An approach that can help mitigate key policy risks from cryptocurrency
3 min read 03 Dec 2021, 06:10 AM ISTIndia Wallet is envisaged as a de-duplicated unique wallet every citizen can open
PremiumThe government has reiterated its position of regulating the cryptocurrency industry strictly in a manner that does leave room for innovation. This is not an easy balance to achieve, however, nor does India have many models to look up to. China recently enforced a full ban and is now struggling with compliance as citizens shift to stealth mining. In general, the bouquet of risks India faces—investor protection, illicit activity, capital controls, financial stability, taxation—cannot be managed the same as the US, Europe and other leading regions primarily because of a different monetary policy framework, different financial regulation framework and a plethora of small investors with low financial literacy. The policy process has been slow due to a lack of options on the table to tackle all these risks.
An approach to regulate cryptocurrencies as ‘commodity’ or ‘asset’ fails to tackle the financial stability or capital control risks that the RBI has repeatedly emphasized upon. Similarly, the regulatory approach focused on regulating only via intermediaries such as crypto exchanges is faltering because of growing decentralization of the cryptocurrency ecosystem with the rise of decentralized finance (DeFi) and non-fungible token (NFT) ecosystems. Even if crypto assets are bought through centralized and regulated exchanges, they cannot provide any visibility once cryptos are transferred to these other platforms. Regulators around the world are grappling with this development.
However, India has some infrastructure that many other countries do not—digital identity via Aadhaar and a credential management system via DigiLocker. What is missing is an approach towards regulation, which is grounded in the fundamental realities of the technology of cryptocurrency and can leverage India’s unique strengths. Policy 4.0 has released an innovative regulatory solution for cryptocurrencies, which derives its design from the premise that all crypto assets, whether tokens such as bitcoin, altcoins, NFTs, stablecoins, whether listed on a centralized or decentralized exchange, are fundamentally just a key pair, comprising a public and a private key. Ownership of the keys gives ownership to the asset. Both the custody of keys as well as transactions across the cryptocurrency ecosystem are managed by wallets such as Metamask, Trust Wallet and others, which become a de facto passport into the cryptocurrency ecosystem. Therefore, the focus or basis of regulation must be ‘wallets’ and not intermediaries or crypto exchanges.
The India Wallet is envisaged as a de-duplicated unique wallet every citizen can open to participate in crypto finance. It would be one-time KYCed at genesis via the DigiLocker, by aggregating all relevant credentials—Aadhaar, PAN, bank account details. These could also be periodically updated to be current.
The India Wallet would give every Indian a secure “passport" to engage in the crypto ecosystem and could theoretically enable access to all crypto platforms, whether centralized or decentralized, in a manner that all regulatory concerns can still be addressed. The wallet would also provide an integration to various crypto applications, spanning the full spectrum of centralized, DeFi and NFT platforms. It would thus become a gateway for various crypto businesses engaging with Indian citizens. At the moment, the government has no visibility into this activity.
The other major function performed by the wallet is that it would clearly put a jurisdiction on ‘Indian’ activity. All wallets verified through DigiLocker would be ‘Indian’ and all unverified wallets would be foreign. Thus, any transfers between the two could be clearly delineated as “cross border" for the purposes of FEMA compliance. The caps under the liberalized remittance scheme (LRS) could potentially be imposed on the wallet to manage exchange rate risk, one of the most major monetary concerns around cryptocurrency. Separate checks on cross-border transactions can check against the flow of crypto funds for illicit activities such terror financing and anti-money laundering (AML). Blockchain forensics tools are highly advanced at checking for this as long as there is some degree of KYC in the transaction, which the India Wallet provides quite well.
The other major monetary concern is financial stability risk. The wallet provides an easy platform for both regulators and users to manage investment inflows into cryptocurrency. If financial stability risks are deemed acute, then a cap could potentially be enforced on each wallet on the amount of investment into cryptocurrencies by citizens. Such caps may be managed flexibly and imposed only when stability risks are deemed acute. They can also be increased or decreased based on criteria that the government and RBI define.
With many countries now looking to effectively regulate the rapid growth in decentralized finance, the India Wallet could become a model for many and cement India’s leadership in digital governance.
Tanvi Ratna is cryptocurrency regulation expert and founder and chief executive officer of Policy 4.0.
