Recently, the International Monetary Fund (IMF) shared a policy paper titled “Elements of Effective Policies for Crypto Assets” addressing questions on how to respond to the rise of crypto assets and the associated risks. The paper presents a policy framework for crypto assets that aims to achieve key policy objectives such as macroeconomic stability, financial stability, consumer protection, and market and financial integrity.
In response to this policy paper, the Bharat Web3 Association (BWA), an industry body uniting leading members from the Indian Web3 ecosystem and committed towards navigating seamless policies for the Web3 space, provided their comments and thoughts on some of the key findings of the IMF.
CoinDCX being a founding member of the BWA would like to share these comments with our customers for a better and cohesive understanding.
1. Preference to comprehensive regulation over blanket ban
The IMF policy paper titled “Elements of Effective Policies for Crypto Assets”, henceforth the “document”, advocates for a comprehensive regulation for crypto assets, over a blanket ban. It offers several poignant arguments in support of this stance, such as the adverse impact of a ban on innovation; its ability to drive transactions underground; the cost associated with enforcing a ban etc. We wholeheartedly agree with the reasoning offered in the document and its support for regulating the ecosystem, as opposed to banning it. Owing to its borderless nature, crypto is a unique asset class. Not only will enforcing a ban on it be difficult, but it will also discourage innovation and encourage circumvention and illegal activities. This pattern has been clearly visible in countries including Nigeria and China that have taken unilateral action to ringfence crypto assets. When the Central Bank of Nigeria prohibited financial institutions from dealing with individuals or businesses dealing in cryptocurrency, P2P volumes on international crypto-asset platforms exponentially rose to over USD 1 billion a month in outflows. In the same vein, Chainalysis and the BIS reported that Chinese crypto-assets activity increased last year despite the harsh policies put in place in 2021.
We also want to take this opportunity to highlight the benefits offered by Web3, powered by crypto-assets, and the consequent adverse impact of its ban. Web3 is an open and decentralised internet that leverages blockchain technology and crypto assets. It empowers users to read-write-own on the internet. It is based on Web 1.0’s defining features of openness and community ownership, while addressing the challenge of lack of incentives. Like Web 2.0, it promises to deliver secure and sophisticated solutions, but it addresses the challenges associated with centralisation. As the next iteration of the internet, Web3 promises to serve as the basis for new forms of economic and social interactions allowing people to collaborate, create, exchange, and take ownership of their data. Web3 cannot exist without crypto-assets. They play a fundamental role in incentivising participants of a public blockchain network to engage with the blockchain and perform validation tasks on the network. Crypto creates incentives and disincentives that encourage honest participation on the blockchain and penalises malfeasance. Banning crypto would effectively render Web3 impossible.
2. The scope and taxonomy of the IMF document
The document defines crypto assets as “privately issued digital representations of value that are cryptographically secured and deployed using distributed ledger technology”. Under this broad definition, it further identifies three categories:
Unbacked tokens: no backing assets, are usually issued in a decentralised manner, are transferable, have no redemption pledge, and provide no direct claims on the issuer. With no backing assets, unbacked tokens have volatile prices, and are thus generally not well suited to perform the main functions of money: store of value, medium of exchange, and unit of account. Instead, they are mostly held in the hope that prices will rise.
Stablecoins: are centrally or decentrally issued crypto assets that aim to have a stable price through reserve assets or through algorithms. Stablecoins are generally denominated in a monetary unit of account, such as the dollar, and may pledge to redeem into cash at par. The stablecoins that hold very safe and liquid assets as reserves and offer direct legal claims on the issuer may be in a position to do so, but others may fall short. Even if they do, direct redemptions are often constrained by how often withdrawals are allowed, fees, and other conditions, such as a minimum withdrawal threshold. Many algorithmic stablecoins used in decentralised finance have also proven to be volatile.
Other assets: include utility and security tokens.
- Utility tokens are crypto assets that are usually centrally issued and provide the token holder with access to an existing or prospective product or service. These are usually limited to a single network (that is, the issuer), or a closed network linked to the issuer, and have limited transferability. Use cases include loyalty programs and access to pre-launch discounts.
- Security tokens are crypto assets that are usually centrally issued, transferable, and meet the definition of a security within respective jurisdictions. Their use cases include tokenized equities, fractionalized non-fungible tokens, and initial coin offerings.
