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Home / Opinion / Columns /  The brush with crypto offers some lessons for regulation

The brouhaha over crypto exchanges, especially the ease with which they were able to formalize and propagate pieces of software code masquerading as financial assets, once again focuses attention on entry norms into sensitive areas like financial services. The fact that crypto exchanges successfully managed to signal legitimacy for their services and offer these tokens to a mostly-uninformed public for over a year provides lessons on how the government and sectoral regulators may need to act before the game gets out of hand.

Technology innovation typically remains a step ahead of regulatory frameworks, which are designed with current practices in mind. Problems occur when these innovations push the envelope beyond accepted codes of social and ethical behaviour. The joint parliamentary committee (JPC) on a proposed data privacy law that recently released its controversial report has pointed to dubious “digital" lending apps proliferating on the Android platform: “At least 60 such loan apps available on Google Play Store were not registered or recognised by the Reserve Bank of India (RBI) as a Non-Banking Financial Company (NBFC). India’s Google Play Store has several such applications owned by Chinese operators or companies including those named like other legitimate fintech companies. For instance, ‘Udhaar Loan’ resembles ‘Udhaar’, a fintech focusing on micro loans, recognised by the Government of India."

Blockchain technology, of which cryptos are a part, is an innovation that can facilitate transactions across assorted functions. But crypto exchanges in India have pushed the boundaries of this invention. They have been advertising aggressively across media platforms. For example, they carpet-bombed television broadcasts during recent cricket tournaments, using every trick in the book to circumvent responsible norms of advertising, often announcing important disclaimers at warp speed. These provisos were supposed to communicate that cryptos are neither currencies nor strictly “assets", and that these trading platforms are not truly “exchanges", that crypto values are not determined by the usual dynamics governing other income-yielding assets, and that investing in cryptos was an exceedingly risky proposition. Some estimates show that over 15 million Indians have invested in cryptos, many of whom live in Tier-II or Tier-III towns. Indian cricket-lovers, after all, constitute a considerable population cohort in India. In the meantime, with advertising overload stimulating viewer interest, many scam crypto issuers and exchanges have sprung up in attempts to separate the gullible from their savings.

The government has now stepped in, seized with the political perils of speculative investments turning sour in election season. Finance minister Nirmala Sitharaman announced in Parliament that the government is drafting legislation to regulate cryptos. The government has been toying with such a draft for a while, but a combination of factors—pressure from various quarters and apprehensions of small savers losing money on the eve of upcoming assembly elections in Uttar Pradesh, Punjab, Goa, Uttarakhand and Manipur during the first quarter of 2022—appears to have prompted swift executive intervention. Unfortunately, sectoral regulators, such as the Reserve Bank of India (RBI) and Securities Exchange Board of India (Sebi), were unable to step in and act earlier because they are governed by specific Acts which do not mention cryptos as a category that needs regulation. Hopefully, the Centre’s intended legislation will now provide the enabling teeth.

But, looking ahead, this episode provides a valuable lesson on how these Acts should perhaps include some enabling clauses that allow financial sector regulators to intervene whenever any intermediary tries to sell a financial service or any new innovative financial service poses the risk of disrupting financial stability. The relevant amendments or additions to existing laws should strive to neither be too open-ended nor become overly sector-specific, which would leave our regulators once again trailing technology innovation.

Coincidentally, two important documents have recently been released which discuss entry norms into formal banking, both further strengthening RBI’s hands. Think-tank Niti Aayog’s paper on licensing digital banks recommends an evolutionary path for digital banks that’s RBI-regulated at all stages: first a restricted licence, then a regulatory sandbox offering some relaxations, and finally a “full-stack" digital banking licence. Simultaneously, RBI has weighed in on recommendations made by its internal working group on ownership guidelines for Indian private sector banks: it has accepted some of the suggestions and modified a few to make entry norms stricter, but has maintained a sphinx-like silence on the entry of private sector corporate houses into banking.

The JPC’s concerns over unregulated digital lending have also focused attention on an RBI-appointed committee’s report on digital lending, given that multiple fintech-based online lenders have mushroomed during the pandemic. These lenders, some of which were found using unethical methods of lending and recovering loans, have bristled at the prospect of being regulated. Arguably, this is neither the first nor the last time that interlopers will test the system. This then further strengthens the case for principle-based regulations, rather than rule-based regulations, to allow for flexibility and adaptability in a fast-changing technology environment.

Rajrishi Singhal is a policy consultant and journalist. His Twitter handle is @rajrishisinghal.

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