Context

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.

Regulating the technology innovation

• 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.
• Digital lending apps: 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.
• Blockchain technology, of which cryptos are a part, is an innovation that can facilitate transactions across assorted functions.

Issues with unregulated cryptocurrencies in India

• Some estimates show that over 15 million Indians have invested in cryptos, many of whom live in Tier-II or Tier-III towns.
• But crypto exchanges in India have pushed the boundaries of this invention.
• Important disclaimer not communicated properly: They have been advertising aggressively across media platforms 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.
•  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.

Regulation challenges and how government is tackling it

• The government has now stepped in, seized with the political perils of speculative investments turning sour.
•  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.
• Need for enabling clauses: 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.
• 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 accepted some of the suggestions of its internal working group and modified a few to make entry norms stricter, but has maintained 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.

Conclusion

This highlights the need for principle-based regulations, rather than rule-based regulations, to allow for flexibility and adaptability in a fast-changing technology environment.

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