capital gains would not apply to it.

Accordingly, the income tax authorities may choose to tax the value of bitcoins received from mining under the head Income from other sources. On the contrary, the income arising out of bitcoins trading activity would give rise to income from business and accordingly, the profits arising out of such business would be subject to tax as per the individual slab rates.

What we can Learn from China

Complete eradication of Cryptocurrency from the Indian Financial Sector is unlikely since blockchain technology has huge potential (perhaps even more than Big Data and AI), and the government realizes that. In September 2017, the People’s Bank of China outlawed Cryptocurrency.

China banned mainland residents from trading in VCs on exchanges, made it illegal for Chinese Start-Ups to raise funds via ICOs and even imposed travel bans on Huobi and OKCoin executives, two of the nation’s largest exchanges.

Bitcoin prices fell (from a record high above $5,000 per bitcoin at the beginning of September to a low of $2,951 by mid-September), only to dramatically surge again in December 2017. This is because Bitcoin moved elsewhere and quickly re-established its market.

The self sufficiency of blockchain challenges the age old rhetoric that any communication or transaction between two individuals depends on a third party (which seeks to profit off of these transactions). Although still in a state of turmoil, most VCs quickly overcame the blow to their market value. They got back on their feet, their resolution resembling that of an Asgardian God hard to knock down. That's it. That's the point.

With the legalization of cryptocurrency in 2017, the Government of Japan continues its quest to become a global cryptocurrency hub.

The United States of America doesn’t recognize Cryptocurrency as legal tender, instead, it is treated as property and the Internal Revenue Service has proper laws in place for taxation of the same.

China was eliminated from a huge emerging market pretty quickly, and so could India if the State Government decides upon complete eradication.

“Japan and the U.S. have proven China is unnecessary for bitcoin to thrive," Charles Hayter, CEO, and Founder of digital currency comparison website Crypto Compare told CNBC.