Abstract

Blockchain technology, the foundation of cryptocurrencies, presents significant regulatory challenges due to issues such as data privacy, jurisdictional uncertainty, and anonymity. The financial system's integrity is threatened by the use of NFTs for money laundering, mixed services exploitation, and privacy-focused cryptocurrencies. Authorities are enforcing stronger KYC and AML guidelines to combat cryptocurrency laundering. The dynamic nature of cryptocurrencies calls for a balance between security and innovation. This study examines potential and regulatory concerns surrounding blockchain technology and cryptocurrencies like NFTs, ICOs, and STOs, emphasizing the need for strong AML regulations to preserve global financial integrity. Collaboration between regulators and law enforcement agencies is crucial for effective detection and prevention of misuse while maintaining legal usage and technical innovation. The paper emphasizes the importance of regulatory experimentation, consortium formations, and the creation of a regulatory framework with progressive, fit-for-purpose, and agile adaptations. It also reviews the global standing on crypto regulations and explores collaborations for governance, sandbox approaches for regulatory adoption, and progressive implementation.

Keywords: Money laundering · Terrorist financing · Blockchain · Cryptocurrency · New payment methods · FinTech Business · Criminology · Terrorism · Security · Payment · Due Diligence · Futures Contract · Governance

Introduction:

Bitcoin, introduced by Nakamoto in 2008, is designed as "an electronic payment system based on cryptographic proof, allowing any two willing parties to transact directly with each other"1. This peer-to-peer (P2P) system eliminates the need for intermediaries such as central banks to facilitate and validate transactions. Operating on a decentralized and distributed open-source software platform, Bitcoin allows users to join or leave the network at any time.2 Key components of Bitcoin include bitcoins, wallets, public and private keys, and the blockchain. Bitcoins are lines of code stored in wallets, which provide users with an address like a bank account number. Users rarely need to disclose their real-world identity to obtain a wallet, often requiring only an email address.3 Public keys generate Bitcoin addresses, sign transactions, and verify payments, while private keys must be securely stored to prevent loss of access to bitcoins.4 The blockchain records all transactions publicly, including the public keys of the sender and recipient, transaction amount, and timestamp.5 This paper explores the implications of decentralized nature of blockchain on the financial system and developing regulations for its governance.

Blockchain technology, the foundation of cryptocurrencies, presents significant regulatory challenges due to its decentralized nature and anonymity features.6 The lack of comprehensive regulation leaves cryptocurrencies operating in a gray area, prompting governments worldwide to consider regulatory frameworks. Public blockchains face challenges in anonymity and monitoring, with some offering complete anonymity and others providing pseudo-anonymity.7 Jurisdictional ambiguity complicates matters further, as determining jurisdiction in disputes related to crypto-related (smart) contracts and transactions can be challenging.8 Data privacy and security are major concerns, as anonymity can lead to privacy breaches and data theft. Defining cryptocurrencies as securities or commodities is another regulatory challenge, with legislation like the Financial Innovation and Technology (FIT) for the 21st Century Act9 aiming to clarify this distinction.

Technology loopholes in DLT aiding evasion from Regulatory Agencies and Law enforcement

Crypto laundering has emerged as a significant issue in the digital economy, with money launderers employing increasingly sophisticated techniques to obscure the origins and destinations of illicit funds. These criminals exploit privacy features and decentralization, creating unique challenges for regulators. Among the most prevalent methods used in crypto laundering are cryptocurrency mixers and privacy wallets, which are designed to anonymize transactions10, making it difficult for authorities to trace funds.

Cryptocurrency mixers, such as tumblers, are services that aggregate and redistribute crypto assets, effectively breaking the link between the original and final destinations of funds. By blending cryptocurrencies from various sources, mixers make it difficult to trace the origins of transactions.11 Privacy wallets, like Wasabi Wallet and Samurai Wallet12, use advanced anonymization techniques to further complicate tracking efforts.13 These tools are designed to protect user privacy, but they are often misused by criminals to launder money. As a result, regulators are increasingly focused on enhancing oversight, collaborating with industry stakeholders, and employing advanced blockchain analytics to address these challenges.14

The use of non-fungible tokens (NFTs) for illicit money laundering has also become a growing concern. NFTs, due to their inherent characteristics and the anonymity of the blockchain, have been exploited for money laundering schemes.15 Criminals purchase NFTs with cryptocurrency, resell them, or create forged NFTs using cryptographic keys.16 The decentralized and pseudonymous nature of the cryptocurrency ecosystem makes it challenging for regulators to identify perpetrators and trace illicit funds. To mitigate these risks, robust anti-money laundering (AML) measures and enhanced regulatory oversight are essential to maintaining the integrity of the market.

One notable method of crypto laundering involves mixing services that blend cryptocurrencies from various sources, making it difficult for authorities to track the origins of laundered funds. The infamous Silk Road marketplace, which relied heavily on Bitcoin for illegal transactions, highlighted the need for complex laundering techniques to obscure the origins of illicit funds.17 Cryptocurrencies like Monero and Zcash, known for their advanced privacy features, are particularly popular among criminals for laundering money.18 These privacy-focused cryptocurrencies offer features like stealth addresses and ring signatures, which make it difficult for law enforcement agencies to trace transactions and identify the individuals involved.19

The rise of distributed ledger technology (DLT), including blockchain, has added new layers of complexity to the fight against money laundering and terrorist financing. DLT disrupts traditional centralized systems and eliminates the need for trusted intermediaries, posing unique regulatory challenges viz. jurisdictional issues, data privacy, security concerns and regulatory uncertainties.20 The legal uncertainties surrounding DLT highlight the need for technology-neutral regulations that can adapt to these rapidly evolving technologies.21 Privacy-focused cryptocurrencies have become increasingly popular among cybercriminals, as they offer a high level of anonymity that complicates the efforts of law enforcement.22

The Financial Action Task Force (FATF) has reported an increase in complex laundering schemes involving multiple cryptocurrencies and blockchain platforms.23 These schemes often involve a combination of cryptocurrencies and platforms, making it difficult to trace the flow of illicit funds. For example, the 2019 Plus Token Ponzi scheme used multiple cryptocurrencies and blockchain platforms to obscure the origins and destinations of funds, making it one of the largest cases of crypto fraud in recent history24.

