India cryptocurrency crackdown

The Reserve Bank of India has issued a statement banning RBI-regulated financial institutions from dealing with virtual currency transactions. Approximately 5 million Indian citizens have been given three months to withdraw investments in cryptocurrency. The RBI has issued multiple warnings against cryptocurrency in the past.

Background

Cryptocurrency is a form of virtual money that is designed to stay secure. Classified as a subset of digital currencies, it uses cryptography to secure its exchanges, making it nearly impossible to counterfeit. Cryptocurrency is decentralised through a blockchain (a public transaction database).  Bitcoin, created in 2009, is a cryptocurrency and digital payment system. One of the most popular cryptocurrencies in the world, its meteoric rise in 2017 drew concern. However, values have fallen in 2018.

Critics have argued that digital cash systems are volatile and speculative in nature, and come with a number of inherent risks. Experts have noted that the craze around Bitcoins and other cryptocurrencies might be a bubble. Cryptocurrencies are also vulnerable to digital attacks. In January 2018, cryptocurrency exchange Coincheck was victim to a hack that resulted in the loss of approximately $530 million. Additionally, crypto-assets are thought to be used for money laundering and black market trade.

Numerous governments have been critical about cryptocurrencies, and there have been calls for international regulation.  The RBI’s first warning against cryptocurrencies was as early as 2014, when it cautioned users of “potential economic, financial, operational, legal, customer protection and security related risks associated in dealing” with virtual currencies. In his budget speech this year, Finance Minister Arun Jaitley stated that he did not recognise cryptocurrencies as legal tender, and promised to eliminate their use.

In September 2017, China called a freeze on all fundraising through Initial Coin Offerings (ICOs). The country closed exchanges and issued statements to its three major cryptocurrency exchanges (OKCoin, Huobi, and BTC Chine) to shut down trading. In February 2018, China announced that it would block all websites related to cryptocurrency trading and ICOs “to prevent financial risks”.

The head of the International Monetary Fund Christine Lagarde has stated that cryptocurrency regulation is “inevitable”. “It’s clearly a domain where we need international regulation and proper supervision,” she said.

Analysis

India has now issued formal rules against cryptocurrency exchanges. The Reserve Bank of India (RBI) has released a statement banning banks and other financial institutions (such as e-wallets) from dealing with cryptocurrency transactions. While the state has not banned cryptocurrency outright, this move will prevent cryptocurrency trading in India. Legal tender is required to buy and sell crypto-assets.

In a circular released on April 5^th, the RBI noted the possibility of introducing fiat digital currency, and announced that a report is studying the feasibility of such a currency. However it added, “Virtual Currencies (VCs), also variously referred to as crypto currencies and crypto assets, raise concerns of consumer protection, market integrity and money laundering, among others.”

“In view of the associated risks, it has been decided that, with immediate effect, entities regulated by RBI shall not deal with or provide services to any individual or business entities dealing with or settling VCs. Regulated entities which already provide such services shall exit the relationship within a specified time,” the RBI statement read.

The Indian cryptocurrency market has nearly 5 million customers according to some reports, and approximately $2 billion worth of Bitcoin investments. While the RBI ban is effective immediately, investors have been given a window of three months to withdraw. "We have decided to ring-fence the RBI regulated entities from the risk of dealing with entities associated with virtual currencies. They are required to stop having a business relationship with the entities dealing with virtual currencies forthwith and unwind the existing relationship within a period of three months," BP Kanungo, Deputy Governor, RBI said. 

Bitcoin value in India dropped significantly soon after the announcement, falling below international prices. Experts have noted that Indian investors can still trade in cryptocurrency through foreign bank accounts. "The RBI's intent is to protect customer interest, however this move will only adversely impact the organised sector and the government. Cryptocurrency volumes and prices have dropped. This would force customers to sell at losses and make them more susceptible to taking illegal routes for trading," said Payment Council of India chairman Naveen Surya.

Assessment

Our assessment is that the Reserve Bank of India has fallen just short of banning cryptocurrencies outright. The ban may discourage new investors from entering the Indian cryptocurrency market. However, it is uncertain how effective the rule will be. China has been unsuccessful in eradicating cryptocurrency trading. As stated previously, we believe that while blockchain technology may considered hard currency in the future, effective regulation will be necessary to stabilise the market.