Author: Abhishek R. Sharma

ABSTRACT: In India, the Reserve Bank of India (RBI) is authorised under the RBI Act to issue Bank Notes which have legal tender and is guaranteed by the Central Government for honour and commitment. This in a way represents the Fiat Currency, which is issued not against commodities like gold or silver but backed by the Government. Until the advent of technology in the space of currency management in the form of digital currency, virtual currency or electronic money, e-money etc (as it is commonly called), there has not been implicitly written law about the same.

Additionally, the Payment and Settlement Systems Act, does define the payments system as a system used between a payer and a beneficiary which enables payment against the usage of goods or services. RBI in its recent report[1] explained “e-Money” as Pre-Paid Instruments issued as Wallets and Cards.

Globally, initiatives in the form of “Central Bank Digital Currency (CBDC)[2]” has been gaining momentum. Unlike decentralized cryptocurrency projects like Bitcoin, a CBDC would be centralized and regulated by a country’s monetary authority. RBI is also evaluating the possibility of CBDC implementation 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 are 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 legalise the Government backed digital currency. This could be a reality as the budget 2021, may see a new legislative proposal towards “India’s Own Digital Currency”, which could be the dawn of the new digital area when India joins hands amongst the global emerging economies towards a digital currency revolution.

 KEYWORDS: Cryptocurrency, CBDC, RBI, Digital Currency, Bitcoin

1. INTRODUCTION

As per the 2020 Global Crypto Adoption Index (Chainalysis, 2020) published by the blockchain data analytics firm, India stood 11^th rank amongst the ranking table of 154 countries across the globe to identify the adoption rate of cryptocurrency. The word “Cryptocurrency” (or other interchangeable words used in lieu of such as “Virtual Currency, “Private Currency” or “Digital Currency”) has been defined globally as a form of virtual asset which uses cryptography to secure transactions which are financial in nature. As cryptocurrency is based on blockchain-led technology such as Digital Ledger Technology (DLT), one of the cryptocurrency’s attributes is its decentralized operation and control. Due to this regulators and central banks across the world have had apprehensions about the high degree of anonymity, which raises eyebrows due to the possible financial crime risk such as Anti-money laundering, tax evasion etc.

As per the report of the attorney general’s cyber digital task force of the U.S. Department of Justice, it was found that the illicit usage of cryptocurrency typically falls into three categories:

• financial transactions associated with the commission of crimes;
• money laundering and the shielding of legitimate activity from tax, reporting, or other legal requirements; or
• crimes, such as theft, directly implicating the cryptocurrency marketplace itself.

(Justice, 2020)

In India, the banking regulator i.e., the Reserve Bank of India (RBI) in the year 2018 prohibited all banks in India from dealing with cryptocurrency firms which inter alia also operate crypto exchanges. Later on, after industry representations, in the year 2020, the Supreme Court of India struck down the RBI’s circular which prohibited such dealing.

In order to address the risks of the usage of cryptocurrency, globally, initiatives in the form of Central Bank Digital Currency (CBDC) have been gaining momentum. CBDC in layman’s terms would mean issuing digital fiat currency which would be based on blockchain/DLT technology. Unlike decentralized cryptocurrency projects like Bitcoin, a CBDC would be centralized and regulated by a country’s monetary authority. RBI is also evaluating the possibility of CBDC implementation in India.

It can be said that blockchain-led technology has cryptocurrencies as usage which is being evaluated the world over to enable the CBDC space for a much-controlled mechanism to issue digital fiat currency in days to come.

2. LITERATURE REVIEW

In order to understand India’s readiness to adopt cryptocurrency in light of global developments, a comprehensive review is needed of the new initiatives and projects being executed in other countries across the globe. It is also very pertinent to note that the adoption of blockchain-led technology is gaining momentum across various sectors. RBI has also encouraged the usage of smart contracts and digital ledger technology while calling for proposals for cohorts on retail payments, cross border payments under the regulatory sandbox created under fintech adoption initiatives in India.

However, we have also observed that cryptocurrencies (which are one of the usage or use cases of blockchain technology) need changes in the policy perspective, both from the Government and RBI’s side. RBI has encouraged and welcomed blockchain-led innovation minus its usage for cryptocurrency. As in the current arrangement, where fiat currency is issued and there is a full-fledged mechanism towards currency management/currency circulation, a similar mechanism would need to be implemented if central banks evaluate issuing digital currency. Akin to the current set-up, central banks would subject the digital currency – both in terms of storage of value and mode of exchange under its control and supervision.