Initial coin offerings (ICOs) and security token offerings (STOs) are two fundraising strategies that have been exploited for money laundering. ICOs, which gained popularity in 201725, offer utility tokens in exchange for cryptocurrencies. However, the unregulated nature of ICOs has led to numerous scams and fraudulent schemes, such as the Bitconnect case in 2018.26 STOs, on the other hand, sell security tokens under regional securities laws, offering investors greater protection and transparency.27 Despite their regulatory framework, STOs are still vulnerable to exploitation, as they can be used to convert illicit funds into tokens and then back into fiat currency.28

Decentralized mixing technologies, such as CoinJoin, offer enhanced privacy solutions by combining multiple users' transactions into a single transaction.29 While these privacy-enhancing technologies protect users, they are often exploited by criminals for laundering money. Decentralized services like Wasabi Wallet and Join Market have become popular tools for anonymizing cryptocurrency transactions.30 However, the balance between privacy and regulatory compliance remains a critical focus within the cryptocurrency community.

Distributed Ledger Technology (DLT) is a decentralized digital system that enables multiple parties to share and update a common database. Blockchain, a transparent and trustworthy DLT, is believed to be effective against fraud, money laundering, and other financial crimes31. Crypto exchanges have collapsed due to law enforcement traced money to tax havens in countries like South Korea, Bahamas, and USA. DLT allows billions of transactions without strict sovereign currency oversight, supporting legitimate activities like disaster recovery32 and charitable giving33. Balancing innovation with regulation is crucial for harnessing DLT's potential for positive consumer protection.

To address these challenges, law enforcement agencies must enhance their digital capabilities by leveraging technologies such as blockchain analytics, big data, and artificial intelligence (AI)34. Enhanced international cooperation, robust legal frameworks, and continuous adaptation to evolving technologies are essential in combating the risks posed by crypto-laundering. By strengthening collaboration and using advanced technology, regulators and law enforcement agencies can improve their ability to track, trace, and ultimately stop illicit activities within the rapidly growing digital financial ecosystem35.

Global Approaches, Frameworks and Regulatory Recommendations

Cryptocurrency is a contentious global issue with varying legal approaches. The anonymity of transactions limits government control and exposes it to illicit activities like money laundering and terrorism financing36. To combat this, several countries have introduced anti-money laundering and counter-financing of terrorism laws.

In the United States, the regulatory framework for cryptocurrencies is grounded in the Bank Secrecy Act (BSA), which aims to prevent money laundering and other illicit financial activities37. Under the BSA, financial institutions such as banks, savings associations, insurance companies, casinos, and money services businesses (MSBs) must maintain records and file reports on currency transactions and customer relationships. In 2019, the Financial Crimes Enforcement Network (FinCEN) extended this requirement to entities dealing with convertible virtual currencies (CVC), such as Bitcoin, classifying them as MSBs. This means that cryptocurrency businesses accepting or transmitting Bitcoin must register under the BSA and comply with reporting obligations, including filing Currency Transaction Reports (CTRs) and Suspicious Activity Reports (SARs)38.

Despite this framework, there is a lack of uniformity in how U.S. regulatory bodies approach cryptocurrency. FinCEN’s classification of Bitcoin as a money transmitter contradicts the U.S. Department of the Treasury’s stance, which argues that Bitcoin can function like a currency but lacks essential characteristics of legal tender39. Furthermore, the Securities and Exchange Commission (SEC) has a somewhat conflicting stance on Bitcoin40. While it agrees with the Commodity Futures Trading Commission (CFTC) that Bitcoin is a commodity, the SEC also acknowledges that products linked to digital assets, including Bitcoin, can be registered as securities under certain conditions41.

A significant focus for the SEC has been Initial Coin Offerings (ICOs), which resemble crowdfunding campaigns where investors exchange currency for digital assets like tokens42. Given their potential for secondary market trading, the SEC treats some ICOs as security offerings43. However, recent developments, such as the repeal of the SEC’s Staff Accounting Bulletin 121 (SAB 121), signal a potential shift toward a more balanced approach to cryptocurrency regulation44.

Across the Atlantic, the European Union has taken steps to introduce a unified regulatory framework for cryptocurrencies. In 2020, the European Commission finalized a plan to regulate virtual assets to prevent regulatory fragmentation and ensure secure usage of cryptocurrencies45. The EU’s 5th Anti-Money Laundering Directive (5AMLD) extended AML regulations to cover virtual currencies for the first time, requiring member states to regulate cryptocurrency exchanges and wallet providers46.

In Switzerland, progressive legislation on distributed ledger technologies (DLTs) allows for the creation of DLT securities and the tokenization of financial instruments47. Meanwhile, the United Kingdom treats cryptocurrencies as property and controls their use through the Financial Conduct Authority (FCA), which grants licenses to cryptocurrency companies48.