The document focuses on unbacked tokens (such as Bitcoin) and stablecoins (such as USDC) because of their larger scale and associated risks. Public digital money such as central bank digital currencies are also excluded from its scope. The IMF has used this taxonomy for a while now, but we believe it suffers from certain fatal inconsistencies that will deeply impact the suggested policies. These flaws are further amplified by the fact that certain tokens (utility tokens, non-fungible tokens and security tokens) are excluded from the scope of this paper and presumably the policy suggested thereunder. Our key concerns with the taxonomy are as under:
- Firstly, the taxonomy is subjective and hence leaves scope for different stakeholders to interpret it differently. The taxonomy proposed by the IMF broadly divides all crypto-assets into three categories – “unbacked tokens”, “stablecoins” and “other tokens”. The third category of “other tokens” is further divided into “utility tokens” or “security tokens”. While the definitions of unbacked tokens and stablecoins are broad and all encompassing, utility and security tokens are defined with certain criteria that we believe are subjective and may vary across jurisdictions. For instance, security tokens are deemed to be those that meet the “definition of a security within respective jurisdictions”. If the recent events unfolding in the United States are any indication, there is sufficient scope to argue that many tokens may satisfy the definition of a security and qualify as security tokens. This argument has been made in the context of several crypto-assets by the US Securities and Exchanges Commission (SEC) such as Bitcoiin2Gen, XRP, and BOON, etc., as securities as well. These claims have also been made with regard to Flexa’s AMP, RLY, POWR and LCX in a lawsuit against former employees of the exchange Coinbase, who allegedly engaged in insider training. These claims have also been made with regard to Eth by the New York Attorney General, calling it “a speculative asset that relies on the efforts of third-party developers in order to provide profit to the holders of ETH.” Notably, this document does not aim to discuss the merits of whether or not a particular crypto-asset qualifies as a security. It only aims to highlight that owing to the nascency of this space, there is no conclusive answer to this question at this point. Different stakeholders have different opinions on the matter and for this reason, we would not recommend including it as a key component of the IMF policy plan.
- Secondly, different jurisdictions may have different stances on whether a crypto-asset qualifies as an “unbacked token” or a “utility token” or a “security token”. Adopting such a contentious criterion as a factor dictating the inclusion or exclusion of a particular crypto-asset from a policy framework may defeat its primary purpose of developing global alignment.
- Thirdly, the taxonomy proposed by the IMF is not future proof or sustainable in the long term, considering the dynamic nature of this space. It may be possible, in theory, to delineate different categories of crypto assets in the buckets discussed above based on the features they display. However, in practice, such bucketing may prove to be challenging as a crypto asset may exhibit hybrid features.
- Lastly, the exclusion of utility tokens and security tokens has not been adequately justified in the IMF document. It is unclear why the suggestions in the IMF document extend only to “unbacked crypto assets” and “stablecoins”, while excluding “other assets” such as “utility tokens”, and “security tokens”.
We therefore believe that the taxonomy proposed in the IMF document and its scoping needs to be reexamined, with the overarching objective of developing global alignment.
3. The benefits and risks identified
We also want to flag that the document appears lopsided when discussing the benefits and risks of the ecosystem. We believe that while the innovation potential powered by crypto assets has been briefly acknowledged, its transformative impact on public good has not been adequately highlighted. On the other hand, an unfair and disproportionate spotlight has been put on the risks associated with crypto-assets.
We analysed the document’s discussion about the “purported benefits” of crypto assets and found that though it lists six such benefits, each seems backhanded. In listing these benefits, the document also fails to acknowledge the transformative potential that crypto assets offer. They also fail to account for the nascency of this space, which often justifies prevalent gaps or teething issues.
For instance, the document starts by stating that crypto assets could achieve cheaper and faster payments by reducing the need for intermediaries using DLT. However, it proceeds to conclude that crypto assets involve a different type of intermediary, known as validators, which may contribute to transaction costs, and hence concludes that crypto assets may not actually achieve cheaper and faster payments. We believe that this argument is flawed for two reasons. First, it views the transformative value-addition of crypto assets, which is enabling transfer of value over the internet in a decentralised manner, in the very narrow context of payments. It is important to acknowledge that crypto assets are a novel invention that have solved for the two primary issues in Web 1.0 and Web 2.0. Web 1.0, which was open sourced, failed to encourage innovation as it was difficult to monetise; and Web 2.0, which offered sophisticated digital solutions and could be monetised, suffered from issues associated with centralisation. Crypto assets offer a solution to address these issues and allow for sophisticated solutions to be provided, in a decentralised and open manner. Therefore, the potential of Web3, powered by crypto extends much beyond the financial system and is bound to offer transformative benefits across sectors – as can already be seen in the increasing intersection between Web3 and other industries – like gaming. Additionally, the use of public blockchains, powered by crypto-assets, is gaining traction in multiple other sectors, including education, healthcare, law enforcement, and in the maintenance of land records. The space is still at a nascent stage of development and the IMF document views it through a very narrow lens, disregarding these other use cases. Second, the document states that transactions in the crypto ecosystem also involve intermediaries such as validators, exchanges, custodial wallets providers, etc. It is important to acknowledge that decentralisation operates on a spectrum. There are varying levels of decentralisation in this space, ranging from fully decentralised to strong centralised elements. Different models aim to solve for different challenges associated with centralisation such as a single point of failure, centralised governance etc. Therefore, the mere existence of intermediaries, if any, does not in itself take away from the objectives sought to be achieved through decentralisation.
