Let’s take an inclusive approach to the regulation of cryptoassets

The FSB includes policymakers, central bankers and regulators of G20 members, along with financial centers such as Hong Kong, Singapore, Spain and Switzerland, and international standard-setting bodies. This makes it a lynchpin for international coordination of financial market governance. While regulation of cryptoassets is nascent in many emerging and developing economies (EMDEs) such as India, partly due to a lack of government capacity, a risk-based and context-specific understanding of emerging markets is essential. The FSB divides crypto markets into three segments: unbacked crypto assets, stablecoins and decentralized finance. The risk within each of these should be set against the local context of EMDE.

First, unbacked cryptoassets derive their value from a mix of factors, including production costs, network effects, user sentiment, and speculation. Several such assets are listed by centralized service providers that act as intermediaries and are regulated in advanced jurisdictions. For example, the EU’s proposed Markets in Crypto Assets Regulation specifies compliance that such intermediaries must adhere to, including measures related to consumer and investor protection. The EU has effectively established a template that can now be widely copied by other jurisdictions. But it is important that EMDEs weigh in, via the G20 process, to help shape a context-appropriate and responsive global template.

EMDE citizens are more likely to enter the financial markets via unbacked cryptoassets as first-time investors. It is therefore important to preserve their trust in both financial institutions and government supervision. This may lead to stricter standards for the listing of cryptoassets in such markets by intermediaries. The EU prescribes that such intermediaries publish a white paper that has some similarities to prospectuses published under existing financial regulation. EMDEs may consider additional criteria for “verification” of cryptoassets to protect investors.

Another area where EMDEs may consider exceptional measures is customer due diligence for anti-money laundering (AML). The Financial Action Task Force’s (FATF) guidance on AML norms for crypto markets is the current gold standard. It prescribes measures such as identification of customers using reliable data sources, identification of beneficial owners as well as the purpose of transactions. The international anti-money laundering and terrorist financing watchdog also prescribes enhanced due diligence for high-risk transactions linked to notified jurisdictions. These measures include obtaining more information about the customer and the transaction, as well as increasing the frequency of discretionary supervision of such transactions. EMDEs may consider widening the net for situations that require increased due diligence based on their own security priorities, for example via thresholds for additional relevant information to be obtained by intermediaries.

Second, stablecoins are usually backed by specified assets (usually the US dollar) or a basket of assets, and are widely used to exchange crypto-assets for fiat currency. However, EMDEs such as India see a potential currency substitution problem with stablecoins, because dollar-backed coins can offer a better value than their local currencies. International standard-setting bodies such as the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions encourage the use of fixed ‘Principles for Financial Market Infrastructures’ on stablecoins. These principles define international standards for critical infrastructure such as payment systems, and central securities depositories and settlement systems. Application to stablecoins would essentially mean using a “same activity, same risk, same regulation” principle, which India already supports in fintech regulation.

Third, decentralized finance is used to offer financial services and products, allegedly without centralized intermediaries. This segment is potentially the riskiest for EMDEs, given that visibility and verification of the identities of counterparties is usually not required to execute transactions. EMDEs like India are seeing an increase in money laundering across the board, including through traditional banking channels. According to PTI data, the Enforcement Directorate registered a total of 4,637 money laundering cases between July 2005 and November 2021, of which 769 were related to money laundering via bank fraud. Decentralized finance is going to further complicate the nature of financial fraud, and the FSB is unlikely to propose a regulatory perimeter for this new market anytime soon. EMDEs should therefore exercise great caution and allow decentralized finance to operate only within sandbox environments.

Over the past decade, technology has acted as a key vector for financial inclusion, via fintech as we know it today. Crypto markets may represent the future of fintech, or at least offer glimpses of it. Therefore, the upcoming G20 presidency will act as a springboard for India to help shape important financial regulation from the EMDE vantage point.

These are the personal views of the authors.

Arvind Gupta and Vivan Sharan are founders of Digital India Foundation and secretary at Esya Center respectively

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