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A ban on bitcoin is not the answer to the RBI’s regulatory concerns.

The RBI is concerned about probable losses to investors due to volatility in virtual currency markets. But does it always protect investors in all high volatility markets, including the stock and derivatives markets? The RBI is concerned about probable losses to investors due to volatility in virtual currency markets. But does it always protect investors in all high volatility markets, including the stock and derivatives markets?

BY: Anshul Verma and R.K. Pattnaik

A ban on bitcoin is not the answer to the RBI’s regulatory concerns.

Last year, a virtual currency (bitcoin) boomed from $13 to $1,250 per unit value, reaching over Rs 63,000 in the Indian market along its rollercoaster ride. There came a bump on the road when the Reserve Bank of India issued a notification on December 24, 2013, cautioning “users, holders and traders of virtual currencies (VCs), including bitcoin, about the potential financial, operational and legal, customer protection and security related risks that they are exposing themselves to”.

On February 12, in reply to a question posed to him at the annual Nasscom India Leadership Forum, the RBI governor said that he has worries about the underlying fluctuations in the price of bitcoin and also the maintenance of its value. The concern shown by the governor is in light of the fact that any currency gets its value from its stability, which is not the case with virtual currencies. He also said that the RBI is understanding virtual currencies better and will come out with a more considered view.

In this context, it is important to note that virtual currency is a currency that relies on cryptography, peer-to-peer networking and decentralisation. In some cases, like bitcoin, a proof-of-work scheme is used to create and manage the currency. These currencies, especially bitcoin, boast of many exciting features that make it “the perfect digital currency”. Some of these features are frictionless, anonymous and cryptographically secure. Given that bitcoin is invisible to law enforcement agencies and taxation departments, its growing appeal is understandable.

But if these currencies are so good, why are governments and central banks not encouraging such trading? Are they pretending to be advocates of a free market economy while still wanting to keep their monopolistic positions in the currencies market?

First, it is important to address the volatility in bitcoin, as it results in high risk for investors. The RBI is concerned about probable losses to investors due to volatility in virtual currency markets. The analysis of data from bitcoinscharts.com suggests that the bid-ask spread has a high range, between 310 for GBP and 55,490.7 for the rupee. However, does the RBI always protect investors in all high volatility markets, including the stock and derivatives markets?

Second, the RBI also has concerns relating to taxation. Taxes are seen as the medium of providing growth to the economy and virtual currencies like bitcoin are a threat to the federal taxation system due to their intrinsic quality of not identifying the person transacting in the currency. But is a ban on bitcoin likely to solve this concern?

A third concern is security. There could be security risk in transactions relating to trading in virtual currencies like bitcoin, but one must not forget that this kind of risk is built into any transaction done through internet or, for that matter, plastic money as well. Thus, if the argument holds true for virtual currencies, it also holds true for plastic money and e-wallets. At least, bitcoin has a proof-of-work scheme to prevent it.

Fourth is the concern about money laundering. There had been strong opposition to the activities of money laundering, which is said to pose a threat to the federal economic system due to its links to black money and support for anti-national activities. The authorities have strongly acted against hawala transactions where identifying transacting parties had been easy, but it may take new shape through virtual currencies like bitcoin.

Given the over-protective approach of the regulator, it is likely that its considered view is going to lean towards a ban on transactions in virtual currency. Such trade cannot be stopped by a command-and-control approach alone. If the authorities really want to stop trading in virtual currencies like bitcoin, they may have to ban the internet.

Is that even feasible?

The RBI must not throw the baby out with the bathwater. If it desires to counter the rise of these currencies, it must take some intelligent steps like lowering the transaction fee; accelerating the process of receiving payments through cards or the banking system, etc. The RBI could also try to incorporate virtual currencies in their framework for typical transactions like forex, which may counter the typical problems of current account deficit. People invest to earn and if they think bitcoin helps earnings, they will trade in it; if not, bitcoin will perish automatically.

The writers are professors at S.P. Jain Institute of Management & Research, Mumbai.
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