Accessing Crypto-assets Via GIFT City Window

Various terms related to “crypto” have gained prominence over the last decade, since the introduction of Bitcoin. The Bitcoin project was focused on being digital-only, privacy-preserving, and not prone to “debasing” through indiscriminate issuance by its creators.

It was designed to alleviate challenges that its creators perceived with some globally accepted currencies, namely excessive issuance, absence of privacy, absence of robust or low-cost payment systems, obstruction to free flow over the internet, and dependence on central players capable of restricting user actions.

The Indian financial system does not face the kind of challenges that Bitcoin set out to solve. The Indian system is robust, payment systems are extremely low cost and publicly available, its currency is well-managed, and most governments have been fiscally responsible.

The JAM (Jan Dhan, Aadhaar, Mudra) trinity and UPI (Unified Payments Interface) have ensured that the case for a retail CBDC (central bank digital currency) in India is limited to non-existent.

However, it is expected that the revolutionary CBDC/DLT (distributed ledger technology) technologies could provide breakthrough technical benefits in the future. As such, India plans to experiment with the same to avoid falling behind on this technology trend as announced by the Finance Minister during her recent Union budget speech.

India could consider using CBDC in closed-loop wholesale situations like bulk settlements in securities, payments, or foreign exchange. Alternatively, India could consider experimenting with DLT systems and smart contracts in issuance of G-Secs (government securities) to controlled entities, automated interest payments, repayments, and so on.

Crypto-assets

Over the past decade, crypto-assets have emerged as an important asset class for investors. India is no exception and there is a small but growing set of investors dabbling in this market, which is currently unregulated. India may consider regulating crypto-assets to ensure:

1. Implementation of KYC (know your customer) and AML (anti–money laundering) mandates to de-risk the country from nefarious activities

2. Investor protection in terms of mis-selling of assets and regulation of intermediaries

3. Staying at the forefront of DLT research to develop the web 3.0 ecosystem that Indian engineers and companies can benefit from; similar to the IT (information technology) services boom over the last four decades

It is possible to regulate the crypto industry as multiple regulators have requisite experience in related fields — for example, the Securities and Exchange Board of India (SEBI) has expertise in regulating exchanges and stopping malpractices from securities issuers, brokers, merchant bankers, and other intermediaries; Reserve Bank of India (RBI) has expertise around KYC, AML, and concerns around actions by bad actors.

The RBI also has extensive experience in regulating the insatiable demand for gold from Indian citizens via authorised dealers.

The regulators at RBI, SEBI, and the Finance Ministry are rightly concerned about the nature of crypto-assets and their potential to cause disruption in the exercise of monetary policy and, eventually, financial stability. This is understandable as global experience in regulating this asset class is limited. The risk of regulatory failure, and the consequence thereof, can be quite large. As such, proceeding with caution could be the best way forward.

GIFT City

India has been slowly reducing capital controls and allowing Indian citizens to invest or spend abroad via schemes like LRS (liberalised remittance scheme), which mandates an annual cap on funds that citizens can send out of India and their end use.

One way to proceed with caution in the crypto-asset industry could be to use the LRS/GIFT City route to permit citizens to invest in crypto-assets in a safe and controlled environment.

The government could examine the possibility of banning crypto-assets within mainland India while permitting purchase or sale or trade in GIFT City by KYC-ed customers at regulated exchanges within a small LRS sub-limit out of the annual LRS limits currently permitted.

The Indian Financial System Code (IFSC) could be the single-point regulator (which could draw experienced resources from RBI, SEBI, and IRDAI, as required) to licence exchanges, intermediaries, and issuers.

Strict KYC/AML regulation could be mandated for exchanges to operate in GIFT City. Exchanges could be forced to partner with regulated banks that supervise and be responsible for actions by exchanges.

Capital adequacy norms for exchanges or custodians could be defined to ensure well-capitalised agencies operate and minimum net worth criteria defined for investors to ensure that investors understand the risks they let themselves into.

A cut-over date for declaration of crypto-assets by citizens could be provided so that all holdings beyond this date within India become illegal. Beyond this date, all activities related to crypto-assets could be carried out at GIFT City that can operate like a limited sand-box that insulates the mainland financial system entirely.

Detailed regulations can be framed after studying individual concerns and harnessing the learning of other Indian and global regulators in related fields.

Such an approach would enable India to understand the emerging asset class, benefit from potential technology services opportunities that web 3.0 could present to Indian service providers, maintain financial stability, protect investors, and enable regulated and well-behaved market operation while enhancing resource mobilisation through GST (goods and services tax), capital gains, taxes, and other fees.

It will further India’s long-term plan to move over the next few decades towards capital account convertibility. It will also enhance the standing of GIFT City as an offshore centre while enabling its regulators to gain experience intermediating financial transactions between India and the rest of the world that is currently irrevocably lost while going through inaccessible foreign jurisdictions.