India's Crypto-Clueless Regulators

Even those who vaguely follow the cryptocurrency markets (as I am sure many readers of the Mises Wire do) are likely to have seen the recent news on this front from India. The Indian government is proposing legislation to “ban” cryptocurrencies. Given the present segmentation of the Indian government, it is expected that this law will pass. In this article, I will consider some of the chief concerns that may prompt regulators to consider, and unfortunately implement, in some cases, prohibitions on cryptocurrencies and adjacent activities.

Fool Me Once…

Before delving into the evaluation of this ordinance, it is worth considering this law and the context surrounding it in more detail. Indian officials have been mulling over cryptocurrency restrictions for some time now. As some readers might remember, the Reserve Bank of India (RBI), India’s monetary authority, imposed a substantial level of restrictions on cryptocurrencies in April 2018. These restrictions interdicted all RBI-regulated entities from engaging with businesses dealing with cryptocurrencies or settling cryptocurrency payments.

In essence, this compelled domestic cryptocurrency exchanges to make considerable alterations to their business model, leave the country altogether, or shut down their businesses. Understandably upset, Indian cryptocurrency exchanges filed a flurry of petitions with the Indian Supreme Court, which, to the benefit of these businesses, lifted this April 2018 ban. The supreme court, however, left open the possibility of the Indian Parliament imposing formal legislation that would regulate, or even ban cryptocurrencies outright. That is precisely what the government is looking to do, with the proposed law suggesting the penalization of anyone mining, trading, or even holding cryptocurrencies.

A Closer Look

Given the history of widespread corruption at all levels of Indian government that has persisted since its socialist heyday, it is unsurprising that many policymakers have cited the supposedly common cases of the use of cryptocurrencies for money laundering and the facilitation of illicit transactions. On the surface, this seems like a reasonable proposition; after all, (many) cryptocurrencies offer some degree of anonymity while enabling reliable transactions without a trusted third party. Indeed, one estimate suggests that over $75 billion of illegal transactions involve bitcoin!

The reality, however, requires closer scrutiny. A recent Chainalysis report found that only 2.1 percent of all cryptocurrency transaction volume was linked to criminal activity in 2019. In truth, a substantial majority of illicit transactions and money laundering use physical cash, and it is unclear if the enforcement costs associated with a cryptocurrency ban will do more to curb these activities than other measures. Furthermore, it is unlikely that such a ban would have a significant impact on illegal activities and tax evasion; it is doubtful, at best, that criminals are utilizing mainstream Indian exchanges that service most (law-abiding) cryptocurrency investors.

The requirement of ID proof by exchanges to (preemptively) comply with KYC (know-your-customer) and AML (anti–money laundering) regulations likely deters would-be criminals from utilizing these exchanges at all, since this system makes it easy to link cryptocurrency addresses to individuals, eliminating the so-called anonymity of cryptocurrencies that makes them so appealing to those outside of the law. Rather than identifying the financial channels that criminals use to violate the law, a cryptocurrency ban would primarily serve to eliminate access to financial markets by retail investors and step on the burgeoning cryptocurrency-dedicated economy in the country.

Many critics of cryptocurrencies also express concern about cryptocurrency investor protection. Extreme volatility and low liquidity in some cryptocurrency markets are undoubtedly reasons for all potential investors to tread cautiously. However, it is unclear that these reasons would be sufficient to introduce government intervention, especially of such a restrictive brand. I have yet to find evidence that (major) cryptocurrencies are uniquely risky. In fact, a consistent application of the principles behind a cryptocurrency ban stemming from concerns about investor protection would involve much more than taking cryptocurrencies off the Indian market. Consider the incredible volatility in many equity options and commodity futures markets. Are these grounds for a sweeping ban of these derivatives? What about illiquid and volatile “penny” stocks? This is especially true of major cryptocurrencies, like bitcoin and ethereum, that are trading on major exchanges that are flush with liquidity.

Perhaps most troubling to regulators is the notion that cryptocurrencies pose some type of threat to their monopoly on the market for money and, as a result, constitute a significant risk to macroeconomic stability more broadly. Foremost, there is little evidence that suggests that bitcoin is being widely used as a medium of exchange (or even as a store of value), never mind at the scale required to cause macroeconomic disruptions. Indeed, backwards regulations like the proposed prohibition in question can fester uncertainty regarding political risks that could, to a degree, cause capital to flee the markets. If India wants to get on the fast track to development, it would be better served by providing investors and its citizens with clarity and freedom, rather than sweeping declarations with little international precedent.

While the Indian government continues to commit to exploring the potential benefits of blockchain technology, I am perturbed by its unwillingness to admit that it is aiming to do what the private sector is much better equipped for and blocking exploration into a key space for blockchain-based innovation, cryptocurrency. There is no reason to think that, even by the government’s standards, the private sector cannot come up with solutions that the public sector can then leverage for its own ends. I would be silly to suggest that I know the precise potential of cryptocurrencies, but I would be even sillier if I were to say that the Indian government does.