There’s a major new risk in town and it’s called crypto

Crypto-exchanges, animated by a March 2020 Supreme Court judgement, have been intensifying their outreach exercise to retail investors. A quick recap might be useful here. The Reserve Bank of India (RBI) has been warning the general public since 2013 about crypto-products, calling them virtual currencies (VCs) in its communication. Numerous government committees also examined these products and were divided in their opinion: some advocated an outright ban while others were ambivalent. RBI, through a circular dated 6 April 2018, directed banks and other financial intermediaries not to deal with entities, either individuals or institutions, dealing in VCs. In its March 2020 judgement, the Supreme Court ruled that RBI cannot direct banks to withhold services to crypto-exchanges, primarily because the central bank was unable to show that the “interface" with crypto-products had resulted in either harm or adverse effects for these financial intermediaries. The court’s three-member bench, though, refrained from either banning or endorsing crypto-products.

Crypto-exchanges viewed the ruling differently and have been aggressively advertising on all media platforms—print, television and the internet—without the necessary caveats or disclaimers. They have been making all sorts of claims and promises to retail investors, such as urging them to start with only ₹100 or learn crypto-trading in 60 seconds, and comparing crypto returns with those from different asset classes. While their actions are not strictly illegal, because there is no act or rule to bind them yet, the Internet and Mobile Association of India’s apathy in exercising some self-regulation is inexplicable when compared with the alacrity it displayed in filing the writ petition in the Supreme Court against the RBI circular on behalf of crypto-exchanges.

In the end, though, even crypto-exchanges need to exercise self-restraint as a matter of good faith because crypto marketing campaigns have now reached even tier-II and tier-III cities. These platforms have been mining the grey zones in four specific areas.

First, they must ask themselves whether it is proper to use the term ‘currency’ in their communication because crypto-products do not fit its classic definition. It is also dangerous because many investors might mistake it for legal tender backed by government, which it is definitely not. The US Securities and Exchange Commission chairman Gary Gensler told the Aspen Security Forum recently: “Public fiat monies fulfill the three functions of money: a store of value, unit of account, and medium of exchange. No single crypto asset, though, broadly fulfils all the functions of money."

Second, in their rush for yields, retail investors might overlook the fact that crypto-products may not qualify as assets in the true sense of the term. Most crypto-products do not have any underlying commodity, product or cash-flows that can provide them with economic value; a crypto’s value is derived primarily from its shortage because mining crypto-products is a specialized undertaking, requiring extensive investment in hardware and high-level coding expertise.

Third, crypto prices are extremely volatile and can change rapidly without any valid economic reason, as witnessed in recent months. What is more concerning, especially for individual customers, is that crypto-tokens are typically stored in digital wallets which can be hacked and robbed.

Finally, crypto-activity is unregulated in India and any mishap will leave investors stranded. While crypto-products are legal in India, they are not answerable to any authority. As a corollary, it is also pertinent to ask whether fast-mushrooming crypto-exchanges can actually be called ‘exchanges’ at all. They are not supervised by the Securities and Exchange Board of India and their trade matching processes or settlement mechanisms are not well known. It is also not known whether crypto-exchanges assume the counter-party risk and eliminate transaction risk, something that the two main Indian stock exchanges offer.

‘Crypto’, though, is not altogether a bad word. A crypto-token predicated on a blockchain-based distributed ledger, though, is not such a bad thing and can revolutionize many processes, such as international finance. This is for institutional investors, which are expected to be well informed.

But who will stand up for retail investors? Most Indian financial-sector regulators are reluctant to intervene because their respective remits do not include crypto-products. Given the anatomy of financial risks and their proclivity to explode without warning, the government must therefore step in immediately, demarcate the playing field and put firm goalposts in place.

(Rajrishi Singhal, is a policy consultant, journalist and author)