BLOCKCHAIN: DOES INDIAN FINTECH ECOSYSTEM NEED A SEPARATE SANDBOX FOR BLOCKCHAIN LED INNOVATION

BLOCKCHAIN: DOES THE INDIAN FINTECH ECOSYSTEM NEED A SEPARATE SANDBOX FOR BLOCKCHAIN-LED INNOVATION

ABSTRACT:

Blockchain is a digital and distributed ledger of transactions or decentralized database that keeps continuously updated digital records in real time across a network of computers. It is a decentralized ledger of all transactions across a peer-to-peer network. Using this technology, participants can confirm transactions without a need for a central clearing authority.

Niti Aayog, Govt. of India, has issued an initial strategic plan on the possibilities of usage of Blockchain technology for enabling Ease of Doing Business, Ease of Living & Ease of Governance. There is a clear inclination towards the adoption of this technology for public sector projects considering the digital India mission. The usage of blockchain technology may also improve efficiency in large volume-led data processes which would lead to a mark as an enabler towards contributing to USD 5 trillion GDP target by the year 2024.

In the financial sector, especially, in the banking, securities, and insurance areas, the respective regulators viz., RBI, SEBI, and IRDAI have issued guidelines for creating Regulatory Sandbox[1] encouraging early adoption of technology towards ease in financial service enablement for end users and customers. RBI has identified the application of blockchain technologies as one of the areas forming part of the overall sandbox framework for fintech, the question which we all need to evaluate is the focus areas of this fintech, which is towards application of blockchain technology for Cryptocurrency, as a use case.

Time and again, the financial services regulators in India have indicated that while the adoption of blockchain as a technology is encouraged, its usage towards cryptocurrency, virtual & private currencies is not welcomed. This paper makes an attempt to understand and evaluate (a) the Blockchain technology adoption roadmap in India (b) does the present landscape of fintech using blockchain technology is largely towards the application for digital currency as a use case (c) does the national strategy on Blockchain issued by Government of India need to set up a separate sandbox for early-stage start-ups and fintechs to join the momentum with Government for a Public-Private Partnership towards Nation Building.

With the significant development in this field, there would also be the need of developing a suitable legal and regulatory framework that would keep the interest of all the stakeholders in the value chain safe and secure.

 KEYWORDS: Blockchain, Cryptocurrency, RBI, Digital Currency, Bitcoin, Fintech, Start-ups

1. INTRODUCTION

Fintech adoption in India has grown to 87% in 2019 as compared to 52% in 2017 (ETBFSI, 2019). The word “Fintech” (which is a shorter form of the combination of words – Financial or Finance and Technology) has gained the due attention of investors, entrepreneurs, and new age technology experts as also of the Governments and financial sector Regulators, across the globe.

Fintech has been defined as “advances in technology that have the potential to transform financial services provision, spurring the development of new business models, applications, processes, and products.” (WB, 2018). Post demonetization in India (in the year 2016), there has been a major push to create a cashless economy by fuelling incentives for the usage of online modes of financial transactions. The “Digital India Campaign” of the Government of India thrives on the principles of digitization and adoption of technology for ease of living and ease of doing business in India.

As technological innovations in financial services (such as banking, securities, insurance, etc.) would encounter risks such as legal risks, cyber frauds, digital fraud, and security breaches, there has been a need for financial regulators such as the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and Insurance and Regulatory Development Authority of India (IRDAI) in India to bring the standardized mechanism primarily for the following reasons:

• To provide an ecosystem for fintech firms or technology innovators to thrive and get the ground to sustain, innovate and flourish.
• To create a level playing field for the firms with a direction to the areas of innovation and priorities.
• To ensure the systematic risk of the financial system is not compromised keeping the interests of depositors, policyholders, and investors safe and secure.

In this context of fintech innovations, the RBI, SEBI, and the IRDAI have launched regulatory sandboxes in the year 2019 in order to bring in regulatory support from a policy point of view and to create and foster the early adoption of fintech in India.

2. POLICY INTERVENTIONS BY INDIAN FINANCIAL SERVICES REGULATORS

Regulators and Governments worldwide have adopted the change by creating an ecosystem for fintech innovation and growth. Out of the numerous possible ways to bring policy changes in order to foster innovation in financial services, one of the ways is – a regulatory sandbox (RS) approach. This approach has been adopted globally by central banks, securities exchanges, and insurance regulators.

The objective of the RS is to foster responsible innovation in financial services, promote efficiency and bring benefits to consumers (RBI, 2020). As defined by RBI, RS usually refers “to live testing of new products or services in a controlled/test regulatory environment for which regulators may (or may not) permit certain regulatory relaxations for the limited purpose of the testing. The RS allows the regulator, the innovators, the financial service providers (as potential deployers of the technology), and the customers (as final users) to conduct field tests to collect evidence on the benefits and risks of new financial innovations, while carefully monitoring and containing their risks” (RBI, 2020).