India has seen a measured approach and there has been a decent amount of push from the Government of India and RBI with respect to blockchain, digital ledger technology and usage of cryptocurrency.

Major Developments relating to blockchain, DLT in India

To draw a balanced approach wherein the technology of blockchain can be used with a measured control regime of control from central bankers, the CBDC has emerged as the best-suggested option.  Currently, many countries like UK, China, Sweden, and Singapore, among others, are looking into the possibility of introducing CBDC.

The phrase CBDC has been used to refer to various proposals involving digital currency issued by a central bank. As per the Bank for International Settlements (2020 publication on CBDC), the word is defined as – “a digital form of central bank money that is different from balances in traditional reserve or settlement accounts” (Settlements, 2020). It is very clear that world-over steps are being taken to differentiate the need for having digital currency under the CBDC framework which has the elements of centralized control from the regulators. With this approach, in order to legalise its usage, there is a need for necessary amendments to the laws of the lands governing currency, banknotes and mode of storage of value and exchange. Keeping this background, this paper highlights the readiness of India on the adoption of CBDC amidst global changes.

3. OBJECTIVES OF THE STUDY

As mentioned in Section 1, India is amongst the top countries (11^th) in ranking on adoption of cryptocurrency. Further, as suggested in industry reports and start-up media reports, post the Apex court ruling to lift the ban on dealing cryptocurrency and exchanges, there has been a surge in new entrants, new investors and volume of transactions via crypto exchanges.

While presenting the budget for 2021, the Government of India did mention tabling a new bill (to be introduced in the parliament), named the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, with an intention to (a) ban private cryptocurrencies and (b) regulate official digital currency. With this development, this study is to evaluate how the adoption of digital currency, in the context of CBDC, will pave the way to digital fiat currency in India.

4. RESEARCH METHODOLOGY

The present study is based on an exploratory analysis of the secondary data available in the public domain with respect to the central bank’s policy initiatives, the global market research analysis available in the public domain, the data available by the start-ups media houses specifically covering the crypto, blockchain start-ups in India.

The data has been analysed and accessed from the publication papers, articles and relevant market reports. A qualitative study of the present regulatory framework has also been done to understand the legal framework in India which covers the banking regulations, RBI circulars on virtual currencies and later apex court rulings. Furthermore, a review of the global reports on blockchain, cryptocurrency, and digital currency projects was also reviewed to understand the possible use case and its future potential.

5. FINDINGS & ANALYSIS

After the careful analysis of a few of the central bank projects on the potential usages (as a use case) for the adoption of digital currency under CBDC, it can be inferred that the scope and coverage of blockchain technology for cryptocurrency is wide and comprehensive. Due to its technological complexities, it is quintessential for any central bank to analyse the need, its urgency, and priority focus areas, resulting in alteration in the existing settlement processes envisaged and possible changes required in the statutory and regulatory framework etc.

During the study of the progress of CBDC in various countries, it has come to notice that as per the recent report published by the Saudi Central Bank and Central Bank of the U.A.E. Joint Digital Currency and Distributed Ledger Project ((CBUAE), 2020), the have identified three high-level use cases of blockchain/DLT. The three use cases were as follows:

• Use Case 1 (UC1): Payment between central banks
• Use Case 2 (UC2): Domestic Payments between Commercial Banks
• Use Case 3 (UC3): Cross-border Payments between Commercial banks

As a case study, if we analyse how the entire project spanned out and what kind of challenges were witnessed in the above three potential cases, the following key points can be enumerated:

