The future of crypto-financing in India

What is a Cryptocurrency?

It is a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.

Issue:

  • As regulators around the world continue to struggle to formulate an appropriate regulatory framework for cryptocurrencies such as bitcoins and ethereum, a new avatar of blockchain-based financial products—cryptocurrency/crypto-token powered initial coin offerings (ICO)—is gaining popularity as a viable alternative to more traditional means of raising capital.
  • The emergence of a new technology-based means of raising capital will need to be properly regulated in order to streamline investment and ensure adequate investor-protection safeguards.

ICO:

  • An ICO is largely similar to an initial public offering, but it differs to the extent that instead of offering shares in a company, cryptocurrencies or crypto-tokens are offered at a predetermined rate. These crypto-tokens are basically digital assets which can be configured in a number of ways to represent a variety of services.
  • They are a method of payment for the service that the company proposes to offer. Examples of such services may include online music/movie- streaming services or cloud storage space.
  • Companies (especially internet-based) can use an ICO as an alternative means of raising capital.
  • An ICO can be floated by a company by offering its blockchain-based cryptocurrency or crypto-token to the general public in order to raise funding to support its underlying business plan.
  • The success of the company, and by extension, the ICO, is dependent on the strength of the business plan and the quality of the product proposed to be developed, much like the success of an IPO (initial public offering).
  • Further, post an ICO, these crypto-tokens can also be freely traded on independent cryptocurrency exchange platforms (in essence, a secondary market), making it a potential investment tool with the advantage of easy transferability and instant liquidity.

The legal and regulatory challenges that need to be addressed in order to streamline and regulate ICOs in India-

  1. Classification: Based on their nature, crypto-tokens/cryptocurrencies could be classified as securities or currency or a payment system or intangible property.

This classification shall be crucial in determining the regulatory framework governing their issuance even otherwise and through the ICO route.

The hybrid nature of crypto-tokens might require coordination among the Securities and Exchange Board of India (Sebi), the Reserve Bank of India (RBI) and other sectoral regulators for effective regulatory oversight.

  1. Compliance requirementswill also vary, i.e. if crypto-token is a currency then it will be required to follow “know your customer” norms and anti-money laundering requirements—whereas if they are considered securities, then companies will be required to comply with Sebi listing regulations.
  2. “crypto-regulations”will have to be enacted inter alia governing issuance through ICOs, transfer and management of crypto-tokens, which shall serve as the Bible for intermediaries such as “crypto-exchanges” and “crypto-brokers”, among others.

While it will be a task to regulate a “crypto-token rating agency” primarily due to overlap of jurisdiction, an effective rating agency could potentially aid a retail investor in making an informed investment decision by conducting a reliable due diligence exercise.

Way forward:

In India, there is regulatory opaqueness surrounding the regulation of ICOs (and other similarly placed emerging fintech products). As a crucial first step, it is recommended that a regulatory sandbox approach is followed to develop laws that achieve synergy between new technology, investor protection and effective regulatory oversight. If such an approach is followed, it may lead to greater innovation and investment in India.

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