Confusion In The Crypto Universe

While the tax treatment does legitimise past crypto transactions, there is a possibility that any, or all, private cryptocurrencies will be banned in future.

The Budget had several announcements indicating policymakers are actually thinking about the cryptocurrency ecosystem.

Importantly, the Reserve Bank of India is scheduled to roll out a central bank digital currency (CBDC), using a blockchain or similar technologies.

Also, a tax treatment for cryptocurrency and associated digital assets such as NFTs (non-fungible tokens) was announced.

These announcements leave many unanswered questions, however. We'll have to wait for further clarifications and notifications from the RBI and the income tax department to understand the nitty-gritty.

While the crypto trading community and the exchanges are relieved by the granting of some degree of legitimacy, they are also unhappy about high tax imposts.

A crypto high roller who wished to remain anonymous pointed out taxation is de facto legitimisation -- after all, taxes are not imposed on profits from trading heroin!

In a more measured reaction, Bhagaban Behera, CEO and co-founder of the crypto exchange, Defy, said, "The proposal of taxation of digital assets is the first step towards legalising and will go a long way in alleviating fear and uncertainty.

"However, the taxes would impact the industry by making it prohibitive for traders, or might drive it underground, or overseas.

"I am hopeful the government would be open to a review of the proposed tax rates and structure."

The 30 per cent tax rate mentioned in the speech is in line with short-term capital gains on equity, futures trades in commodities and so on.

But the Budget did not clarify if this is only being imposed on short-term capital gains, or on all capital gains including long-term.

Nor does it clarify if trading losses can be offset, as is the norm with other assets. The IT notification will need to clarify these.

Note, also, that the announcement of a tax treatment only implies that these assets are being granted legitimacy -- it doesn't guarantee it.

The draft Cryptocurrency Bill contains provisions that may be interpreted to mean that only specific private cryptocurrencies will be recognised.

So, while the tax treatment does legitimise past crypto transactions, there is a possibility that any, or all, private cryptocurrencies will be banned in future.

Some of the anxiety over regulatory treatment remains.

The bald announcement that RBI will be rolling out a CBDC also raises many questions.

Any conventional fiat currency is interest-bearing.

From the central bank perspective, the RBI sets policy interest rates, conducts treasury auctions and controls money supply.

Users can park rupees in the bank as an electronic asset, or keep the notes as paper, or use a digital wallet issued by a fintech service provider.

Given the Unified Payments Interface (UPI) and dozens of fintech service providers, the rupee is easily used electronically, in both small and large transactions.

So here are the questions that arise immediately with a CBDC:

Will the digital rupee be interest-bearing?

How will the RBI treat this in its accounting of money supply?

Can the CBDC be seamlessly exchanged for the paper rupee at 1:1?

Can it be seamlessly exchanged for the conventional electronic rupee?

Can it be used in a forex transaction or as an instrument of outwards or inwards remittance?

How will a digital note be extinguished if it is to be withdrawn from circulation?

Usage of the blockchain, or similar electronic ledgers, could add puzzling complications and raise privacy concerns.

In private cryptocurrencies, with no central issuing authority, the blockchain is used for crowd-sourced verifications of the authenticity of transactions.

Every crypto coin 'mined' has a unique code (which can, in the case of bitcoin for example, be broken down into a hundred million different unique codes) and that code is associated with the specific wallet that contains the coin.

When a crypto transaction is made, the crowd reviews the blockchain to ascertain if a wallet that possesses a specific coin is transferring that coin to a different wallet.

Literally every transaction that has ever been done can be reviewed, and the history of every specific coin can be traced.

Anonymity, or some degree of anonymity, is maintained because the owner of a digital crypto wallet need not be known, and any entity could own any number of crypto wallets.

We may safely assume the RBI will demand Know Your Customer information for every digital wallet containing the digital rupee since it asks for KYC for every bank account.

So, the question of anonymity using CBDC doesn't arise.

If there is one central authority issuing a CBDC -- or even if the RBI farms out currency management to a small group of scheduled banks and fintech service providers -- where is the need for a blockchain?

The verification of transactions can be done as it is with the UPI.

If the currency is not interest-bearing, why use it, in preference to the UPI?

Would users be wary about the privacy implications since every transaction is traceable all the way down to the specific digital coin used?

Maybe a new digital currency with a new blockchain-based system could be issued more cheaply and used with less latency for a large variety of transactions.

Maybe many new services can be built on a CBDC. But these are questions the RBI will have to address before it successfully launches a new digital rupee.

Feature Presentation: Ashish Narsale/Rediff.com