In India, the fintech innovation regulatory sandbox started in 2016 when RBI created a working group (WG) among the financial services regulators including SEBI, IRDAI, and Pension Fund Regulator (PFRDA). The WG was created to study the scope and potential of fintech innovations in India. The report of the WG was released on February 08, 2018, for public comments. One of the key recommendations of the WG was to introduce an appropriate framework for an RS within a well-defined space and duration where the financial sector regulator will provide the requisite regulatory guidance, so as to increase efficiency, manage risks and create new opportunities for consumers (RBI, 2020).

Accordingly, RBI, SEBI, and IRDAI have issued the regulatory sandbox enabling framework which provides of the eligibility criteria for the fintech firms, the design aspects of the RS which covers the list of innovative products & services, and technology that the regulators would consider for testing. To date, the regulators have called for multiple cohorts for end-to-end testing of fintech products from fintech firms. It is clearly evident that there have been timely interventions by the regulators in India creating a conducive fintech ecosystem.

3. BLOCKCHAIN IN INDIA AND REGULATORY SANDBOX APPROACH

Blockchain technology is a distributed ledger technology (DLT) suitable for decentralized and transactional data shared across a large network of untrusted entities. This technology allows a new type of distributed software architecture capable of finding concurrence on their shared states without the need to establish online trust with any central entity/participant. DLT eliminates the requirement of the central entity / third party to validate the transactions over the peer-to-peer network. All the transactions shared across entities, along with the timestamp are maintained as records and placed in blocks (India, Jan 2021).

Niti Aayog, Govt. of India, has issued an initial strategic plan on the possible usage of Blockchain technology to enable Ease of Doing Business, Ease of Living & Ease of Governance. There is a clear inclination towards the adoption of this technology for public sector projects in alignment with the digital India mission. The usage of blockchain technology may also improve efficiency in large volume-led data processes which would lead to a mark as an enabler towards contributing to USD 5 trillion GDP target by the year 2024.

There have been tremendous efforts put up by the leading economies toward the adoption of blockchain technology. Likewise, the Ministry of Electronics and Information Technology (MeitY), Government of India, has issued the “National Strategy on Blockchain” (Jan 2021).  The national strategy clearly recommends setting up of national-level blockchain framework and exploring the possibilities of the potential usage of this technology in different government departments/ministries in India.

If we draw a reference from the RS framework set up by RBI, SEBI, IRDAI, it can clearly be inferred that the RS design or framework do mention the blockchain-led technologies as one of the product/technologies which would be considered by the regulators for testing. To date, RBI has initiated cohorts for testing covering Retail Payments, Cross Border Payments, and MSME lending (to be announced soon). At this juncture, it will be difficult to contemplate whether the underlying technologies deployed for cohorts uses the blockchain architecture/technology. However, RBI has indicated that innovative products/technologies such as smart contracts and applications under Blockchain technology could be considered for testing under the regulatory sandbox cohorts (RBI, Distributed Ledger Technology, Blockchain, and Central Banks, 2020).

As per the National Strategy on Blockchain issued by the Government of India, it is indicated that RBI is exploring the usage of Blockchain Technology in the banking domain (India, Jan 2021). If there is national-level significance on the adoption of blockchain technology which is evident from the government’s strategy and at the same time, financial regulators in India are creating cohorts using the RS approach for fintech innovation on product and technology adoption, hence, it can be suggested that there is a greater possibility of supplementing the efforts of government by prioritizing the blockchain led specifications and usages towards the financial services.

4. CRYPTOCURRENCY AS A USE CASE (USAGE) TO BLOCKCHAIN TECHNOLOGY

A cryptocurrency, cryptocurrency, or crypto is a digital asset designed to work as a medium of exchange wherein individual coin ownership records are stored in a ledger existing in the form of a computerized database using strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership. It typically does not exist in physical form (like paper money) and is typically not issued by a central authority. Cryptocurrencies typically use decentralized control as opposed to centralized digital currency and central banking systems (Definition, as per Wikipedia – Web search).

 Blockchain gained its popularity from Bitcoin, a cryptocurrency. Since it was infringing the domain of the central bank, which is the sole issuer of currency in an economy, by offering an alternative form of private currency, central banks across the world began to monitor the risks posed by cryptocurrencies. However, while monitoring these developments, central banks exhibited optimism and interest in blockchain-based applications apart from cryptocurrencies (RBI, Distributed Ledger Technology, Blockchain, and Central Banks, 2020). A similar stand has been maintained by RBI in India on the usage of cryptocurrency.

If we dwell in the recent past on the subject of the adoption of cryptocurrency (as a use case of blockchain technology), it is interesting to note that RBI has put forth restrictions with respect to virtual currencies based on blockchain technology and there is circular to bar the usage of crypto-currency transactions in India. Initially, RBI issued restrictions on the use of regulated banking and payment channels for the sale and purchase of virtual currencies in India which was later challenged in the Supreme Court. Later the Apex Court stuck down the RBI Circular.

