How to Regulate Bitcoin

How to Regulate Bitcoin

bitcoin
April 8, 2018 by IBC Staff
390
Bitcoin

This blog first appeared here and has been reposted here with consent from the author

This blog is an attempt to explain how and why embracing and regulating these new age technologies like blockchain and Bitcoin, and technology-driven economic systems are constructive for emerging countries like India.

The first step before regulating cryptos is to have a deep understanding of the technology, social and the economic factors that lead to their major adoption.

  • Why do millennials love bitcoin?
  • How did bitcoins grow from being a gaming token to a worldwide adopted currency?
  • What do we lose (now or in the future) by banning such coins?

Let’s examine regulating Blockchain, Cryptocurrencies and ICOs separately.

Regulating Blockchain

Blockchain (explained here) is essentially a data management technology, like any other database, example Oracle, SQL. Blockchain as a technology should not be considered for regulation. If any regulated institution, say stock exchange uses Blockchain technology, respective Regulator can review the data security, operational challenges & business continuity within the workflow of the technology; as it may be reviewing today as well.

Regulating Crypto-currencies like Bitcoin

Most emerging countries like India, whose currency (INR) is not freely floated, may find it harder to legalize Bitcoin completely. The implications and challenges shall include,

  • Dealing with owner’s anonymity – since bitcoin owners are typically a unique private address on the internet, it is harder to establish who is the end user/owner of the crypto-currency.
  • Avoiding corruption and illegal usage of funds – Crypto-currencies illegal usage, real ownership, syphoning off internationally, is very hard to manage.
  • Taxation – managing Direct and Indirect Taxes on the crypto-currency transactions will be difficult.

But making Bitcoin illegal may also have challenges – Bitcoin and other crypto-currencies may first need to be acknowledged in the constitution of India. Then the legal framework of India shall need to define the consequences of using the Bitcoin for legal or illegal activities. And Bitcoin alike cryptocurrencies may need to be covered under RBI’s FEMA act, for international transactions.

History teaches us that Bitcoin is more like a seed, more a regulator buries it, more it grows, either in the same country in its cash economy or in other competing jurisdictions.

  • Also, as we had predicted here, G20 tried coming together to ban/regulate cryptocurrencies but could not do so earlier this year in 2018)
  • China was 90% of Bitcoin trading, supply, etc. in August 2017, since it’s multiple bans, Bitcoin moved to rest of the world (Japan, Korea, Switzerland) and in parallel cash economy in China.
    • Switzerland has been inventing itself as the future financial destination, by incubating a Crypto valley in Zug (next to Zurich), as highlighted here in The Economist.
  • Disallowing fiat currency conversions, like RBI has recently done, is an indirect move to discourage Bitcoin investment and trading. Its consequences include,
    • It’s not needed, regulator allows for commodities trading, gold investments, real estate funds, under well defined SEBI framework, why can cryptocurrency not be added to it as an asset class?
    • Bitcoin trading and transaction may (undesirably) move to the parallel cash market, which will be harder to track and regulate.
    • It can lead to a loss in tax revenues and jobs across crypto exchanges and related businesses.
    • India will lose out on the big opportunity of innovation in the future of technology and internet driven economic systems (that we cannot even imagine yet), by disallowing cryptocurrencies in the country.

Adopting an open, learning, but cautionary stance maybe the best route. i.e. Crypto-currencies investment is not illegal, but users should consider doing it with caution :

  • And all India based crypto-exchanges / wallets should do KYC on the investors, ensuring they can report to the regulators (like RBI, SEBI) on all major user investments.
  • Income Tax authorities should get similar reporting, and ask all Indian Tax residents to declare income from crypto currency investments and treat them as securities or commodities investment gains/losses for tax calculation purposes.
  • Usage of crypto-currencies for transactions within India may be disallowed (like its already done) until there is strong infrastructure to track and manage such transactions why platforms like UPI.
  • Any out of India spends on Bitcoin, converted from Indian crypto-exchange wallets, above a certain minimum amount (say Rs. 200,000 equivalent) may need reporting and be covered under RBI’s FEMA act.
  • Any usage of crypto-currencies for illegal activities in India or outside may follow usual legal framework around those illegal activities and consequences.
  • Crypto-exchanges, wallets, brokers should be regulated under RBI / SEBI, in order to control fair and secure investment processes, protecting the small investorsThe regulation should cover all challenges of operational continuity of these platforms, security, fit and proper management, minimum net worth, continuous and fair market liquidity, etc. This can be a similar process to how SEBI regulates capital markets.
  • MLM schemes running in the name of Bitcoin, Cryptocurrencies should be tracked and regulated/banned by appropriate regulators like SEBI; as is already being done for other MLM schemes, Chit funds, etc.