• Understanding the digital ledger technology, its nuances and the possible available options to be adopted for issuance of the digital currency under CBDC architecture.
• Looking into the non-functional aspects of the technology which would cover the areas such as relating to anonymity, privacy and financial crime risks.
• Identifying the broad areas which could be used for the project. For example, retail domestic remittances or cross-border remittances etc.
• Very closely define the role of each of participant in the entire eco-system which would mean – the role of the central agency, the commercial banks/participants, the customer user interface, the settlement agency and related arrangements on the flow of the transactions.
• To identify the existing settlement process which is primarily supported for fiat currency or e-money in the form of pre-paid instruments etc. However, a pure digital fiat currency as a mode of exchange and storage of value needs to be re-looked in its entirety.
• To make necessary changes in the regulatory regime, and policy framework which would mean changes in the definition of currency, notes. It would also mean defining the domain of the central authority to regulate and supervise the same.
• Government policy to clearly outline the role of private currency vis-à-vis the CBDC-backed digital currency which would be officially a government back digital form and mode of value and exchange in the country.
• Capacity building exercise for smooth adoption of technology especially for Public Sector Banks.
• One of the issues which has emerged while undertaking proof of concepts (PoC) of this technology among the participant banks is significant complexity in the exchange of data over the web and API-based applications.
• To analyse the impact of the adoption of the technology on the existing arrangements especially on the usage of correspondent banking relationships among the banks.

Recently, RBI in its report on Payment and Settlement Systems in India – Journey in the Second Decade of the Millennium 2010-2020, had clarified its stance on CBDC and has outlined that – “Private digital currencies (PDCs) / virtual currencies (VCs) / cryptocurrencies (CCs) have gained popularity in recent years. In India, the regulators and governments have been sceptical about these currencies and are apprehensive about the associated risks. Nevertheless, RBI is exploring the possibility as to whether there is a need for a digital version of fiat currency and in case there is, then how to operationalise it (RBI, 2020).”

RBI did see potential in the usage of digital ledger technology (DLT) while assessing the overall technological aspects of blockchain technology. It has also been clarified that the Public and Private Key architecture of the DLT facilitates the much-needed verification process required as part of the control mechanism envisaged by the regulators.

Globally, while working on the PoC on blockchain technology for digital currency, there have been a few challenges which are highlighted. As CBDC will use the DLT as an underlying base for implementing the digital fiat cash for exchange, the inherent risks and challenges which are applicable to DLT would also be extended and applicable to the CBDC project as well.

POLICY RECOMMENDATIONS

Despite numerous disruptions, and challenges in the adoption of cryptocurrency across the globe from regulators, the current global cryptocurrency valuation stands at $1.80 Trillion. Also, there are more than 1100 (blocksopt.io, March 14, 2021) cryptocurrency exchanges operating in the world as of date. Further, there are more than 4000+ cryptocurrencies listed in the crypto exchanges across the world as on January 2021.[3]  (https://www.investopedia.com/tech/most-important-cryptocurrencies-other-than-bitcoin, March 2021).

This clearly goes on to show that there has been no stop to the advancement of the crypto in the world including India. While no country has officially adopted the Central Bank Digital Currency, many countries like Russia, Japan, The U.S., China, and the UK are planning to launch the CBDC soon (https://www.theweek.in/news/biz-tech/2021/01/16/top-5-countries-leading-cbdc-adoption-in-2021.html, 2021).

After the careful analysis of multiple facets of developments, initiatives, and policy changes in this field, the few key policy recommendations for the adoption of digital fiat currency in India under CDBS space are as follows:

• A clear policy framework on CBDC can be laid down after due consultation with the Government which aligns with (a) the national strategy for blockchain issued by MeitY, Government of India and (b) the regulatory sandbox regime adopted by all the financial services regulators in India viz., RBI, SEBI, IRDAI.
• A roadmap to implement the CBDC which would outline the intention to utilize the current sandbox regime for possible use cases on payments, cross-border payments etc.
• Change to the law of the lands to define the jurisdiction of acts such as banking, securities etc in light of the CBDC. If a digital currency has become a reality in days to come, necessary statutory amendments will be required to avoid ambiguity and misinterpretations.
• Financial Services regulators may start the PoC with select commercial banks on the possible usages of the digital currency. This is suggested keeping in mind the developments in other countries wherein it has been contemplated to test on multiple levels.
• To bring focus on awareness and capacity building amongst the banks considering the need for technological advancements.
• To define the key regulatory requirements on financial crime compliance which would include anti-money laundering etc, if digital currency will be used as a mode of storage of value and exchange.

7. CONCLUSION

The government has set up expectations right with a clear strategy for the adoption of blockchain technology. Likewise, there has been constant review and evaluation undertaken by RBI in fostering the fintech start-up ecosystem under the regulatory sandbox regime. RBI has also covered blockchain-led technology as one of the design parameters while seeking proposals from start-ups on various cohorts for testing financial products and services.