Japan has taken a self-regulatory approach, encouraging industry associations to develop guidelines and best practices for cryptocurrency exchanges. In Canada, the government considers cryptocurrencies a financial instrument for tax purposes and was the first country to approve Bitcoin-traded funds (ETFs) traded on the Toronto Stock Exchange49. Canadian cryptocurrency exchanges are required to register under the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC)50, which also monitors Bitcoin ATMs for potential money laundering activities51.

The diverse approaches taken by various countries reflect the complexities of regulating cryptocurrencies. As digital assets continue to evolve, global collaboration and comprehensive frameworks will be crucial in addressing concerns around anonymity, security, and market stability while fostering innovation.

As governments worldwide grapple with the rapid rise of cryptocurrencies and distributed ledger technology (DLT), regulatory frameworks are gradually evolving to address the unique challenges posed by these new financial instruments. The European Union (EU) introduced the Markets in Crypto-Assets Regulation (MiCA) in May 2023, a comprehensive framework requiring licensing for companies issuing or trading cryptocurrencies52. MiCA aims to enhance transparency and prevent illicit activities by mandating that service providers obtain and verify sender and beneficiary information for crypto transfers starting in January 2026.

France has taken a proactive approach to consumer protection, requiring advertisers to disclose the risks associated with investing in cryptocurrencies to help consumers make more informed decisions53. Meanwhile, in Switzerland, taxpayers are subject to income or wealth taxes on their crypto holdings, ensuring that crypto assets are integrated into the traditional tax system54.

El Salvador has adopted a more radical approach, becoming the first country in the world to declare Bitcoin as legal tender. Bitcoin is now accepted nationwide, and all merchants are required to accept it for payments. Foreigners who make Bitcoin gains are exempt from paying taxes, which is part of El Salvador's effort to attract crypto investments55.

In the United States, the development of a regulatory framework for cryptocurrencies is ongoing. Bills such as the Financial Innovation and Technology (FIT)56 for the 21st Century Act and the Blockchain Regulatory Certainty Act57 aim to clarify how cryptocurrencies should be treated—as securities or commodities—and define the roles of regulatory bodies like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC)58. However, these legislative efforts have faced challenges and have yet to significantly advance.

Countries like Singapore and the United Arab Emirates (UAE) have embraced the evolving crypto landscape by balancing innovation with risk management. Singapore's neutral legal environment and arbitration-friendly laws promote regulatory compliance while fostering innovation in cryptocurrency transactions59. The UAE, on the other hand, has implemented a complex regulatory system overseen by multiple authorities, such as the Central Bank of the UAE (CBUAE) and the Securities and Commodities Authority (SCA)60. These authorities work together to ensure market integrity and investor protection in the rapidly growing crypto market.

At the international level, global organizations such as the Financial Action Task Force (FATF), the International Monetary Fund (IMF), and the Basel Committee on Banking Supervision (BCBS) are leading efforts to harmonize regulations across borders. FATF, in particular, has issued guidelines for virtual assets and service providers, emphasizing customer due diligence, record-keeping, and the reporting of suspicious transactions. The FATF's "travel rule" requires Virtual Asset Service Providers (VASPs)61 to collect and transfer customer information during crypto transactions, aiming to prevent the misuse of cryptocurrencies for illicit activities62.

The Basel Committee has also published warnings about the risks that banks face when dealing with virtual assets, including market volatility, fraud, hacking, money laundering, and terrorism financing. These international standards set the tone for national regulations and shape the future of the global cryptocurrency market63.

The International Organization of Securities Commissions (IOSCO) has issued 18 policy recommendations for regulating cryptocurrencies and digital assets. These recommendations focus on ensuring market integrity and investor protection through robust governance, combating abusive behaviors, enhancing cross-border cooperation, and managing technological risks64.

The organizations like the World Economic Forum with papers like "Pathways to the Regulation of Crypto-Assets: The paper "A Global Approach"65, International Monitory Fund (IMF) with paper viz. ‘Global Crypto Regulation Should be Comprehensive, Consistent, and Coordinated’66, and Chatham House67 are advocating for international coordination in regulating cryptocurrencies. Their frameworks emphasize transparency, global cooperation, and the need for harmonized standards to balance innovation with risk management. The future of cryptocurrency governance depends on effective global collaboration to create a secure and transparent ecosystem that promotes responsible innovation while protecting investors.

India’s Cryptocurrency Regulatory Landscape: Challenges and Opportunities

India’s cryptocurrency regulatory landscape is a complex and evolving environment, marked by both challenges and opportunities. As global financial bodies such as the Financial Action Task Force (FATF), the International Monetary Fund (IMF), and the World Bank recommend stricter regulatory oversight, India is navigating a transitional phase characterized by uncertainty and ambiguity68. The fundamental nature of blockchain technology, particularly the decentralized structure of public blockchains like Bitcoin, challenges traditional regulatory frameworks, while permissioned blockchains, hosted on private networks, offer more centralized control69.

India’s regulatory journey with cryptocurrencies began in 2013 when the Reserve Bank of India (RBI) issued its first warning about the risks associated with trading digital currencies like Bitcoin70. At that time, there was no formal regulatory framework in place, leaving the market exposed to significant legal and financial risks. In 2018, the RBI took more drastic action by issuing a circular that prohibited banks and financial institutions from dealing with cryptocurrency-related transactions. This move effectively cut off banking services to the crypto sector, citing concerns around money laundering, investor protection, and financial stability. However, this ban was short-lived. In 2020, the Supreme Court of India overturned the RBI’s restrictions, ruling that the ban was disproportionate and lacked a proper assessment of the cryptocurrency market’s impact71.

