On February 1, India’s Union budget imposed a 30% tax on income earned from the transfer of virtual digital assets (VDAs), and 1% tax deducted at source (TDS) for tracking transactions. Interestingly, crypto prices went up, and crypto platforms saw a 30-50% increase in investor sign-ups. Transaction volumes shot up too. Evidently, various constituents hold conflicting views about something still nebulous.
GoI’s position is that the mining of currency by individuals is an illicit act. Nirmala Sitharaman announced the launch of a CBDC, and a working group of experts to help the government take a call on whether to ban other virtual currencies. The economic affairs secretary has highlighted that a sustainable policy response requires global cooperation, since just banning other virtual currencies will encourage P2P (peer-to-peer) transactions, or the use of websites hosted abroad.
GoI would also have to put data governance guardrails in place. Savings to the tune of 15% would accrue to the central bank from the use of digital currency, considering the costs incurred for printing, transport, storage and distribution of cash. At the same time, GoI needs to worry about the shrinkage of seigniorage – potential losses relating to returns from the assets it buys by just printing currency.
For crypto bourses, that price arbitraging happens between exchanges here and abroad is a reality. They are implementing procedures for facial recognition, identity proof and verification, to pre-empt measures the RBI will mandate to protect India’s financial stability. Now, they will have to address tax-related aspects too. Consequently, a software overhaul is inescapable.
15 million crypto investors in India are probably seeing this as the mainstreaming of an asset class. They have interpreted GoI’s moves as an unspoken endorsement of crypto trade. The more knowledgeable are hedging their investment bets. But the vast number of small investors joining the party in recent weeks underscores that a herd mentality is dictating behaviours. That decimal units of bitcoin and other cryptos are also in play with very small ticket sizes may also be fuelling their appetite. Investors are seeking out experts to definitively understand whether they can treat this as capital gains instead of as business income.
The banking sector will have to worry about disintermediation. As CBDC represents legal tender with limited default risk, individuals will feel encouraged to deal directly with the central bank. And they could prefer investing in digital currency over bank deposits, hurting the balance sheet and lending ability of banks. Presuming the CBDC is blockchain-backed, banks would be further disadvantaged as the digital currency system would operate round-the-clock, at faster speeds, more securely, without the need for elaborate document checks, and with an abbreviated approval chain.
That said, most people have assumed that CBDC will be based on blockchain. Sitharaman’s statement, ‘Cryptocurrency has become generic for anything using blockchain technology,’ may have led to that. But expert advice could influence the final decision differently, considering that power consumption while using blockchain is extremely high, and speeds may still be inadequate when transaction volumes per hour are in millions.
Importantly, there could be an inclination, instead, to get citizens to open an account to operate the digital rupee – to better leverage India’s existing public digital infrastructure including the universal payment interface (UPI) and Aadhaar – to facilitate eKYC and money transfer in real time. India’s burgeoning blockchain ecosystem that employs thousands is eager to know more.
According to the International Monetary Fund (IMF), 110 countries are developing their own CBDCs. A recent Official Monetary and Financial Institutions Forum (OMFIF) report indicates that developing countries are more likely to use them.
Some nations have already launched CBDCs. China has done so in response to massive capital outflows, choosing a centralised system over blockchain. Nigeria and eight Caribbean nations have done so too. Meanwhile, El Salvador became the first nation to make bitcoin legal tender in June 2021. Bitcoins can be used for daily transactions there through a state-sponsored wallet that businesses have to accept.
Street protests in San Salvador indicate that El Salvador is divided about whether the move is a good one. 20% of the country’s GDP constitutes inward remittances from Salvadoreans settled abroad. Considering the huge fluctuations in the value of bitcoin, the number of happy Salvadoreans is also fluctuating from day to day.
Against the backdrop of the RBI governor’s vehement opposition to cryptocurrency, GoI has to announce India’s crypto policies soon.