In the same vein, when the document identifies transparency and traceability of transactions as a potential benefit, it also identifies challenges with blockchain analytics. As noted previously, this technology is still at a nascent stage. Despite that, since transparency and auditability constitute its core ethos, crypto-asset activities are much easier to monitor than other traditional systems including TradFi. This space, by design, offers publicly available and verifiable data. In parallel advanced tools are being developed to increase efficiency in this process of analysing such data and monitoring the space. There are now a wide variety of private platforms offering publicly available aggregated blockchain data. An illustrative list of these platforms includes Coinmarketcap, Chainalysis, Coinfirm, Elliptic blockchain analytics etc. We acknowledge that the pseudonymous nature of this space presents unique challenges to traceability, which may potentially be augmented by the development of privacy enhancing technologies. However, at the outset, it is important to recognize that the overwhelming majority of flows on crypto-asset platforms are for legitimate purposes. Further, as the ecosystem continues to develop, effective tools to capture bad faith actors have also emerged and successful enforcement action has been undertaken as in the case of Hydra. A key tool will be leveraging centralised crypto-asset service providers and other access points into the ecosystem. This issue, along with issues relating to the lack of consistent reporting is surmountable with clear, effective policies and industry cooperation.
4. Proposed policy and regulatory responses
The document also prescribes nine high-level elements or an effective policy framework. While these elements are currently generic, we have the following key comments:
- First, we acknowledge the pressing need for regulatory oversight over the crypto-assets ecosystem. In parallel though, it is imperative to strike a balance between effective, efficient regulation and encouraging innovation in the space. We believe that Web3, powered by crypto assets, will play a key role in our common digital future. Therefore, ensuring that regulation for this space is robust, but at the same time provides a neutral level playing field for all participants, and fosters an innovative, secure, and competitive environment is key. Promotion of regulatory sandboxes and safe harbour provisions could be a step in the right direction to provide an environment of balanced innovation and regulation. Further, establishment of acceleration centres to empower and support the developer community in respective jurisdictions coupled with infrastructure support could be the way forward. At this point, the elements identified in the IMF document are focused on addressing risks posed by the crypto-assets ecosystem. They do not lay any emphasis on developing an environment that promotes responsible and competitive innovation.
- Second, Web 3 is a highly complex ecosystem, hinging on novel concepts like decentralisation, and enabling the transfer of value at an unprecedented speed. Its impact is likely to transcend geographic and sectoral boundaries, and fundamentally alter traditional governance structures and applicable legal principles. Therefore, defining policies for this space requires cooperation. In addition to cross border cooperation, there is also a pressing need for cooperation between international organisations, cooperation between different regulatory authorities, within the same jurisdiction, and perhaps most importantly, cooperation between public authorities and stakeholders such as industry players and other subject matter experts. We hope that consonant and constructive cooperation with industry players is also fed into the IMF’s policy recommendations for the crypto assets ecosystem.
- Third, we appreciate the IMF’s efforts of setting out high level elements to global policy for the crypto space. However, in order to facilitate the overarching objective of promoting a global standard and minimising the scope for arbitrage and evasion, we suggest that the IMF should develop an implementation roadmap. This roadmap should include certain minimum policy and technology standards that countries across the globe undertake to adopt. Common aspects such as definitions, minimum data collection and real time monitoring infrastructure, the mandate to establish an intersectional body in each jurisdiction to regularly evaluate the crypto ecosystem, and a nudge to develop self-regulatory authorities etc. may be standardised. While prescribing these standards, it is also important to account for the different infrastructure, enforcement, and administrative capabilities of different nations. The G20 Summit has undertaken to focus on the concerns of developing countries and the global south. This presents the IMF with an opportunity to develop a framework that is equitable and can be enforced by developed and developing nations alike.
We at CoinDCX, alongwith BWA, have always endeavoured to encourage our members to go above and beyond the minimum standard to run a safe and wholly compliant crypto-assets platform. We strongly believe that constructive dialogue and outreach will play a pivotal role in addressing the policy challenges in this complex and dynamic space.
We appreciate BWA for taking this opportunity to provide comments on the IMF document. If you have any questions or need further clarification on the comments mentioned, please feel free to reach out to us at [email protected].
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