Good crypto and bad: Defining, regulating and taxing this world

News: The government and regulatory authorities are considering a legislative and regulatory framework for cryptocurrencies. 

As enforcing a ban on cryptocurrencies is not advisable, hence, the current policy approach is a step in the right direction.

What parameters must be considered for regulating cryptocurrencies?

Define a tax structure: This must outline the incidence of long-term and short-term capital gains for crypto investors.

Define a good crypto: The regulatory framework should include a definition of what makes a good crypto. It must include some reference to the most common use cases for crypto, like remittances. 

Incentivizing good crypto: Bitcoin and many other cryptocurrencies have very energy-intensive verification systems. More energy-efficient cryptos are desirable. There could be tax structured incentives to design more energy-efficient verification systems.

What is a good crypto?

A good cryptocurrency includes

– a secure peer-to-peer verification system

– an assurance of some anonymity

– a method of mining that allows for predictable growth in money supply, which cannot be manipulated, and so on.

What are some use cases of good crypto?

– Remittances: A remittance of, say, dirhams to rupees, involves bank charges and delays while the Reserve Bank of India (RBI) processes payments. Instead, one can buy cryptocurrency with dirhams and hand over the relevant codes to somebody who can sell the crypto in rupees. This process will be much faster and not involve bank charges if the parties are comfortable with price volatility.

– Currency swaps: A swap is a deal where two entities exchange two currencies, say USD and INR, at an agreed rate. They commit to the reverse exchange of exactly the same amounts of USD and INR after an agreed time, at the agreed rate, even if the exchange rate has gone up or down. The RBI itself has done swaps, most notably during the global financial crisis. It is easier to do swaps by using cryptocurrency trades rather than via banks.

– Purchasing assets: Crypto can be used to purchase assets or services. But a clear accounting process must be framed for such transactions. For example, El Salvador adopted bitcoin as an alternative currency. Although this experiment has revealed several challenges, it’s worth studying.

– Trustless contract enabled by blockchain: This could prove quite useful in the Indian context. In such a contract, money is put into an escrow account. Instructions are put in blockchain that if certain conditions are fulfilled, the money is to be transferred automatically to a given account. This is much cheaper and less cumbersome than conventional bank escrow.

For example, a municipality hands out a garbage disposal contract. It may create a blockchain where the residents can vote whether they are satisfied with the garbage disposal service. Such contracts cut down on corruption and accelerate government payment processes.

Source: This post is based on the article “Good crypto and bad: Defining, regulating and taxing this world” published in Business Standard on 17th Nov 2021.