Since the Supreme Court’s decision, India’s cryptocurrency sector has seen a revival, with a renewed focus on regulatory clarity. Discussions around the "Cryptocurrency and Regulation of Official Digital Currency Bill, 2021" highlighted the government’s intent to ban private cryptocurrencies while exploring the introduction of a central bank digital currency (CBDC)72. Despite these discussions, a definitive regulatory framework is yet to emerge, leaving market participants in a state of limbo.

India's approach to cryptocurrency regulation is further complicated by the inherent volatility and unpredictability of digital currencies. The lack of clear legal guidelines makes investing in cryptocurrencies particularly risky73. In response to this, Finance Minister Nirmala Sitharaman proposed a taxation scheme on digital assets in 2022, which ignited debates regarding the legality of cryptocurrencies 74. The Union Budget 2022 introduced a comprehensive tax regime for virtual or digital assets, imposing a 30% tax on profits from cryptocurrency transactions and NFTs, along with a 1% Tax Deducted at Source (TDS) on transfers exceeding certain thresholds 75.

Despite the challenges, there are signs of progress in India’s regulatory approach. The Securities and Exchange Board of India (SEBI) has proposed a multi-regulatory framework to oversee the virtual digital assets (VDA) sector76. This approach is seen as a balanced way to improve regulatory clarity while fostering innovation. A well-regulated environment would not only provide greater protection for investors but also reduce the risk of market abuses, enhancing trust and integrity within the ecosystem 77.

India's regulatory framework is evolving, causing investors to be cautious. To mitigate risks, conduct thorough research, use reputable platforms, and implement security measures like two-factor authentication. The future of cryptocurrency regulation in India remains uncertain, but growth opportunities exist if regulatory and security challenges are addressed.

Comprehensive Framework

Cryptocurrencies, operating on decentralized networks, pose significant regulatory challenges due to their distributed nature, lack of central authority, and complexity of monitoring and enforcement. The global reach and variations in legal frameworks make it challenging to establish uniform regulations78. Key concerns include anti-money laundering compliance, investor protection, market volatility, privacy, and anonymity. The technological complexity of blockchain technology complicates tracking transactions and identifying illicit activities. A globally coordinated regulatory framework is essential to balance privacy and security with regulatory demands, protect investors from fraud, and address market volatility, fostering innovation while maintaining financial stability.

India, with its evolving stance on cryptocurrency regulation, stands at a pivotal moment that could influence both its domestic market and the broader global cryptocurrency debate. As part of its approach, India is implementing a five-point regulatory framework, which emphasizes self-regulation by cryptocurrency exchanges, global collaboration, and balancing innovation with consumer protection. Exchanges like CoinSwitch Kuber, for example, have implemented robust Know Your Customer (KYC) processes, ensuring secure onboarding and identity validation by matching bank account details with KYC documents 79.

The Indian government is also pushing for global cooperation in regulating cryptocurrencies, particularly in areas such as taxation and compliance. For instance, it has required cryptocurrency companies to adopt strong KYC procedures to ensure security and prevent illicit activities. In the future, India’s regulatory framework will need to balance fostering innovation with ensuring consumer protection, maintaining market integrity, and complying with legal and tax requirements. India’s calls for global cooperation align with the G20’s emphasis on collaboration, positioning the country as a significant player in shaping the global cryptocurrency landscape 80.

India's involvement in global regulatory discussions is crucial for creating a well-coordinated and harmonized environment for cryptocurrencies. By collaborating with international bodies like the International Monetary Fund (IMF) and the Financial Stability Board (FSB), India can contribute to shaping the world’s first comprehensive set of crypto regulations81. This coordination would promote regulatory consistency, reduce arbitrage opportunities, and enhance investor confidence. Extrapolating further, by tapping into global expertise in risk assessment and mitigation, India can learn from international best practices, enabling it to develop robust and efficient regulatory frameworks 82.

International cooperation would also facilitate cross-border cryptocurrency transactions, integrating India’s crypto ecosystem with the global financial system83. Such collaboration would improve market integrity and bolster consumer protection by allowing India to benefit from the regulatory experiences of other jurisdictions.

India’s proposed five-point regulatory framework offers a solid foundation for shaping cryptocurrency regulations84. It includes global collaboration, clear guidelines on crypto taxation, and the adoption of robust KYC procedures. In addition, the framework emphasizes the importance of innovation, market integrity, and consumer protection.

By adhering to these principles, India can contribute to a well-regulated global cryptocurrency ecosystem that fosters sustainable growth, encourages blockchain innovation, and ensures financial stability85.

India's active role in shaping global regulations will benefit both its domestic cryptocurrency sector and international trade. By embracing innovation while safeguarding investors and minimizing risks, India can create a robust and secure regulatory environment that promotes financial inclusion and economic growth.

India's Cryptocurrency Regulation Fostering Strategic Collaborations

India's Reserve Bank of India (RBI) is addressing the evolving landscape of cryptocurrency regulations, a complex task that requires a strategic approach. The global crypto ecosystem spans diverse jurisdictions, making coordination efforts challenging. Cryptocurrencies serve multiple purposes, including speculative investments and facilitating cross-border remittances. India can adopt a principle-based regulatory framework, aligning with global standards, for agility and adaptability. India should consider its unique context, such as economic conditions, financial inclusion goals, and consumer protection needs. Existing frameworks like the Interoperable Regulatory Sandbox (IoRS)86 and the European Union's Markets in Crypto-Assets Regulation (MiCA)87 can serve as reference models for India's RBI. In the end of 2022, with 28 to one vote in the EU parliament, The European Economic and Monetary Affairs Committee approved the first blockchain-related asset regulation making MiCA the world's first comprehensive crypto regulation, covering issuance, trading, and service provision, and mandates companies involved in issuing or trading cryptocurrencies to obtain licenses under it 88.

