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Big Story | Know the risk in bitcoin, digital gold and overseas forex trading

Lokeshwarri S K Anand Kalyanaraman Akhil Nallamuthu Rajalakshmi Nirmal | Updated on September 05, 2020 Published on September 05, 2020

Bitcoins: Mouth-watering returns, but unregulated

Which investment or asset has given the best returns from the March 2020 lows? If your answer is gold, you would be wrong. Gold has gained only around 30 per cent over the last five months. The gain in Nifty 50 is also around the same level. It’s bitcoin, the crypto asset, that has trumped them all with over 100 per cent returns, even as Covid-19 had the world in its grip. No wonder that bitcoin market places are doing brisk business and many investors are wondering if they should start putting some money into this asset.

If you are one such investor, here are a few things you need to know.

It’s not a currency

The term crypto currency or virtual currency is often used to describe Bitcoin, Litecoin, Dash, Etherium, etc. But that is a wrong description. While the creator of Bitcoin, Satoshi Nakamoto, intended it to be a digital currency that would ultimately replace fiat currencies, it has not been accepted as a legal tender in any country with the exception of Japan.

These crypto assets can be mined or created by anyone, by solving complex problems. The coins thus created are stored on open digital ledgers that are maintained by the public. These coins can be bought or sold on online market places. While the concept is beautiful — a democratically created currency that is extremely transparent — it also has many flaws that make it unsuitable as a currency. It is not tied to any underlying asset, has no guarantor and is too volatile.

Since bitcoin is not a currency, the RBI does not regulate it.

Rewind

Bitcoins et al, are, in fact, unregulated assets. Crypto assets have had a chequered history in India. When bitcoin prices neared $1,000 for the first time in late 2013, the RBI issued a warning stating that it is risky to deal in these assets. Following a lull over a few years, there was another frenzy in 2017, when prices increased 12-fold in one year. It was in late 2017 that many online platforms facilitating trading in bitcoins mushroomed in India and so did Ponzi schemes offering stupendous returns to investors. But with the 76 per cent crash in prices in 2018, interest in the assets also waned.

It was in April 2018 that the RBI decided to address allegations of illegal money laundering activity in some bitcoin exchanges by issuing a circular directing banks and financial institutions regulated by it to stop dealing in virtual currencies and facilitating any dealing involving virtual currencies.

This circular brought trading bitcoin and other crypto currencies in India to a halt. Further the committee headed by Subhash Chandra Garg had proposed banning crypto-currencies in India. But the Bill has not seen the light of day yet.

In March this year, the Supreme Court set aside the RBI circular, thus reviving buying and selling of bitcoins and other crypto assets in India.

An unregulated asset

With trading in bitcoin and other virtual assets recommencing, should you go for them? Indians can buy and sell these assets on online platforms such as WazirX and Unocoin. You will have to transfer money to these exchanges digitally with which the crypto assets can be purchased. While the process is simple, there are a few things to note.

There is no regulatory supervision over these online platforms, they are not like other stock exchanges regulated by SEBI. There is no net worth requirements for these platforms, no trade guarantee fund, no standard rules for client on-boarding, trade and settlement process, etc. Many such platforms have closed down and disappeared overnight, globally.

Two, the crypto assets have no intrinsic value. The price is based only on the demand and supply of the assets. According to the design, only 21 million bitcoins can ever be mined. The number already mined is 18.5 millions. As the number of bitcoins mined increases, demand could increase. But it is believed that the design can be tweaked to allow creation of bitcoins beyond 21 million. Arriving at a value for these coins is therefore very difficult.

That leads us to the next problem — extreme volatility. The price of bitcoin has grown over 19-fold in the last five years but there have been extremely violent corrections too. For instance, the price fell from over $13,000 to $3,000 in 2018. It is now again back above $10,000. The price tends to react violently every time any country clamps down on trading or usage of these assets. There is a very high degree of regulatory risk.

Four, crypto assets are not considered a store of value, unlike gold. You cannot purchase crypto assets and hold them with the intention of passing them down to children.

And most important of all, beware of companies promising you fixed returns through trading in bitcoins and other crypto assets. Many Ponzi schemes involving bitcoins had cropped up in 2017-18. The most famous of them is the ₹2,000-crore scam involving GainBitcoin.

Our take

If you are a regular investor with moderate to low risk appetite, it is best to watch the show involving the cryptos from the sidelines. You may not be able to take the stomach-churning volatility. Lack of regulation is another reason why you need to stay away.