While RBI is quite clear in adopting blockchain, private cryptocurrency has not been encouraged because of obvious reasons such as anonymity, riskiness and speculation. With the government mulling to bring in laws to regulate private cryptocurrencies and have a clear roadmap for CBDC-led India’s own digital currency, there are many more important developments envisaged in days to come.

India has to adopt a phase-wise PoC model to experiment with the creation of digital currency and study the possible area where it can be used effectively. RBI has also used the regulatory sandbox approach to fuel the changes of innovation in this field. In order to have a clear plan, we may have to wait and watch as to how RBI put forth the plans for execution for CBDC. If India needs to create a cashless economy, the chances of innovation on domestic and cross-border payments are high. However, the change comes after due consideration of the legal framework and compliance with KYC, AML and other risks. Hence, there is a need for a balanced and phased manner of adoption of change in digital currency, DLT.

8. IMPLICATION OF THE STUDY

One of the important implications of the study is to agree with the fact that India can’t be oblivious to the developments happening globally. There is a need to have a phased-out plan and clarity to consider the adoption of digital fiat currency under CBDC, with a comprehensive implementation framework in place.

 BIBLIOGRAPHY

(CBUAE), S. C. (2020). Project Aber. SAMA & CBUAE.

blocksopt.io, a. p. (March 14, 2021). as per blocksopt.io. as per blocksopt.io.

Chainalysis, B. d. (2020, September 8). The 2020 Global Crypto Adoption Index . Annual, p. 131.

https://www.investopedia.com/tech/most-important-cryptocurrencies-other-than-bitcoin. (March 2021). https://www.investopedia.com/tech/most-important-cryptocurrencies-other-than-bitcoin. https://www.investopedia.com/tech/most-important-cryptocurrencies-other-than-bitcoin.

https://www.theweek.in/news/biz-tech/2021/01/16/top-5-countries-leading-cbdc-adoption-in-2021.html. (2021). https://www.theweek.in/news/biz-tech/2021/01/16/top-5-countries-leading-cbdc-adoption-in-2021.html. https://www.theweek.in/news/biz-tech/2021/01/16/top-5-countries-leading-cbdc-adoption-in-2021.html.

IREDALE, G. (2020). Top 10 Blockchain Adoption Challenges. 101 Blockchains, 2.

Justice, U. D. (2020). REPORT OF THE ATTORNEY GENERAL’S CYBERDIGITALTASK FORCE. USA: U.S. Department of Justice.

RBI. (2020, February). Blockchain, DLT Technologies. Periodical – Bulletin, p. 13.

RBI, D. (2020). Payment and Settlement Systems in India -2010-2020. Mumbai: RBI.

Settlements, B. f. (2020). Central Bank Digital Currency. BIS.

www.coinmarketcap.com. (March 14, 2021). www.coinmarketcap.com. www.coinmarketcap.com.

[1] Payment and Settlement Systems in India, Journey in the Second Decade of the Millennium – 2010-2020 (Jan, 2021)

[2] Central bank digital currency (CBDC) would use digital tokens and blockchain technology to represent a country’s official currency.

[3] As per the market research reports and inputs available in the Investopedia.

Notes: This research paper was 1st published at VIPS National Conference, 2021 by Abhishek R. Sharma.

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.

Abstract:

In the given context, Digital Identity is only a form that constitutes pieces of evidence of core identifiers or attributes of an Individual, primarily associated with usage in more organized set-ups such as National IDs. If the digital identity is created, developed, and sustained in a regulated environment under the governmental policy, then the same becomes an identifier for allowing (means identifying the genuineness & authenticating) a commercial/financial transaction to pass through. This essay is directed towards understanding the nuances of digital identity, digital identity system, an existing use case of digital identity, a proposed digital identity with possible technology features, and the kind of policy changes required for using digital identity as a tool for fighting crime & corruption. The essay also covers the need for digital identity systems to promote transparency and integrity in the financial sector.

KEYWORDS: Digital Identity, Digital Identity System/s, Financial Crime & Corruption

Good to know; as we begin – The entire essay is explained through six literal idiomatic expressions which encompass a journey from “Let’s check it” (1), to “Let’s know it” (2). In the process, as we prosper and achieve, we say “That’s done” (3) to highlight the use case scenario. We will go on exploring a new approach, so to say “Let’s do it” (4), and finally arrive at a formidable spot “That’s needed” (5). And, we conclude by saying “That’s it” (6)!