Regulating Initial Coin Offerings

India may have a short golden window of opportunity to create India as a major investment destination for global ICOs, Blockchain technology firms, attract capital, talent and form a potential future version of “silicon valley”.

France, Spain, Estonia, Switzerland and many others have started embracing this space. 

Regulating the ICOs

It is a regulator’s job to protect investors from unscrupulous activity and with ICO investments at record levels, it’s no surprise that regulators have stepped in to limit unsavoury activity and encourage best practice within the ICO community. The challenges regulators face include founders raising funds through ICOs with nothing but a whitepaper then disappearing, difficulty governing cryptocurrencies that are hard to track and companies choosing ICOs over traditional fundraising methods to avoid being regulated under the usual securities laws.

  • Regulators have started to respond since July 2017: The SEC has said that if the token is a security, then it falls under the Securities Act
  • Canada, Singapore, Hong Kong, have echoed similar statements with a warning to investors to be cautious in their investment process.
  • China has banned all ICOs within the country. The ban is thought to be temporary while they figure out how to regulate ICOs. Sooner they come with guidelines, better it would be for removing such wide blanket bans.

But if we take a step back, the idea of Bitcoin was to get away from centralization, including regulation.

If we introduce new coins/tokens in some regulated environment, are we not defeating the purpose of cryptocurrencies? Are we not trying to create a new breed of tokens that can shift the economic structure of companies but then regulating them back so they become securities?

Realistically, regulation is unavoidable as there is now far too much money involved in ICOs and cryptocurrencies, so much like the peer-to-peer funding industry actively sought out and encouraged financial regulation, the ICO industry should work with regulators to draft laws that protect investors and prevent illegal activity whilst still encouraging innovations in technologies and corporate structures. These would be my suggestions to regulators who would be considering regulating ICOs:

ICO Regulations Indian authorities can consider

Regulating ICOs like Crowdfunding is the best mechanism as described here

Introduce KYC processes within ICOs

This can be useful for various compliance requirements such as:

  • Tax laws (helping tax authorities figure out if some investors had realized or unrealized profits on their tokens).
  • Ensuring any country-specific compliance is met.
  • Protecting against money laundering.
  • Allowing for a certain accredited investor base for certain kinds of ICOs.

Introduce guidelines for ICO documentation and process

Potentially inspired by existing IPO and other fundraising processes:

  • Clearer disclaimers marked in the ICO papers about investment risks.
  • Ensuring company exists by including its registration/audit reports, etc.
  • Including comprehensive details about the team, product and business.
  • Post investment audits are periodically shared with the investors

Classify the tokens before regulating them

As Canadian regulation says, each token is different and should be evaluated independently (CSA staff notice, 46–307 “Cryptocurrency offerings” released by CSA Canada):

  • Tokens that are cryptocurrencies like Bitcoin or Ether could be regulated in a similar way to the fiat currencies.
  • Tokens that mimic securities — that give ownership in the company are for-profit investments, etc. may be regulated within existing or enhanced Securities laws.
  • Tokens that are for in-platform use only may continue to be unregulated or lightly regulated if needed. In principal, they are very similar to loyalty points, frequent flyer miles, vouchers, or even tokens for games. These are typically not treated as securities and for now, are generally not regulated.

ICOs have witnessed incredible growth in the last few months but may face some challenging times while regulators figure out what to do to them and certainty returns to the market. We truly believe that constructively curated regulation that encourages ICOs to challenge imperfect corporate structures can lead us to a much better decentralized digital world.

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