It is quite likely that some of you with very high risk appetite may want to buy some of these assets. If you do, make sure that you churn your holding regularly, booking profits at regular intervals. If you want to see where the price goes in the long term, set aside a tiny fraction of your portfolio towards this. This should be money that you are willing to write off completely.

Online overseas forex trading: Illegal, fraught with risks

Anand Kalyanaraman

The advertisements are ubiquitous — foreign internet portals luring customers with carrot of quick returns and big money on online currency trading. Don’t fall for the spiel. When you trade on such portals, you not only run the risk of losing money but will also be committing an illegal act.

The RBI has, on several occasions, warned against overseas foreign exchange trading through trading portals.

It has clarified that “any person resident in India collecting and effecting/remitting payments directly/indirectly outside India in any form towards overseas foreign exchange trading through electronic/internet trading portals would make himself/herself/themselves liable to be proceeded against with for contravention of the Foreign Exchange Management Act (FEMA), 1999 besides being liable for violation of regulations relating to Know Your Customer (KYC) norms/Anti Money Laundering (AML) standards.”

So, legal action can be taken against Indian residents collecting and remitting such payments for such online forex trades. Under the Liberalised Remittance Scheme under which $2,50,000 annually can be remitted abroad for various transactions, there are some prohibited transactions — including “remittance from India for margins or margin calls to overseas exchanges/overseas counterparty” and “remittance for trading in foreign exchange abroad”.

With forex portals offering leverage on margin money for trades in foreign currency, resident Indians opting for this will be in violation of RBI guidelines.

Indian residents who get into such trades, and entities such as agents, banks and credit card companies that facilitate them, are liable for regulatory action.

Many banks and credit card companies in India seem to have tightened their processes. But some investors try to work around the restrictions by transferring funds to money transfer entities such as Skrill or Neteller, and then do such forex trades. But that would be too clever by half. That’s because the RBI has said that “effecting/remitting payments directly/indirectly outside India in any form” would be illegal. So, even indirect transfers in any form would fall afoul of the law.

Pitfalls aplenty

The products may seem tempting — very high leverage (bets as high as 400 times or more allowed on the margin) and several currency pairs to trade on. But besides the illegality for Indian residents, there are risks galore in such products. The global currency market is a very sophisticated one, and gullible investors can easily burn their fingers. Also, such currency trading may be in the nature of ‘contracts for difference’ (CFD), a derivative product that many traders may not be familiar with. Besides, while high leverage has the potential to multiply profits, it can also magnify losses. There is also the conversion risk and cost, and commission charge.

Then, there is also the danger that the party at the other end may not honour its commitment. Most companies offering overseas currency trades execute trades not on regulated exchanges where trade settlement is guaranteed but in the riskier over-the-counter (OTC) market.

Companies that offer overseas forex trading in India may be outside the purview of the country’s regulations. Indian residents who find themselves short-changed may have little or no recourse.

With the many risks involved, resident Indians who have the know-how and want to benefit from forex movements should trade in the exchange traded currency derivatives available in the country.

Trading of the rupee against four major currencies — USD, euro, British pound and Japanese yen — and three cross-currency pairs — EUR-USD, GBP-USD and USD-JPY — is allowed.

Guaranteed return exchange traded products: Nothing but a ponzi scheme

Akhil Nallamuthu

Time and again investors are lured by offerings promising extremely high returns through trading in stocks or commodities, especially involving trading in futures and options. Those offering such schemes claim to have developed complex strategies that are capable of producing exceedingly high returns.

But as the NSEL episode, and the more recent Anugrah Stock and Broking scam show, these are highly risky and can result in deep losses.

The main reason why such schemes are untenable is because it is impossible to generate a fixed or guaranteed returns through securities — be it stocks, commodities, currencies, bonds or their derivatives — that are listed and traded on exchanges. Prices can move both up and down and if someone is promising you guaranteed returns through these trades, you need to run in the other direction.

You also need to keep in mind that these are unregulated. Fixed or guaranteed return schemes through trading are not approved by SEBI.

Only registered fund houses like Portfolio Management Services (PMS) and Alternative Investment Funds (AIF), which are under tight regulatory scrutiny, can handle client accounts directly.

Here, the disclosures, risk profiling, net worth, etc, are to be strictly adhered to.

Even regulated fund managers are not allowed to guarantee returns on their market-linked products.

