The Reserve Bank of India’s (RBI’s) decision to lower the boom on crytocurrency will have multiple repercussions. Some of those may be unforeseen and unpleasant. The RBI has decreed that banks and non-banking financial companies must stop services and support to cryptocurrency exchanges, and to any entity for the purpose of cryptocurrency trading. In effect, this cuts bitcoin and its siblings off the formal banking system.
Does that mean that cryptocurrency trading will stop? No. All legitimate and legal trading in crypto will stop. But the currencies will continue to be traded. And, since these trades will be completely unregulated, they will also be untaxed and unrecorded transactions. In short, this is the hawala operator’s dream scenario.
As an analogy, consider gold. Gold is a store of value, much-beloved of Indians. Back in 1968, the Gold Control Act was enacted to curb legal imports. That enabled an ecosystem of smugglers, who bought the metal in Dubai and loaded it on to dhows that landed on West Coast beaches, to be sold at a massive premium. The smugglers not only became rich; they became heroes. Bollywood built a romantic mythos around them.
Gold is a heavy, bulky metal. Transporting, warehousing and selling it requires a complex, visible logistics chain. Cryptocurrencies are strings of computer code. Even keeping a digital record of a crypto-transaction is not needed. Just remember the code required to operate the wallet where the crypto is stored. It is, therefore, possible to buy digital currency paying cash, keep no physical evidence of transaction, and sell it, again for cash.
There will be a transaction record on the blockchain, since most cryptocurrencies use blockchain. However, the blockchain record just confirms a transfer of crytocoins from one wallet to another. It doesn’t indicate the ownership of the wallets. A cyber-savvy trader can make a million wallets (that’s an understatement, anybody can create a hundred million), and bounce his or her crypto holdings around between those wallets, to obscure any genuine trade.
Consider the following “thought experiment”. A diamond merchant, let’s call him Nirav, goes to Hong Kong, or Macau, or Bangkok. You will be shocked to learn that there are establishments in those fleshpots, which accept credit cards for sexual services. The sex is usually billed as “chocolates” or “flowers”. These establishments will also swipe a card for a fake transaction, and hand over the cash for trifling commission. (So will most casinos.)
So, let’s say our hero, Nirav, “buys flowers” on his credit card, and actually uses that cash to buy cryptocurrency. He puts that cash in a digital wallet, memorises the codes and deletes all records. When he returns to India, he walks through the Green Channel. He can sell the crypto for rupees in India; actually he can just sell the code that operates the wallet. Or, the next time he’s in Rotterdam, he can sell the crypto for euros.
This sort of transaction cannot be stopped. Cutting off legitimate cryptocurrency exchanges from the formal banking system will just encourage this circumvention of the ban. The ban will also mean that cryptos are not used as units of exchange in normal transactions, since they cannot be exchanged legally or deposited in a bank. This will drive the trade deeper underground.
This thought experiment isn’t just a theoretical projection. China imposed similar bans on crypto, cutting it off the PRC’s formal banking system, in September 2017. Despite “The Great Firewall of China” and efficient administrative controls, the People’s Bank of China has been unable to prevent Chinese citizens from circumventing that ban on a mass-scale.
Instead of emulating China, the RBI could have looked at Japan, Germany, Korea, Australia and Singapore. Those nations have actually legitimised the use of cryptocurrencies after legislating rules for crypto-transactions, including stringent Know Your Client norms and margins. Of course, those nations have open capital accounts.
But surely, a central bank which could, upon a whim, remove 87 per cent of its own currency from circulation would have the courage to press for an open currency? That would have been the way to go.