Blockchain caught in regulatory crossfire
When Union finance minister Arun Jaitley during the budget speech declared that the government does not consider cryptocurrencies legal tender, and will take all measures to eliminate use of these crypto-assets in financing illegitimate activities or as part of the payment system, it ended an era of regulatory forbearance and optimistic uncertainty in the cryptocurrency industry. Some interpreted this statement as spelling the death sentence for the blockchain industry while others took a more optimistic interpretation and assumed this to herald a clampdown on cryptocurrencies and initial coin offerings, but not blockchain technology-based products. Jaitley’s speech had also highlighted that the government will explore the use of blockchain technology, so perhaps there is some credibility to this interpretation.
The Indian cryptocurrency industry has been marred with uncertainty, given the laissez-faire approach followed by the government and the fear that regulators will not appreciate the nuanced distinctions between blockchain technology and blockchain products. It is for this very reason that proponents of blockchain technology have been frenetically trying to divorce the underlying technology from cryptocurrencies, but the two have been growing inextricably intertwined, making it increasingly challenging for blockchain-based products to escape getting caught in the crossfire of legislation designed to regulate cryptocurrencies.
With the Union cabinet’s approval of the Banning of Unregulated Deposit Schemes Bill, 2018 in the wake of Jaitley’s speech, the question as to what measures would be implemented to clamp down on crypto-assets appears to be self-evident. The government appears to have chosen a binary approach towards regulation of cryptocurrency products. Having left them hitherto unregulated, and now attempting to ban them altogether, the Indian government has now assumed the formidable responsibility of imposing regulations on an industry engineered to remain unregulated.
Since there has been a burgeoning number of initial coin offerings attracting investors with blithe promises of exponential returns (the most recent being Inmusik which, without any presence in India, ran advertisements soliciting investments in what can only be called a get-rich-quick scheme), there has been palpable concern relating to the legitimacy of these cryptocurrency offerings. It therefore comes as no surprise that the government has decided to clamp down on unregulated solicitation of public funds with the proposed legislation which appears to be intended to target “illicit deposit-taking activities in the country” and “companies/ institutions running such schemes to exploit existing regulatory gaps and lack of strict administrative measures to dupe poor and gullible people of their hard-earned savings”.
The burning question now is what would be brought within the ambit of the term “deposit-taking activities” for if it is defined vaguely, or interpreted over-zealously by those enforcing it, it could be fatal to the evolution of the blockchain and crypto industry in India.
With the diversification of blockchain products, the “initial coin offering” label has become an ubiquitous misnomer for blockchain-based token offerings. Blockchain-based “tokens” often represent the mere “tokenization” of certain rights and can be redeemed for goods or services. If such tokens are devoid of any implicit or explicit representation that the tokens themselves will appreciate in value, they represent value analogous to an assignable ticket.
Utility tokens, intrinsically, have never been intended to offer the attraction of appreciation in value but are called so because they are a fungible and tradable “right” to receive certain goods or services that provide some utility and are akin to purchasing “rights” to goods and services. Since utility tokens derive their value from the rights they represent, one could perhaps argue that such tokens, while obviously unrelated to cryptocurrencies, are a tradable right to utilities, goods, and services, and bear a closer relationship with derivatives than deposits. Similarly, tokens entitle the holder to a share in the profits of the issuer, or include some aspect of profit. It could be argued that these “tokenized securities” are analogous to securities as they share common characteristics possessed by equity instruments. While this may lead to some tokens being classified as a security and others as derivatives under certain circumstances, it would be myopic to attempt to fit all tokens within the definition of securities, derivatives, or stretch the definition of deposit to cover every offer for sale of blockchain-based tokens.
Therefore, tokens that are wholly unrelated to securities, currencies or deposits, should theoretically fall outside the ambit of the proposed legislation that appears to criminalize the “promoting, operating, issuing advertisements or accepting deposits in any unregulated deposit scheme”. Without attempting to infer regulatory intent beyond what is apparent, the legislation attempts to target unregulated solicitation of public funds in deposit schemes that purport to be an avenue for investment.
What remains to be seen is whether the definition of “deposit scheme” would be capable of being perversely construed to bring blockchain-based products such as utility tokens within its ambit. Without a clearly defined government policy for cryptocurrencies, targeted legislation intended to address the menace of Ponzi schemes masquerading as initial coin offerings could be interpreted by overzealous regulators to be a ban on all blockchain products and cause collateral damage to this industry.
Whilst the future of blockchain-based products continues to remain uncertain in the days to come, one thing is certain. Regulators in India will begin making attempts to regulate crypto-assets and the future of the blockchain industry cannot be predicated on the interpretation of ambiguously worded statutes. It is therefore critical that the government formulate a clear policy and promulgate a regulatory framework to govern the blockchain industry as a whole, so that emerging industries based on blockchain don’t become inadvertent victims of cryptocurrency regulations.
Akash Karmakar is a fintech and data privacy lawyer associated with Veritas Legal.
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