Under the digital India campaign, Indian Government as also the financial regulator RBI is evaluating the possibility of having the government back digital currency by banning private virtual currency to (a) overcome any ambiguity created due to Apex Court Judgement and (b) to legalize the Government backed digital currency. As clarified in the recent media reports, the government is evaluating the adoption of a hybrid approach towards cryptos in India and the actual outcome would be clarified as we move ahead in the future.

After careful analysis of the developments in the field of cryptos, cryptocurrencies, and virtual currencies in India, it can clearly be construed the following:

• The government of India as well as the financial services regulators including the central bank is open, receptive, and ready to facilitate and encourage blockchain technology minus its usage for cryptocurrencies, virtual/private currency, etc.
• The RS framework gives due weightage to the blockchain as technology enablement while calling for fintech innovation using cohorts for various areas such as payments, lending, etc.

5. CONCLUSION AND WAY FORWARD

Fintech adoption has been phenomenal in India which is clearly evident from the recent market reports. Likewise, the start-up program by the Government of India has created an environment of new-age entrepreneurs with incentives on tax rebates and recognition. At the same time, the government has made it clear that blockchain as a technology has the potential for adoption in numerous areas.

As per the industry reports, it was estimated that more than 70% of the financial services industry is planning to adopt blockchain till last year. However, the world has witnessed the unseen pandemic which to some extent has delayed the progress and implementation due to apparent reasons.

According to auditing and consulting firm (PwC) PricewaterhouseCoopers’ ‘Time for Trust’ report, blockchain technology is said to boost the global economy by $1.76 Tn, contributing about 1.4% of global GDP and creating 40 Mn jobs by 2030. Further, the report stated that blockchain will make the biggest impact on Asia’s economy with China, India, and Japan driving adoption in the region (Naik, 2020).

In the Indian context, the efforts of the Government, RBI, SEBI, and IRDAI are highly appreciated with the timely policy interventions, sandbox support, and cohorts on emerging significant areas such as payments, lending, etc. As we progress, there is also the need of understanding the legal aspects involved in the adoption of blockchain-led technology and its implication on the financial services offerings and use cases. The issues which may fall under Information Technology Act, Consumer Protection Act, Data Protection Laws, etc. need to be evaluated.

The following points on the topic which are directly related to blockchain-led technology adoption and the regulatory sandbox approach adopted with few specific comments are as follows:

• The government of India has a national strategy document for the adoption of blockchain technology in India which outlines the need for the national level framework, capacity building, involvement of innovative start-ups, and evolving the regulatory and policy requirements for the blockchain in India.
• The government has also indicated that cryptocurrency, virtual currencies which are based on blockchain technology would be dealt with this caution and a hybrid approach will be followed with certain restrictions on private currency usage.
• Likewise, RBI has also created RS which has blockchain as one of the specified technologies for adoption, as part of the RS design/framework.
• RBI has also indicated that blockchain use case other than cryptocurrency is welcomed and encouraged. These are based on the multiple developments in the financial sector undertaken by banks in India.
• If India is looking to use the future potential towards blockchain technology both in the public sector as well as in the private sector, especially towards financial services which are regulated and supervised by RBI, SEBI. IRDAI, PFRDA, there appears to be a need for a focused regulatory sandbox cohort that is primarily led by blockchain technology innovations.
• While RBI has clearly indicated that innovative products/technologies such as smart contracts and applications under Blockchain technology could be considered for testing under the regulatory sandbox cohorts, there is a need to look for the possibilities of setting up cohorts that would design to address the product and services innovation purely led by blockchain technology.
• As Government has proposed the multi-level center of excellence towards implementation of a national-level framework on blockchain adoption, a similar drive and impetus may also be provided for its adoption for the private sector. This is possible by bringing in the incentives under the Start-up program for blockchain-led technology start-ups specifically.

Considering the above argument, it will be progressive, beneficial, and specific, if the Indian Fintech ecosystem makes provision for a regulatory sandbox that has cohort programs with specific blockchain-led technological innovations and start-ups. This will foster the growth and optimal utilization of the growth estimates based on industry reports.

Bibliography

ETBFSI. (2019, August 28). FinTech adoption soars by 87% in India: EY. ET BFSI, p. 1.

India, M. -G. (Jan 2021). National Strategy on Blockchain. New Delhi: MeitY – Government of India.

Naik, A. R. (2020, October 14). Blockchain This Week: PwC’s ‘Time For Trust’ Report 2020 On India Driving Blockchain Adoption & More. BLOCKCHAIN THIS WEEK.

RBI. (2020, Feb). Distributed Ledger Technology, Blockchain and Central Banks. RBI Bulletin February 2020, p. 13.

RBI. (2020). Enabling Framework for Regulatory Sandbox. Mumbai: RBI.

1. (2018). The IMF, WBG Bali Fintech Agenda. The World Bank.

  [1] A regulatory sandbox is a framework set up by a regulator that allows Fintech start-ups and other innovators to conduct live experiments in a controlled environment under a regulator’s supervision.

Note – This paper was 1st published at National Conference, ASE, March 2021 by Abhishek R. Sharma.