The brush with crypto offers some lessons for regulation

News: Technology innovation typically remains a step ahead of regulatory frameworks designed with current practices in mind. Problems occur when these innovations push the envelope beyond accepted codes of social and ethical behaviour.

At present, innovations in two sectors are a cause of worry for India’s sectoral regulators: Proliferation of Cryptocurrency exchanges and unregulated digital lending marked by the rise of dubious digital lending apps.

The government and sectoral regulators should act before it’s too late.

Further, the regulatory architecture must be based on principle-based regulations, rather than rule-based regulations, to allow for flexibility and adaptability in a fast-changing technology environment.

What are the issues/concerns with rise of Crypto exchanges and unregulated digital lending?

Crypto exchanges:

Through aggressive media advertising, these platforms have quickly spread their business amongst Indian masses. There are an estimated 15-20 million crypto users in India, many of whom live in Tier-II or Tier-III towns.

They have circumvented responsible norms of advertising, like:

– announcing important disclaimers at high speed

– Not communicating that cryptos are neither currencies nor strictly assets

– Not mentioning that trading platforms are not truly “exchanges

– Not stating that Crypto values are not determined by the usual dynamics governing other income-yielding assets

– Investing in cryptos was an exceedingly risky proposition.

As a result, many scam crypto issuers and exchanges have come up.

Unregulated digital lending:

A report of the joint parliamentary committee (JPC) on a proposed data privacy law, has pointed at the proliferation of shady digital lending apps on the Google Play Store. At least 60 such loan apps are there.

– They are neither registered nor recognised by the Reserve Bank of India (RBI) as a Non-Banking Financial Company (NBFC).

– These applications are owned by Chinese operators or companies, including those named like other legitimate fintech companies. For instance, ‘Udhaar Loan’ resembles ‘Udhaar’, a fintech focusing on micro loans, recognised by the Government of India.

– These lenders have been found using unethical methods of lending and recovering loans.

Why sectoral regulators couldn’t act on this issue?

Sectoral regulators, such as RBI and Securities Exchange Board of India (SEBI), were unable to step in and act earlier because they are governed by specific Acts which do not mention cryptos as a category that needs regulation.

What is the way forward?

The government has now stepped in and is drafting legislation to regulate cryptos.

Financial sector regulators should be able to intervene, by law, whenever any intermediary tries to sell a financial service or any new innovative financial service that poses the risk of disrupting financial stability. For this, relevant enabling clauses must be added to the existing Acts.

The relevant amendments or additions to existing laws should strive to neither be too open-ended nor become overly sector-specific.

NITI Aayog’s paper on licensing digital banks recommends an evolutionary path for digital banks that’s RBI-regulated at all stages:

– first a restricted licence, then a regulatory sandbox offering some relaxations, and finally a “full-stack” digital banking licence.

Recommendations made by RBI’s internal working group on ownership guidelines for Indian private sector banks: RBI has accepted some of the suggestions and modified a few to make entry norms stricter.

Source: This post is based on the article “The brush with crypto offers some lessons for regulation” published in Livemint on 6th Dec 2021.