Context

The growing use of cryptos has led to several innovations and changes in the global economic sphere. However, the anonymity of cryptos may become a serious threat to India’s national security.

Background

What is Crypto Currency?

• A cryptocurrency is a medium of exchange that is digital, encrypted and decentralized. 
• Crypto Currency is a type of digital or virtual currency which is concealed, secure and impossible to counterfeit. 
• It is not a physical source, everything is online.

Bitcoin was the first cryptocurrency, first outlined in principle by Satoshi Nakamoto in a 2008 paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”

What makes crypto currency different from other sources of online payments?

• The main difference in crypto currency is that a specific person can directly transfer his/her money to another person without any middleman that is a bank.
• One doesn’t have to link his/her money to a bank account.
• The banks or any other financial institutions have no control over crypto transactions.
• Hence, it is said to be one of the most secure sources of payment.
• All these crypto currency transactions are stored in a record keeping technology known as Blockchain technology.

Cryptocurrency: the Indian conundrum

 

• There are 15 million to 20 million crypto investors in India, with total crypto holdings of around 400 billion rupees ($5.37 billion).
• In Budget 20222, government announced that India will impose a tax of 30% on income from cryptocurrencies and other digital assets.
• Many countries around the world like Saudi Arabia, Turkey have completely banned crypto currencies.
• Other Countries like USA, Japan, and Canada have imposed reasonable restrictions regarding the same.
• In the recent budget, Government has announced the Reserve Bank of India (RBI) will soon issue a central bank-backed digital currency (CBDC).

How is cryptocurrency a threat to national security?

• Terrorism (through dark net): The use of cryptocurrencies on the dark net for terror acts and drug trafficking by militant organisations is posing a severe threat to the national security and a big challenge to security agencies in India
  • Cryptocurrencies have emerged as the most advanced methods of terror financing and when it is being transacted on the dark net like TOR, Freenet, Zeronet and Perfectdark, it becomes untraceable for the security agencies.
• Money Laundering: Money launderers, cyber criminals and terrorists find cryptocurrencies such as Bitcoin, Monero, Ripples and Zcash highly convenient because they offer anonymity and non-traceability.

Money laundering The UN Vienna 1988 Convention described Money Laundering as the conversion of property derived from any offenses for the purpose of concealing the origin. In India, the Prevention of Money Laundering Act, 2002 (PMLA) describes money laundering as an activity connected with the process to project proceeds of a crime as untainted property.

• Illegal game: The legal environment of this phenomenon is not regulated.
• Cryptocurrency frauds: Crypto frauds can take many shapes and impact a wide range of demographics. Some common frauds include:
  • (i) Scam Initial Coin Offerings where scammers offer cryptocurrency coins to a select pool of investors and then vanish after the sale;
  • (ii) Pump and Dump schemes where fraud is perpetuated when a fraudulent group starts selling coins based on a show and then selling entire holdings, once the value goes up. OneCoin Scam, BitConnect fraud, Karnatake Bitcoin scam are some example; and
  • (iii) Fraud through Defi platforms, recorded to the tune of USD 10.5 billion in 2021. 

Dark Net The dark net is a deep under variable link in the area of internet where one cannot find the identity of the users as the router browser keeps complete anonymity on the identity of the users. It keeps the user anonymous with whom he or she is interacting with because of the end-to-end encryption. Popular dark net browsers: The TOR software, Freenet, Zeronet, Perfect dark, are some popular dark net browsers and these can be accessed only through the specialised software.

Extant laws

• In India, cryptocurrencies in the absence of a governing legislation, have been operating in an open field. (In 2020, Supreme Court had set aside an RBI Circular prohibiting regulated entities from dealing in virtual currencies).
• The traditional AML and combating of financing of terrorism (CFT) apparatus consists of PMLA as the primary legislation aided by others as the Foreign Exchange Management Act, 1999, the Securities and Exchange Board of India Act, 1992, the AML Guidelines 2006, and a RBI Master Circular.
• Cryptocurrency ecosystems by design bypass traditional institutional intermediaries and hence in the current state, may not fall within the purview of the legal regime.
• Till now, cryptocurrency facilitated money laundering has been (established) more through statistical space.
• Though Enforcement Directorate has been investigating role of exchanges in few cases neither cryptocurrencies nor exchanges fall under the entities covered under PMLA/FEMA.
• It is yet to be seen how the courts would treat any such criminal liability within the domain of extant laws and regulations.
• Globally, the Financial Action Task Force (FATF) has been issuing recommendations surrounding virtual currencies.
• In 2021, FATF issued Updated Guidance on Virtual Assets suggesting specific activity-based AML/CFT obligations on intermediaries and recommending licensing requirements, compliance, and supervision mechanisms.

Way forward

• The Indian government is planning to introduce the Cryptocurrency Bill in the Parliament.
• While, the measure has been long overdue, it is unlikely the proposed legislation will end the debate on regulation versus complete ban of cryptocurrencies.
• Where protectionists recommend banning of cryptocurrencies to counter illicit activities and safeguard against volatility and speculation, enthusiasts recommend regulation considering the potential for job creation and contribution to India’s GDP.
• The argument also finds support from the data which shows that less than 1% of illicit activity is through cryptocurrency transactions. Of that, scams make up majority of cryptocurrency related crime.
• Even so, it is accepted that either of the approaches would not suffice to counter illicit activities through P2P networks which by design are immune to institutional control.
• Inclusive regulations with strict enforcement (through mandatory KYC (know your customer), real-time suspicious transaction reporting, industry wide-compliance standards, stringent reporting and monitoring by the regulator might help minimise crypto related illegal activities.
• Thus, enabling economic growth and financial inclusion versus a complete ban which could further push illegal transactions to the underbelly leading to more difficult tracking and penalizing the genuine investor.
• A comprehensive Cryptocurrency Bill would as a first step go a long way in establishing a sound regulatory and inclusive regime for the cryptocurrency ecosystem.