India could improve its crypto asset classification by defining crypto assets within its regulatory framework, setting clear market expectations, and promoting responsible innovation. Balancing innovation with oversight is crucial, as US bills emphasize the need for adequate oversight. India's regulations can help the crypto industry thrive while mitigating risks like money laundering and fraud. Learning from the US's stalled progress89 can help anticipate potential regulatory roadblocks. Global and industry collaboration can build a stronger crypto ecosystem in India, adaptable to future technology advancements. This collaboration can mitigate risks, promote informed regulation, market confidence, open communication, and global engagement. The RBI could create a regulatory framework that promotes innovation, consumer protection, and positions India as a leader in responsible crypto ecosystem development.

Indian authorities play a crucial role in shaping the regulatory landscape for cryptocurrencies. The Financial Intelligence Unit - India (FIU-IND) is a key agency in India's crypto landscape, focusing on anti-money laundering and combating the financing of terrorism. It receives, processes, analyzes, and disseminates information related to suspicious financial transactions and issues compliance notices to virtual digital asset (VDA) service providers under the Prevention of Money Laundering Act (PMLA)90. FIU-IND collaborates with international counterparts to prevent regulatory arbitrage91. The Enforcement Directorate (ED) investigates money laundering cases involving cryptocurrencies, seizing assets amounting to ₹135 crore (approximately $18 million) linked to crypto-related crimes92 and issuing show cause notices to exchanges like WazirX for transactions exceeding ₹3,222 crore i.e. (roughly $390 million)93. ED also issued show cause notices to exchanges like Binance, Huobi, and Kraken94. The Ministry of Finance is poised to oversee the crypto asset policy framework and related policy & governance, recognizing the need for international collaboration, supports risk evaluation, benefits evaluation, and taxation implications related to crypto assets, while the Securities and Exchange Board of India (SEBI) monitors market integrity and investor protection, and ensures fair practices in security contracts95. The National Investigation Agency (NIA) investigates cases related to national security, including any misuse of crypto for illicit purposes96. These agencies work together to strike a balance between innovation and security in India's evolving crypto landscape.

India should adopt a balanced approach a.k.a. "Goldilocks zone" of regulation to support innovation and protect investors97. This can be achieved by providing well-defined rules that foster a supportive environment for digital assets. India should recognize the value of utility tokens within networks and encourage innovation. Cryptocurrencies in India lack a definitive legal classification and are not recognized as legal tender98. The government categorizes cryptocurrencies and NFTs as virtual digital assets under the Income Tax Act 99.

Contemplations for Indian Regulators while considering Virtual Currencies (VCs)

Bitcoin's status as a currency is problematic due to its lack of government sanction and legal tender status, while as of now (i.e. July 2024), the live Bitcoin price stands at approximately $62,610.36 USD, with a 24-hour trading volume of $21.89 billion USD100. It cannot be accepted for all debts, public charges, taxes, and dues, unlike traditional fiat currencies. To address this, a global exchange for governance and monitoring of Virtual Currencies (VCs) is needed for only accepted crypto currencies to be traded, circulated, and minted. Bitcoin production should be capped and regulated for tax-worthy issuers with good standing parameters like vigilance and reporting. Governance factors should be set to ensure that virtual currencies (VCs) reach their global function of value storage without undermining the ecosystem of traditional fiat currencies. Bitcoin's volatility prevents it from accurately serving as an effective unit of account101. To govern abrupt fluctuations, global exchanges regulating and monitoring VCs could tie prices to relatable parameters, such as the currency of the country/jurisdiction where the VC originates or pays tax. Unmanageable price aggregates observed in crypto currencies' behavior should be tuned in a duration-oriented manner, such as 24 hours with a 'no change' mandate over a global rest day. Bitcoin's unpredictable nature may be a speculative asset, potentially encouraging arbitrage and undermining the function of money. It could be used for purchasing power or wealth in the private sector for investment or by governments in official foreign exchange reserves.

Bitcoin, like fiat currencies, is not minted or regulated by governments and has finite supply. However, it operates differently from other commodities, making it a commodity. To be considered a commodity, VCs must have attributes like future delivery and maintaining value during market distress. The SEBI won't have jurisdiction over transactions where Bitcoin is exchanged for cash, as "currency" isn't considered a security102. Therefore, VCs must have attributes like future delivery and maintaining value during market distress to be seen as a commodity.

Bitcoin is not a "Stock" as it lacks rights to dividends, voting, or economic participation103. It is not a note or bond, as transactions do not create ongoing payment obligations. However, it could be considered an investment contract104, as both parties must be equally involved in the contract's value, rather than purchasing bitcoins for market-driven profits.

In 2014, the US IRS issued guidance designating Bitcoin as property for federal tax purposes105. The market value and basis of Bitcoin are determined by converting it to U.S. dollars at the exchange rate on an exchange. A digital asset is a digital representation of value recorded on a blockchain or similar technology, such as virtual currencies like Bitcoin, stablecoins, and NFTs. Users utilize IRS forms such as Form 1099 for crypto income, Form 8949 for capital gains/losses, and Form 1099-B for brokerage transactions106. From 2023 the US federal tax return, one needs to answer "Yes" or "No" to whether they’ve received, sold, exchanged, or disposed of a digital asset. If there’s a reported digital asset transaction, then one must report capital gains or losses107. Non-reporting may result in fines and criminal charges. Bitcoin transactions can offset gains, potentially lowering tax liability108. Payments in Bitcoin should be included in gross income, calculated by the market value in dollars on the payment receipt date. Taxable gains or losses occur if the fair market value of received property differs from the taxpayer's adjusted basis of the virtual currency. The character of the gain or loss depends on whether the virtual currency is a capital asset 109.

