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The manner in which cryptocurrencies which began as innocuous playthings of geeks went on to become the most sought after asset class and a threat to traditional cross-border payment channels, while managing to stay beyond the reach of regulators, shows the challenges that digital innovation pose.

The original white paper on Bitcoin, put out by its founder, the anonymous Satoshi Nakamoto, described it as, “a purely peer-to-peer version of electronic cash (that) would allow online payments to be sent directly from one party to another without going through a financial institution.”

Most regulators did not take it seriously then, since its usage appeared to be limited to a few rebels who wanted to express their displeasure against the traditional fiat currencies. But Bitcoin has cloned thousands of other cryptocurrencies, which are no longer innocent payment channels but have morphed into a highly speculative asset and conduits of illicit cross-border money transfers.

The experience with cryptocurrencies shows that fintech products and innovations need to be taken more seriously going ahead and quickly brought under the regulatory radar before they grow in to a many-headed monster. There are other similar digital innovations such as digital lending or algo trades that have grown surreptitiously in the shadows in a similar manner with the regulators struggling to frame rules them.

Digital lending entities

More than a decade ago, the usurious practices of microfinance companies charging exorbitant rates of interests, harassing and shaming borrowers had led to a spate of suicides making the RBI issue regulations to check the lenders in this space. The same sequence of events is now being repeated, but in digital space.

As the Covid-19 pandemic hit the livelihoods and small businesses, digital lending apps turned out to be a ready source of money to these small borrowers. While funds could be accessed for extremely short periods, ranging from 7 to 15 days, the rates of interest charged by the digital lenders were extremely high, ranging from 60 to 100 per cent, according to reports. These apps required the borrower to give them permission to access all the information on their smartphones under the garb of doing KYC checks. The problem started when the borrowers were unable to repay the loans. They were harassed, publicly shamed and even blackmailed leading to some borrowers even resorting to the extreme step of taking their lives.

The RBI had taken note of these malpractices and issued an advisory in December and had also opened a portal for registering complaints. It recently set up a working group to give recommendations on regulating these businesses.

The swiftness shown by the central bank in trying to bring digital lending entities under regulatory purview is laudable. It’s clear that there is demand for loans from such digital lenders and total clamp-down on this space is not a good idea. Weeding out the bad players and ensuring that the lending activities continue with sufficient protection to borrowers is the way forward.

But the point to note is the manner in which the miscreants were quick to find a regulatory gap and begin operations. This requires equal amount of agility from regulators as well.

Dealing with algo trading

Another instance of a digital innovation blind-siding regulators was seen in the proliferation of algorithmic or programmed trading in Indian stock exchanges. These trades that require little or no manual intervention, where computer programs shoot orders to the exchange servers at lightning speed, currently account for over 60 per cent of turnover in derivatives section and 50 per cent in cash segment of the NSE.

There was a lot of furore about these algo trading around 2012 when it was first revealed that programmed trading, especially from colocation sites located close to exchange servers, are ahead of the small investors in trade execution due to their proximity to the exchanges. Further, the high-frequency-trading programs and other rogue programs were gaming the market to stay ahead of other traditional traders.

But no one could explain how or when algo trading had started on Indian exchanges and how they had become so widespread by 2012. The market regulator was in a fix then, since banning algos would have resulted in depriving liquidity from market and making FPIs turn away. SEBI decided to embrace algos and regulate them by issuing guidelines to exchanges, intermediaries and investors about dealing with algos.

We had dealt with this logjam in https://www.thehindubusinessline. com/opinion/columns/lokeshwarri-sk/ learn-to-live-with-algo-trading/ article22995759.ece

Regulating cryptos will be tricky

With fintech adoption growing at a break-neck speed in the country with growing smart phone and data accessibility, it is clear that innovative products that fox regulators and at times border on the illegal will keep cropping up. Regulators need to be on their toes and increase the strength of their digital surveillance team which has the skills to understand these products.

But, while innovations like digital lending and algo trading can be regulated and streamlined by regulators, cryptocurrencies will be much more challenging. This is because — one, it is hard to categorise cryptocurrencies as either currency or asset. So determining the regulator for them is quite difficult. Two, the creation or mining of the cryptocurrencies takes place globally and hence cannot be controlled. While trading can be banned in India, it will continue in other global trading platforms which can be easily accessed by Indians. Three, the investors of these crypto assets are mostly not the investors of traditional asset classes.

Hence it may not be possible for issuing reactive regulations for these crypto assets and absorb them into the mainstream as done for other tech innovations. A global consensus on crypto mining and trading could be the way forward, with uniform rules and regulations framed for crypto trading platforms in all countries. While the contours of the Cryptocurrency Bill to be presented in Parliament is awaited, the last word has not yet been said on taming this beast.

The last two decades have seen rapid innovation in fintech with these digital entities seeping into spaces hitherto occupied by traditional banks, insurance companies, stock brokers, investment advisories, and so on. Some of these entities have tried pushing the boundary between the acceptable and unacceptable, ethical and unethical, legal and illegal and, in many instances, regulators have been caught sleeping at the wheel. Regulators will have to upskill and increase the manpower equipped to deal with fintech entities so that they are not caught off-guard, once too often.