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The cryptocurrencies conundrum

Published: 7th Sep 2021 12:05 am | Updated: 10th Sep 2021 12:49 am

By Durgesh Chandra Pathak

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The Government of India has shown an inclination to take cryptocurrencies seriously and is pondering over declaring them as an asset class. They may not be declared legal tender as the central bank would lose its control over the money supply in the economy. However, declaring these an asset class is also rife with nuances.

There are some significant challenges inherent in dealing with cryptocurrencies. The world has never seen anything like cryptocurrencies before. It is an object that can hardly be seen, touched, or stuffed under mattresses. Cryptos originate not in a royal mint but in complex mathematical operations performed in CPUs and GPUs stacked in crypto farms.

The price of cryptocurrencies undergoes unbridled fluctuations at the drop of a hat. We have just witnessed an epic fall in the price of the king of the cryptocurrencies, the Bitcoin (BTC), triggered mainly by some tweets.

Main Issues

Unlike other investment avenues, cryptocurrency exchanges are open 24×7. An individual may buy and sell cryptocurrency hundreds of times in a day. Some of the main issues involved with cryptocurrencies are:

Energy Gobbler: There are miners, and then there are investors. While the investors are like any other saver-investor, miners pose an interesting problem. One can establish a cryptocurrency mining farm at home by using a couple of PCs. The mining operation is highly energy inefficient because all the CPUs and GPUs crunching complex problems gobble up lots of electricity. A study by Cambridge University shows that Bitcoin mining worldwide consumes more energy than consumed by Argentina. It makes cryptos the third-highest energy gobbler after China and the USA.

The only variable cost for a miner is the electricity bill s/he will be paying at a domestic rate while the miner’s profits would be unparalleled. Here comes the issue of negative externality originating from crypto mining. The social cost of the electricity gobbled up by the farm is much more than the private cost the miner pays. When he sucks up the electricity at peak hours, he imposes a negative externality on society.

Dead Abound: The investors do not create any externality, but they are susceptible to scams. As there is no regulated market for cryptos, dead cryptocurrencies abound. Dead coins are the cryptocurrencies that cease to exist due to many reasons, scams being the most prominent ones. According to coinopsy.com, a website that tracks and records dead coins, the number of dead coins has increased to 2,195. Investors may end up losing their hard-earned money in such scams.

Money Laundering: This possibility exists in the current scenario, especially in peer-to-peer transactions.

Multiple Rates: Multiple rates for the same currency coexist in different exchanges due to differential demand-supply pressures and trading practices.

Let us now focus on what the government could do to resolve the above issues.

Create Regulated Exchange

We have multiple exchanges like WazirX, CoinDCX and so forth that deal in cryptocurrency. The government should create a unified trading exchange for cryptocurrency where these exchanges will take the role of brokers. Individuals can have their crypto-trading account with a broker of their liking, while all the transactions would be under the umbrella of one exchange for cryptocurrencies.

This will help investors in three ways: first, all the transaction details will be available with the broker in one place; second, investors could be safeguarded against dead cryptocurrencies. In a regulated exchange, scams could be
prevented to a large extent by a background check to any new currency; third, one price of a coin will prevail in the exchange. Further, the possibility of peer-to-peer transactions would be ruled off, and so will be the issue of money-laundering to a large extent. With a unified exchange in place, investors could attach their trading operations to a single bank account, which makes tracking the transactions easier for investors as well as the tax authority.

The government must start monitoring the process of mining also. It would solve the massive difference in the private energy cost to the miner and its social cost as well. Crypto-miners must register and pay for all the electricity they consume at the commercial rate. It may sound pretentious now, but as cryptocurrencies acquire legal status, mining activities will sky-rocket in India and, along with it, the electricity consumption. Mining rigs could also be incentivised for using green energy. It will keep the carbon footprint of crypto mining under check.

Handling Taxation Worries

There could be two options for taxing the gains from cryptocurrencies. One, the government should make it mandatory on the part of brokers (the erstwhile exchanges) to keep transaction records of individuals and make it available either to the individual directly or to the income tax department, or both. This way, individuals get a pre-filled income tax return form and cannot escape paying taxes.

Another option could be that the government should tax the net withdrawal. For instance, Mr X has an account in SBI and maintains a crypto-trading account with exchange Y. All the dealings of money in and from the cryptocurrency take place using the SBI account of Mr X. He invested Rs 1,000 in bitcoin and sold it at Rs 2,000. Let us assume he withdraws this Rs 2,000. The net withdrawal is Rs 2,000 – Rs 1,000, ie, Rs 1,000, which is the gain Mr X made trading in bitcoin and this amount should be taxed. However, if he reinvests the money in another cryptocurrency rather than withdrawing it, it does not count as a withdrawal and should not be taxed. The underlying assumption is that individuals would withdraw money only with profit.

It is also important not to differentiate between short-term and long-term capital gains for cryptocurrencies as there is no long-run cryptocurrency market. In fact, in the long run, cryptocurrency could be dead. The tax could be according to an individual’s tax bracket. If handled prudently, cryptocurrency trading could prove to be one of the largest sources of tax revenue.

Durgesh Chandra Pathak

(The author is Assistant Professor of Economics, Birla Institute of Technology and Science – Pilani, Hyderabad Campus)

 

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