Bitcoin's classification as “Property” poses several challenges110. Unlike traditional property, Bitcoin transactions rely solely on technological requirements, specifically the correct use of private and public keys. This makes transactions irreversible and overlooks errors, fraud, or coercion111. The global and pseudo-anonymous nature of Bitcoin complicates jurisdictional issues, as it is difficult to identify the governing national law for each transfer. Furthermore, treating Bitcoin as property impacts its fungibility, leading to significant tax implications for everyday transactions 112.

A Regulatory sandbox approach

The rapid pace of technological innovation presents both opportunities and challenges for regulatory effectiveness113. As technologies like artificial intelligence (AI) evolves, regulators must stay informed and design fit-for-purpose (F4P) frameworks114. However, it can also play a crucial role in fostering a conducive environment for technological advancements. Agile regulation, which is technology-neutral and risk-based, allows regulators to adapt to changing circumstances, improve operations, automate routine tasks, and make data-driven decisions115. Regulatory experimentation with anticipatory approaches, such as regulatory sandboxes or pilot programs, could enable more agile and adaptive responses. Effective regulation is essential to manage digital risks, such as vulnerability testing, gradation and certification of fintech in the pre-launch phase for regulatory safety, cybersecurity, data privacy, and consumer protection. Governments must operate with a “digital first mindset” to attract and retain skilled professionals who understand emerging technologies, as public sector wages for regulators often lag behind those in the private sector116. By doing so, resilient systems can be created that adapt to the changing landscape while minimizing risks.

The use of a regulatory sandbox approach can significantly improve the cryptocurrency market in India, with complementing regulatory framework in India117. These sandboxes offer benefits such as reduced innovation costs, access to insights, and market monitoring. Although they pose risks like competition and limited regulatory capacity, they are valuable tools for promoting innovation and understanding market developments118. The Telangana Web3 Sandbox, a government initiative in Telangana, tests blockchain-based solutions, encouraging local talent to develop and deploy DApps across various domains. This sandbox promotes collaboration and knowledge sharing among stakeholders, potentially boosting economic growth by streamlining processes, enhancing transparency, and reducing intermediaries119. The initiative signals India's commitment to technological advancement and attracts investment and talent. The regulatory sandbox approach also provides a live testing environment for companies to test innovative crypto products and services, fostering innovation, risk management, and informed policymaking. Key considerations include defining scope, setting eligibility criteria, determining testing periods, and providing regular reports on experiments 120.

Regulatory sandboxes are essential risk management tools, enabling regulators to observe experiments closely and make informed decisions. They allow for adapting rules to emerging trends without compromising consumer protection or market stability, fostering innovation while ensuring responsible risk management121. Within a sandbox, companies can test crypto products and services in controlled environments, identifying and mitigating potential risks early on. This iterative process helps refine existing regulations or develop new ones based on real-world outcomes, ensuring regulations remain relevant and effective. The sandbox environment offers real-time insights into blockchain and cryptocurrency technologies, aiding regulators in anticipating challenges and adapting regulations accordingly. By providing data-driven decision-making and fostering collaboration among regulators, industry participants, and stakeholders, regulatory sandboxes contribute to developing effective regulations and a responsible cryptocurrency market in India.

The sandbox should include fintech products, blockchain solutions, digital payment models, and new business models. The Indian government, law enforcement agencies, and regulators can establish a regulatory sandbox to foster innovation and tackle regulatory barriers122. This involves setting clear objectives, identifying challenges, monitoring market developments, selecting relevant innovations, setting rules, collaborating with stakeholders, evaluating data, planning exit strategies, and continuously assessing outcomes. Regulations should ensure close oversight, risk mitigation measures, and collaboration with industry players, academic institutions, and international partners. This sandbox balances innovation and stability, ensuring consumer protection and financial stability 123.

Government Research Programs

The potential of disruptive financial technologies (FinTech) is immense, but a disconnect between governments and the academic/research community hinders effective regulation and leaves financial systems vulnerable124. Factors contributing to this disconnect include limited public funding, revolving door issues, and slow regulatory responses125. For instance, Facebook's 2019 Libra cryptocurrency plans were abandoned due to concerns about money laundering, consumer protection, and financial stability126. Collaboration between governments and academics is crucial to identify risks, develop effective regulations, and inform policymaking127. Academic research can help policymakers understand FinTech nuances and craft appropriate regulations. Governments can work with university research organizations to investigate digital payments and financial instruments, addressing new threats and improving anti-money laundering and counter-terrorism financing measures. Establishing clear research objectives, recognizing patterns in digital payments, and evaluating the likelihood of illegal exploitation are essential steps. Globally, central banks play an important role by constituting committees to review and improve vigilance in the digital payments ecosystem128, contributing to developing consultative papers that invite expert recommendations and enhance the growth of digital payments 129.

Developers of disruptive financial technologies can significantly contribute to government-commissioned research on money laundering (ML) and terrorist financing (TF) risks130. They provide technical insights, foresight on emerging trends, and practical expertise, which aid in developing realistic mitigation strategies. Challenges, such as conflicts of interest and balancing innovation with security, need careful management. Successful collaborations, including regulatory sandboxes131 and public-private partnerships132, facilitate the development of AML/CFT solutions and best practices. Integrating FinTech developers offers valuable insights into ML/TF risks. Collaboration with global research organizations, focusing on universities or institutes proficient in distributed ledger technologies, AML, and financial technology133, can be highly beneficial. Research collaborations, conferences, and data-sharing agreements yield useful information, ensuring sensitive information is protected while granting researchers access to necessary financial data134. Clear communication among governments, academics, and the financial industry enhances information flow, guiding future regulations and mitigation strategies. Financial institutions should implement research recommendations to improve AML/CFT procedures, adapting to the rapidly evolving digital payment landscape. This strategy enhances understanding of new threats and strengthens the foundation for combating financial crime in an increasingly digital world 135.

