The Covid-19 crisis seems to have given a surge to cryptocurrencies trading domestically and globally. One of India’s homegrown crypto-assets exchange claims to have recorded a 30% growth in signups and a volume growth of 270% during the lockdown period.
This surge in the domestic market may also be attributed to the Supreme Court’s recent decision to strike down a 2018 circular issued by the Reserve Bank of India (RBI) which prohibited entities regulated by it from dealing in cryptocurrencies. The court found the RBI’s approach towards cryptocurrencies to be disproportionate.
This growth in cryptocurrency trading, however, is currently happening in a regulatory vacuum in India. A first step for the RBI to address this could be by not barring cryptocurrencies from its fintech regulatory sandbox.
This approach may sound unconventional given that central banks have traditionally been against the use of cryptocurrencies for several reasons. Agustín Carstens, general manager at the Bank for International Settlements, warned that cryptocurrencies should not become entrenched as they pose a risk to financial stability.
However, there are certain benefits for considering the sandbox approach to cryptocurrencies. Countries such as Russia, South Africa, the US and the UK have been experimenting with this approach.
Broadly, both the RBI and Securities and Exchange Board of India (SEBI) have a role to play in the regulation of cryptocurrencies. The Supreme Court held that users and traders of cryptocurrencies can carry on an activity that falls squarely within the purview of the RBI. SEBI’s intervention will, however, be necessary for regulating crypto exchanges.
The present framework on regulatory sandboxes for financial innovations is siloed on the basis of sector. However, this is inadequate because cryptocurrencies may pose cross-sectoral issues.
Therefore, a coordinated approach on regulating cryptocurrencies between the RBI and SEBI is necessary. Hong Kong seems to be a good example of inter-regulatory coordination for sandboxing.
The Supreme Court struck down the impugned circular on broadly two grounds. First, that the RBI did not adduce any evidence of the actual impact or likely harm the circular sought to address. In the event there was actual harm caused, the court expected the RBI to produce supporting empirical data. Second, the RBI did not consider achieving the same objectives through less intrusive regulatory responses, as suggested by an inter-ministerial committee initially. The measure adopted by the RBI was thus found to be disproportionate.
A regulatory sandbox offers a way out of this. The advantage of a regulatory sandbox is that it allows testing of products in a closed environment, and more importantly, in a regulatory vacuum.
A key function performed by a regulatory sandbox is to feed into the regulation-making process for emerging technologies. By providing cryptocurrencies operators this platform, the regulators will be able to assess the exact approach that is required.
The regulatory regime traditionally covers, among others, licensing, filing of returns at regular intervals, submission of information, inspection, complying with directions and a robust grievance redress mechanism. As cryptocurrencies use high-end technology, there seems to be no clarity yet as to the efficacy or relevance of such a traditional regulatory regime.
A regulatory sandbox may be expected to bring the necessary clarity on the scope of regulatory regime, use of appropriate technology to supervise the operations and the method of administering the regulations. One critical feature that any entrant will need to satisfy is that the proposed innovation should ‘show promise of easing or effecting delivery of financial services in a significant way’.
Sandboxing will allow the RBI to make models that could predict the effect of scaling up of cryptocurrencies on macroeconomic stability, anti-money laundering and capital account convertibility. This will enable the RBI to choose the most appropriate intervention from the spectrum of regulatory tools available.
Two outcomes may emerge out of this exercise. First, the RBI may choose to adopt the same approach as it did previously, but armed with supporting evidence to justify its stance. Second, the RBI may choose to regulate cryptocurrencies, which could vary from light touch to strict regulations.
Varun Marwah and Sohini Chatterjee are research fellows at law firm Shardul Amarchand Mangaldas & Co. Views are personal.
(With inputs from Prashant Saran, Gopalkrishna Hegde, Sudarshan Sen, Veena Sivaramakrishnan and Sumant Prashant)