India took the first step toward regulating cryptos, one of the many virtual digital assets (VDA), in the 2022-23 Budget. It imposed capital gains tax of 30 per cent without ceding concomitant adjustment on capital losses.

Many had interpreted the earlier striking down of RBI’s April 6, 2018 circular by the Supreme Court as lifting of the ban on crypto trading in India. “Historic day for crypto in India,” tweeted Nischal Shetty, founder of WazirX, after the judgment, adding “We can now innovate.”

Similarly, the Budget announcement was thought to be a step closer toward legalising the more stable cryptos in the country.

Both the interpretations could be fallacious as deduced from the apex court’s recent inquisition with Additional Solicitor General while hearing a case involving the Enforcement Directorate (ED) and a private person. The apex court asked “We would like you, as the Union of India, to place on record the regime as to bitcoin and crypto currency. Is it still an offence?”

Cryptos and blockchain

Proponents of cryptos link blockchain with the VDAs somewhat like Siamese twins. You separate them and the chances are, both will end up in the dustbin.

It is unclear which is pulling what: whether blockchain is necessary for cryptos to keep them breathing or it is just an alibi advanced by the advocates to further the cause of cryptos.

The RBI is in no mood to roll out a red carpet for the crypto warriors. And the government is in no mood to kill the hen that can lay golden eggs, especially when it is in need of revenues. So confusion reigns.

Only the Tax Department finds the situation conducive as it tries to retrieve its lost glory that was partially diminished with the government’s decision to implement non-face-to-face assessment and appeal procedures with a de-localised administrative arrangement.

The court’s objections

All these uncertainties could have been avoided had the apex court not turned over the RBI circular of April 6, 2018 issued to banks/FIs prohibiting them from extending banking hospitality to ‘any person or entity dealing with or settling virtual currencies.’

What were the objections of the Supreme Court?

The text of the judgment running into 180 pages dwells eloquently on RBI’s powers, responsibilities and expertise in the first 143 pages. But in the subsequent pages it takes a U-turn and comes down heavily on the judgment and diligence of RBI resulting in the petitioners walking away with their dreams to become unicorns, sooner than later.

The Supreme Court while declining to treat the April 6 circular as ultra vires found fault with the choking RBI diktat as being ‘disproportionate’ to the VCEs’ acts of omission and commission. It argued that the central bank was unable to showcase the injury or losses suffered by its regulated entities and that its decision was not backed by any empirical data to prove any “semblance of damage” to the real economy.

The data quagmire

Now let us see certain characteristics of cryptos. The anonymity of ownership of crypto assets and limited global standards create significant data gaps for central banks. Gathering data on more than 10,000 tokens is an impossible task especially when the VCEs are not regulated and hence do not have to provide any data to any data feeding services. The lack of central intermediaries further complicates authorities’ efforts to monitor and regulate their turnover data and implications of interconnectedness.

Monitoring the activity of crypto asset service providers, that is the VCEs, is complicated by limited, fragmented, and, in some cases, unreliable data. Public data sharing by VCEs continues to be voluntary, lacking standardisation.

Moreover, it may not be possible for the central banking authority to monitor users who can access crypto assets through global crypto exchanges, such as, Binance. So far, there is no reliable way to estimate the stock or flow of crypto assets based on country residency.

In such a scenario, to expect the central bank to produce empirical data before the apex court to support its action would be difficult. Compiling unconventional data on a decentralised product having cross border and 24x7 market would require super human effort and still may not yield any significant result.

Weather forecast parallel

There are striking similarities between the weather warnings issued by the India Meteorological Department (IMD) and the persistent warnings issued by the central bank on the ill-effects of crypto assets. The central bank is obligated to play the role of an IMD, at times, to ward off or take pre-emptive steps to either reduce the impact of a severe cyclonic storm, in this case financial, or avert a systemic crisis. It does not have the luxury to wait for sufficient empirical evidence to initiate a particular action in the larger interests of the banking and financial system and systemic stability.

Recall the decision of Governor YV Reddy in slamming the brakes on bank financing of commercial real estate in the run up to the 2008 financial crisis. Just as this was pre-emptive, the April 6 directive was also pre-emptive and was a warning in action when warnings in words proved futile. And it was intended to reduce “acute risks of currency substitution through crypto assets, the so-called cryptoisation”.

The plunging fortunes of several virtual coins and intermediaries dealing with them in recent times have brought to the fore a pertinent question: Did the Supreme Court “operate in future”, far ahead of its time?

The Court should have believed in itself when it emphatically wrote in its judgment that “the power of RBI is not merely curative but also preventive” and “RBI has a right to take pre-emptive action taking into account the totality of the circumstances”.

Probably, RBI’s action was disproportionate purely from a view point of legal doctrinaire. But was it irrational?

So where do we stand today? On a wide road, not knowing whether the traffic signal would change to green or red?

The writer is a former central banker. Views expressed are personal.

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