Regulators can incubate a model in collaboration with The Enterprise Ethereum Alliance (EEA) which is a global community of blockchain leaders, adopters, innovators, developers, and businesses that aims to accelerate the adoption of Ethereum by providing professional and commercial support, advocacy, research, standards development, and ecosystem trust services136. The EEA connects diverse organizations, from early startups to Fortune 500 companies, fostering collaboration and knowledge sharing137. Members benefit from networking opportunities, research, and guidance on Ethereum adoption. The EEA is member-governed, allowing participants to shape its direction and empowers enterprises to leverage Ethereum's capabilities for real-world applications. The EEA provides resources and expertise to support businesses interested in Ethereum adoption138. Indian regulators could incubate such initiatives by engaging with the EEA, creating local consortia, launching pilot programs, developing regulatory sandboxes, and crafting clear policies. They can raise public awareness, collaborate with industry, and support Ethereum-based solutions. Participation in working groups, funding projects, and drafting legislation for blockchain governance and investor protection are essential steps. Educating stakeholders and integrating Ethereum solutions within financial systems further enhance this collaborative effort.

Indian regulators can collaborate and regulate the financial technology realtime as it develops and support the growth into a viable adoption as nation’s hub for regulatory ecosystem. Observing global adoptions, e.g. Switzerland's "Crypto Valley" in Zug has become a hub for blockchain startups due to its favorable regulatory environment139. Bitmain, a Beijing-based company, designs ASIC chips and software for bitcoin mining and is preparing for an IPO in Hong Kong140. Hdac Technology, backed by Hyundai BS&C, develops a blockchain-based platform for the Internet of Things, handling identity, authentication, data storage, and micro-payments. Tezos, a smart contract platform, allows blockchain evolution through protocol amendments voted on by token holders. Dfinity aims to create a decentralized "Internet computer" that reduces cloud service costs and achieves transaction finality in an average of 7.5 seconds. A nation’s regulatory maturity lies in creating an acceptance and nonforcible framework to aid innovation parallelly with regulation as it ripens to get publicly adopted for the sectorial growth. The reputation of Zug as a Crypto Valley continues to attract innovative blockchain ventures, making it a focal point for industry growth 141.

The evaluation of technological developments for potential crime risks involves a comprehensive approach considering both the drivers of technological advancement and the corresponding criminal exploitation trends142. This includes understanding current drivers of disruption in digital payments and transactions, such as blockchain, cryptocurrencies, P2P payments, and digital wallets143. Advancements in AI, machine learning, and IoT play a pivotal role in shaping the FinTech landscape, and a comprehensive risk assessment framework is essential to identify key risk factors and assign risk scores144. Mitigation strategies, such as analyzing existing AML/CFT regulations, exploring RegTech solutions, and proposing regulatory adjustments, are crucial steps in addressing emerging risks in the financial sector145. Government research bodies are increasingly studying digital payments and financial transaction mechanisms. In the US, the NIST Information Technology Laboratory's Financial Services Division investigates the impact of digital transactions on processing, security, scalability, and machine learning146. The European Commission's Joint Research Centre assesses the regulatory landscape for digital payments, identifies gaps, and proposes harmonized regulations147. The UK's FCA Innovation Hub evaluates FinTech solutions148, conducts pilot programs, develops regulatory sandboxes149, and provides AML/CFT guidance. The Financial Action Task Force sets AML/CFT standards and promotes global collaboration and information sharing 150.

As we observed the interdepartmental turf war in the US governance system, amongst FinCEN, CFTC, SEC, and IRS over Bitcoin regulation151, based on existing legal frameworks such as the BSA, CEA, Securities Act of 1933152, SEA, and IRS' 2014 Guidance153, Indian government need to set an observatory interdepartmental research for an integrated report where there is a consensus among RBI, SEBI, Income Tax, and other concerned departments dealing with the virtual assets.

Progressive Regulatory Implementations

Over the past decade, global economies have experienced significant digitalization154, leading to the formation of working committees by central banks to improve the digital payments ecosystem. These committees aim to develop consultative reports, vision, benchmarking, and a future roadmap strategy for digital payments growth155. To effectively regulate disruptive payment and transaction technologies, global and national regulatory bodies must implement several essential steps, including proactive monitoring, flexible regulatory frameworks, collaboration, and engagement with industry stakeholders156. Investing in advanced detection tools, ensuring transparency, and implementing stringent enforcement and penalties are crucial. Developing flexible regulatory frameworks allows for a phased approach, allowing regulatory authorities to implement rapid, progressive, and simultaneous regulations while ensuring vigilance 157.

Implementing FinTech startups requires rapid and progressive strategies, including establishing regulatory sandboxes, adoption of RegTech solutions, and developing adaptable frameworks158. Recurring practices for financial system safety include risk-based regulation, continuous monitoring, information sharing, public-private partnerships, and education initiatives. Challenges include balancing innovation and security, global collaboration, and adapting to rapid technological changes159. Overly stringent regulations can stifle innovation160, while lax regulations can expose consumers and financial systems to vulnerabilities161.

