Everyone must have heard the news by now. The Indian government will bring in the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, in the Winter Session of Parliament starting November 29. What is the big deal? It seems that the Bill will ban most of the private cryptocurrencies except a few. A lot of details about the Bill are not known. Yet people like to speculate. It is absurdly silly to talk about something when there is nothing to go by, but why should I be left behind? Let me throw in my proverbial 2 cents as well.
Disclosure: I have not in the past or present ever owned, traded or involved in dealing with any kind of cryptopcurrencies
Why do cryptocurrencies trade at such high prices? It is perhaps just speculation akin to the tulip mania of yore. All I can see is that people seem to value it more because it is in limited supply like gold or real estate. You cannot create more of it using alchemy. As long as someone else thinks there is value in holding a Bitcoin there is value in it. But that is the case with physical currency as well. If you trust that my 100 rupee note is worth what it says, I can trade. In the past, fiat currency was at least backed by gold. Now it is nothing but paper, backed by a government’s promise to pay the bearer the value of the note.
RBI and the government have always been against cryptocurrencies and cautioned us, citing risks inherent with virtual currencies. Way back in April 2018, RBI announced a ban on the sale or purchase of cryptocurrencies. RBI banned financial institutions from dealing with entities that trade in virtual currencies. The banks were given 3 months to unwind their exposures to such entities. The central bank had this to say about cryptocurrencies (emphasis is mine) –
Reserve Bank has repeatedly cautioned users, holders and traders of virtual currencies, including Bitcoins, regarding various risks associated in dealing with such virtual currencies. 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. A circular in this regard is being issued separately
Obviously, you would expect the virtual currencies’s value to drop which is exactly what has happened. Bitcoin dropped by 10%. Even before this ban the Indian government had been warnings about the economic, financial, operational, legal, consumer protection and security-related risks of virtual currencies. So you could actually predict that the ban is coming :). Obviously which government would like a private currency system where they cannot collect taxes especially if they can’t even know who is making the transactions. Meanwhile, which central bank would like a cryptocurrency if they cannot control the flow of currency to control inflation and such.
Supreme court involvement
Ever since the RBI issued the circular, banks found it convenient to cite the April 2018 circular to turn away customers invovled in dealing with cryptocurrencies. The Supreme Court in one of the judgements overturned the RBI’s 2018 circular. The court felt that RBI is exercising too much power in restricting the trade of cryptocurrencies. It is going against the fundamental rights of citizens to involve in any trade that is legitimate.
As a result of the judgement RBI issued another statement clarifying that banks cannot cite the April 2018 circular as a reason to stop customers from dealing with cryptocurrencies. As a result the cryptocurrencies have been trading like crazy in India. Given that the price of many of these currencies have been going up like crazy some people got seriously rich :).
Cryptocurrency and Regulation of Official Digital Currency Bill, 2021
That brings us to the lastest happenings in the realm of cryptocurrencies – the Bill. Again, like before in history, RBI has been sounding alarms about cryptocurrencies for some time now. RBI believes cryptocurrencies to be a very serious concern from a macro economic and financial stability point of view. In addition RBI governor Shaktikanta Das cautioned investors on the potential pitfalls of the digital currency. Where have I seen this before?
There is no clarity yet, but it seems like the Bill will prohibit several private cryptocurrencies. The government also has plans to introduce an official digital currency. The Reserve Bank of India (RBI) is expected to issue the digital coin that will be regulated by the central bank. There is no point in owning this coin if it is going to be regulated by the central bank now is there? Cryptocurrencies were introduced with the promise of decentralized currency. But for governments and central banks it makes sense because they have inflow of taxes and can control inflation and economic activity.
As expected, people got spooked and traded down the price of several cryptocurrencies by 15% or more after that announcement. What else is new anyway? It seems like history just repeats all the time. I really doubt that the government will ban all private currencies, but what do I know. The market participants seem to know more :).
Anyway, another possibility is that the Bill might render cryptocurrency to not be legal tender. But that is not a problem anyway. It just means that individuals and entities cannot accept bitcoins as a legal tender to offer products or services. However, it is already the case with gold or silver. That does not mean we cannot own them. You cannot use gold as a means of payment to buy anything anyway. But you can certainly convert to cash and then buy the product. Cryptocurrency will become the same (if it is not already that). Most consider cryptocurrency to be a stable store of value like gold, so they are accumulating it.
Again there is no clarity on this front, but most speculate that it will be considered as a captial asset. Which means the short term tax will be the same as your applicable tax rate and the long term tax will be 20% on the capital gains. Not sure if there will be indexation benefit. The period of holding could be 36 months for it to be considered as long term.
There is no clarity as to whether cryptocurrencies will be considered as foriegn assets or not. Since most (all?) cryptocurrencies have foreign roots and have servers outside India, they may be considered as foreign assets in which case you cannot take the indexation benefit for long term investment. Moreover, you will have to report them in Schedule FA (Foreign Assets) when your taxes are due.
I don’t have either a positive or negative view of cryptocurrencies. I am not encouraging anyone to invest or trade in them nor am I recommending that one should avoid it. It is just a confusing blur of an investment vehicle as far as I am concerned. If you know what you are doing, by all means go ahead. I will not invest because I don’t understand, not as a concept but as an investment. If my view changes in the future, I will be sure to let you know.
Cryptocurrency is a store of value as long as everyone (or most people) agree on it, just like gold. However, unlike gold It does not have a real inherent value because it cannot be used in/for anything. If I have a lot of rice, I can say I can live off it. If I have real estate or gold I can find someone to live in my real estate or use the gold in electronics or medicine and give me rice. If I have a lot of Bitcoin, I cannot eat it and I cannot find its use in something. However, if someone can trade it for some rice, it has value. And that is how you will have to look at it. Lets wait for more details to be released about the Bill and then we can revisit.