Regulating Cryptocurrencies: Finding Ways To Protect Investors

The Indian government is currently in the midst of reviewing a cryptocurrency legislation which had earlier intended to impose a ban on these tokens.

Prime Minister Narendra Modi led a review meeting on digital currencies on Saturday, and it was decided that the government will continue to proactively engage with experts and other stakeholders on the evolving technology, Bloomberg reported.

The industry has been arguing in favour of regulation in the hope of avoiding a complete ban that was earlier contemplated.

As a start, any legislation around cryptocurrencies would have to define different kinds of tokens. This, according to Siddharth Menon, co-founder and chief operating officer of WazirX, is essential because the industry continues to change at a rapid pace.

According to Menon, cryptocurrencies can be broken down into four categories:

• An asset that stores , like Bitcoin;

• A utility-based token, like Ethereum;

• A virtual currency, like Tether;

• And a central bank backed digital currency.

So while some tokens would fall under the category of assets and could be regulated as such, others may be more in the nature of utilities, he explained.

This categorisation itself can help weed out non-serious coins, commonly known as meme coins. These tokens, like Shiba Inu or Dogecoin, began as jokes but have still surged in even though they lack any intrinsic worth.

As a next step, authorities can set up a framework to determine which tokens can be offered on local crypto exchanges to investors. "From the perspective of retailer protection, we can look at limiting retail investments on coins with low liquidity or high risk," said Vikram Subburaj, co-founder and CEO of Giottus.

The government could do periodic screening of available cryptos, said Subburaj. The screening can include the purpose of the project, liquidity, viability, transparency, market cap and even whether coins or tokens are withdrawable, he said.

Globally, some models are starting to emerge on ways to regulate cryptocurrencies.

For instance, the European Union has proposed segregation of different types of tokens along the following lines:

• Crypto-assets like Bitcoin and Ether;

• Utility Tokens like Filecoin and Basic Attention Token;

• Asset-Referenced Tokens like Facebook's Libra;

• E-Money Tokens like Tether and USD Coin.

The EU also proposes that any new crypto project be preceded by a white paper submitted to regulatory authorities. To be sure, authorities do not currently have the power to authorise or reject projects other than stable coins, which are backed by fiat currency.

Other geographies, such as Malaysia, have also implemented screening processes.

"Malaysia has already implemented regular screening checks to ensure rogue cryptos aren't able to operate fly-by-night operations. At the same time, some minimum parameters such as market cap or volume should be required to ensure credibility," Subburaj said.

In Malaysia, the exchanges have to be registered with the regulator and only a few cryptos are available for purchase. For example, Luno Exchange is permitted to host only five cryptos, unlike thousands which are listed globally.

A similar setup is available in Singapore, said Avinash Shekhar, co-CEO of ZebPay. According to Singapore's Securities and Futures Act, tokens are called capital market products. An issuer of such a token must hold a licence for the issue of such a token. Independent due diligence is conducted to address any risks associated with money laundering and financing terrorism during the issuance of tokens.

Some of these models could be used as benchmarks as India develops its own set of regulations.

While exchanges, eager to avoid a cryptocurrency ban in India, are offering up solutions, they acknowledge that these options are less than ideal in a fast changing market.

"We are still discovering applications of crypto and tokens, so more than outdated, the classifications will become narrow and limited," said Edul Patel, co-founder and CEO, Mudrex. "We'll need better classifications if new purposes like voting or land registries start moving to crypto. Hence, it's said that these terminologies shall remain constantly evolving."

Sandboxing is the best way to go forward since it helps establish the pros and cons in a controlled environment, he said. The RBI already has very good experience with sandboxing, as we've seen with a host of fintech innovations like payments, wallets, and even cross-border transactions.

The RBI, however, has remained opposed to cryptocurrencies. Speaking at a Business Standard event last week, RBI governor Shaktikanta Das reiterated the central bank’s concerns around cryptocurrencies, saying that these pose a financial stability risk.