The World Wide Web Consortium (W3C), an international organization that creates web standards and guidelines for accessibility, internationalization, privacy, and security, could enhance the financial sector through a bottom-up regulatory system162. The government can collaborate with W3C experts to create reliable web technologies, ensuring the financial sector benefits from a more efficient and secure online environment. By collaborating with member organizations, industry leaders, and the public to create reliable web technologies and on other hand with international bodies like the FATF, this system could broadly address AML/CFT challenges by developing standards for secure wallet interfaces, transaction validation, and privacy for Bitcoin163. It would encourage cryptocurrency exchanges and wallet providers to implement robust procedures, promote transparency, and educate users on risks and compliance. Additionally, W3C could develop inclusive web standards for digital financial services, ensure interoperability between traditional and decentralized finance platforms, and foster financial inclusion. This three-tiered system would integrate Bitcoin companies and state governments to enforce regulations, monitor transactions, and maintain financial stability. However, practical implementation would require complex coordination and regulatory considerations. W3Schools is a useful resource for learning various languages and technologies, ensuring user education about safe practices is crucial164. Bitcoin's decentralized nature allows for efficient cross-border transactions, and W3C could observe the interoperability between traditional financial systems and blockchain networks. This could guide the regulators in creating a bottom-up regulatory system could address challenges like Anti-Money Laundering and Countering Terrorist Financing by collaborating with international bodies like the FATF, IMF, WB and WEF. Bitcoin operators and issuers could work on a three-tiered system, with government licensing and allowance into providing legal and regulatory support.

Crypto governance models include consortium governance frameworks, decentralized autonomous organizations (DAOs)165, token-based governance166, and multi-stakeholder governance committees could be experimented with. Consortium governance frameworks outline decision-making processes, dispute resolution mechanisms, and member responsibilities, ensuring alignment among consortium members. DAOs enable collective governance through smart contracts167 and token-based voting168, providing transparent decision-making, resource allocation, and coordination within consortia. In Token-based governance method as observed in projects like Tezos169 and Polkadot170 where on-chain governance mechanisms are used, token holders can vote on protocol upgrades and governance proposals. Enterprises can adopt similar token-based models to empower members in governance decisions, while multi-stakeholder governance committees oversee strategic direction, technical standards, and dispute resolution, as observed in the R3 consortium’s governance committee and the Corda Network’s governing body171. Effective governance fosters trust, transparency, and cooperation within crypto networks and consortia. Examples include the Enterprise Ethereum Alliance (EEA)172 and Hyperledger consortium 173.

FinTech regulation offers both advantages and disadvantages. A comprehensive study can identify potential risks and create proactive regulatory frameworks174. However, this approach can be complex and resource-intensive, leading to reactive measures and outdated policies. A balanced strategy focusing on high-risk technologies, adaptable frameworks, and continuous monitoring can address immediate threats while remaining flexible for future adoption challenges175. Collaboration between international regulatory bodies, law enforcement agencies, and financial institutions, using advanced detection tools like machine learning and artificial intelligence, is essential176. Regular updates and training programs are necessary to stay informed on new technologies and regulatory best practices 177.

Global central banks have set clear objectives to separate regulator roles from payment operators, such as the National Payment Corporation of India (NPCI), under the RBI's Payments And Settlement Systems Act, 2007178. The World Bank's 2018 Global Payment Systems Survey identified two critical aspects of payments system oversight: depth dimension, defining operator roles, and breadth dimension, controlling critical fund transfer systems 179. Central banks play a crucial role in regulating payments systems to meet public policy objectives.

Financial regulatory bodies and national banks are working together to implement regulations for new payment and transaction technologies180. Singapore's Monetary Authority of Singapore (MAS) uses a "sandbox" approach181, allowing FinTech companies to experiment in a controlled environment before enforcing stricter measures182. The UK's Financial Conduct Authority (FCA) uses a staged approach, granting temporary permissions with ongoing monitoring and regulatory adjustments183. The Securities and Exchange Commission (SEC) has FinTech working groups to stay updated on emerging technologies184. The European Commission is developing a comprehensive regulatory framework for crypto assets 185.

Central banks worldwide are enhancing payments services for small-to-mid-value transactions186, formulating acts for payments and settlements in Singapore and India187, establishing a dedicated framework for developing payments infrastructure in India188, and establishing data protection and localization laws in the EU, India, and China 189.

Conclusion

Considering the facts and propositions presented in this paper, the challenges presented by cryptocurrencies in terms of governance as of today, seems like a mere “Teething Trouble” especially until the digital assets find a way to become more mainstream in the future. Today, Cryptocurrencies face several challenges in their governance, including regulatory uncertainty, global nature, decentralization vs. control, security and consumer protection, volatility and investor confidence, privacy vs. transparency, technological complexity, institutional adoption, community consensus, and the evolution of governance models. The rapidly evolving financial ecosystem and the chasing regulatory landscape must consider incorporating these thorny adoptions, in the process of creating governance frameworks, and avoid creating uncertainty for investors, businesses, and users. Indian regulators must consider the unruly nature of cryptocurrencies that transcend borders, making it difficult for any single country to enforce consistent regulations. The decentralized nature of cryptocurrencies clashes with centralized control mechanisms of traditional financial systems, necessitating a balance between innovation and oversight. Security measures and consumer protection are crucial, as cryptocurrencies are susceptible to hacking, scams, and fraud. Effective governance can stabilize markets and foster trust, while balancing privacy with transparency is a delicate task. The complexity of blockchain technology and the need for institutional adoption make governance critical for institutional players. Public private partnerships are essential for community consensus to aid decisions about upgrades, forks, and governance, but alignment among diverse stakeholders can be challenging. In the end we as humans will innovate and adapt for the cycle to go on, as it always has.

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