Anugrah debacle

The recent incident involving Anugrah Stock and Broking and its associates goes to show how schemes to make investors park money for earning returns through trading still exist.

The company is reported to have been running unauthorised derivative advisory services for a decade through which investors were offered schemes that produced consistent monthly returns.

Recently, the firm seems to have made huge losses and several of its clients’ stock holding seems to have disappeared.

The most likely reason could be that the broker could have used the investors’ demat holdings to adjust against the mark-to-market (MTM) losses incurred in derivatives trading. The contract notes issued by the company turned out to be fake and so investors were not alerted to the issue earlier.

Since almost all the clients would have submitted Power of Attorney (PoA) to the broker, that would have allowed the broker to transfer shares from clients’ demat account to its own demat account, which would enable the broker to sell them in the event of margin shortfall.

Currently, the true status of the demat accounts of investors is unknown.

Notably, Power of Attorney was also at the centre of the Karvy debacle, where investors’ shares were sold from their demat accounts using PoA given by them.

But effective September 1, 2020, new rules have limited the use of PoA, giving protection to investors. However, it is always prudent to read and know what you are signing.

The NSEL saga

The NSEL episode also involves intermediaries selling paired contracts to clients, promising guaranteed returns to them. These were actually means of providing short-term finance to entities associated with the exchange.

The investors of NSEL product could have averted the loss if they had asked a few hard questions of the brokers — for instance, how can an instrument that is based on commodity trading give an assured return?

It is eventually up to each investor to look closer at guaranteed return products based on traded products and recognise them for what they are.

Digital gold, Jewellers’ instalment schemes: Operating sans a watchdog

Rajalakshmi Nirmal

Indians’ love affair with gold spans centuries. Given the yellow metal’s ability to generate tidy returns, particularly in a low/negative real returns scenario, such as the present, there is always demand for the metal, be it in the form of jewellery or coins. But one should choose the investment tool carefully, as some instruments in gold operate in a regulatory vacuum.

Digital gold

There are options today to buy gold through the digital platform of mobile wallets such as Paytm, PhonePe or Google Pay and also through stock brokers such as HDFC Securities or Motilal Oswal. But note, there is no watchdog for the digital space in gold. While mobile wallets’ payment bank functions are regulated by the RBI and brokers’ capital market operations are governed by SEBI, the gold business of these companies — which is through a tie-up with MMTC-PAMP or other entities such as SafeGold — is not regulated. If you have an issue with the delivery of physical gold from these entities, there is no option but to knock on the doors of the Consumer Court.

On the other hand, gold-ETFs, run by mutual funds (MFs), are safer options, as there is a custodian and trustee, safeguarding the interest of investors. Also, the regular audits by SEBI and the underlying gold kept with an independent vaulting agency act as additional checks.

Gold schemes of jewellers

To attract small consumers/investors, jewellers offer savings schemes. Here, you deposit a fixed amount for a chosen tenure and at the end of the tenure, you use the total amount deposited (plus a bonus that jewellers usually add) to buy gold jewellery. But there have been many instances of certain jewellers duping consumers. You may recollect the case of Nathella Sampath Jewellery in Tamil Nadu. The jeweller shut all its shops and the company and its promoters filed for insolvency, leaving customers who put money in the gold savings scheme in the lurch. Note that in insolvency proceedings, unsecured creditors (customers of gold savings schemes fall in this category) are the last to be paid.

In 2014, to check the mushrooming growth of unregulated deposit schemes run by Builders and Jewellers, the new Companies Act placed some conditions. It said that any registered company, including a jeweller, that raises money from the public for a tenure of more than 365 days has to get itself rated for repayment capacity and take deposit insurance. Further, the rate of return on the deposit should not be more than what NBFCs offer, it said. But jewellers modified their schemes to bring the tenure down to 11 months from 12/24/36 months earlier, to avoid the rating mandate.

Subsequently, in 2019, the Centre announced the ‘Banning of the Unregulated Deposit Schemes Act’. This was aimed at curbing all unregulated schemes, including those of jewellers. But many jewellers got away, claiming that the deposit amount they collect from customers is in the nature of trade advance. Thus, currently, schemes run by jewellers are operating in a regulatory vacuum. If you burn your fingers by depositing money with a jeweller, there is little recourse. Many of these jewellers are not registered companies, and hence they fall outside the ambit of the Ministry of Corporate Affairs.

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Published on September 05, 2020
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