 

1. Let’s check it!

 Organizations, firms, and business units which are working in the financial services sector, which are described by the acronym “BFSI”[1], the full form of which means Banking, Financial Services & Insurance, are facing tougher financial crime & corruption risk than ever before. According to recent Javelin’s 2019 Identity Fraud Study (2019, Summary), “The losses increased from US$ 3 billion in 2017 to US$ 3.4 billion in 2018, on the count of New Account Fraud (NAF), where fraudsters open new accounts under victims’ names[i].”

In the Experian India Fraud Report 2018-19, among the trends of fraud, Identity Theft (28%) is the largest contributor to the overall fraud distribution. This is despite the fact that India is amongst the pioneer in implementing the Digital Identity program which to date covers over 1.24 billion Indians, enrolled in Aadhaar[2], representing about 90% of the total estimated population. This goes on to clearly indicate that financial crime is only going to increase considering the usage of new methods of crime including identity theft by fraud perpetrators. Off late, many fraud detection firms have reported preventing more than millions of fraud attempts using fake or stolen identity credentials targeting mainly financial sectors.

At the same time, the regulatory environment is becoming increasingly stringent. According to a report from IBM, the average cost of a data breach has increased to US$ 3.92 million, which is a 1.6% increase in costs in 2018 and a 12% rise over the last five years[ii]. The year 2019 has already seen organizations slammed with sizable fines and settlements for security incidents or misusing customers’ information including Personal Identity Information (PII). Ever since GDPR[3] was launched, data regulators are getting more serious about companies that are not cognizant of consumer data protection.

Given the rise in the instances of fraud and the increasingly heavy fines for compliance failures, it has never been more urgent for businesses to digitize and strengthen their digital fraud prevention methods, which would go a long way to reduce the cost of compliance and increase efficiency.

Notes:

[1] Banking, financial services, and insurance (BFSI) is an industry term for companies that provide a range of such financial products or services.

[1] Aadhaar is a 12-digit unique identity number that can be obtained voluntarily by residents or passport holders of India, based on their biometric and demographic data.

[1] General Data Protection Regulation, European Union (EU)

2. Let’s know it!

• Digital Identity

 Digital identity is data about individuals stored and accessible through computer systems that closely link to their civil and national identities[iii]. The information contained in a digital identity allows for assessment and authentication of a user interacting with a business system on the web, without the involvement of human operators. Digital identities allow access to computers and the services provided are automated and make it possible for computers to mediate relationships.

The term “digital identity” also denotes certain aspects of civil and personal identity that have resulted from the widespread use of identity information to represent people in an acceptable trusted digital format in computer systems.

• Digital Identity System/s[iv]

Digital ID systems (DIS) use electronic means to assert and prove an individual’s official identity in online (digital) and/or in-person environments at various levels of assurance. DIS covers the process of identity proofing/enrolment and authentication. DIS can involve different operational models and may rely on various entities and uses types of technology, processes, and architecture.

Not all elements of a DIS are necessarily digital. In a DIS, identity proofing and enrolment can be digital or physical (documentary), or a combination, but binding, credentialing, authentication, and portability/federation (where applicable) must be digital.

• Financial Crime & Corruption

Financial crime has increasingly become a concern to financial institutions over the last few decades. If we consider the definition which is most prevalent in the countries like The UK, Europe, or The USA, Financial crime includes offenses such as money laundering, terrorist financing, fraud, bribery and corruption, market abuse, and insider trading. A financial crime is an act or attempted act against institutions, governments, or individuals by internal or external agents to illegally appropriate, defraud, manipulate, or circumvent legislation. The act of financial crime may or may not result in a monetary loss.

In the recent, Emerging Financial Crime Threats for 2019, published in ACAMS Today (January 30, 2019)[v], it is highlighted that “not just “traditional” money laundering that has jumped by leaps and bounds; electronic money laundering, in which actors take advantage of the online financial system, is also on the uptick. Black Friday 2018 set all sorts of records for the biggest online sales ever, the most money spent online ever, etc. Given the ubiquity of online shopping, it is natural that bad actors would take advantage of any way they can. That could include hacking websites, stealing customer credit card data, or credential stuffing scams when sites are trolled for user information in order to gain access to online bank accounts and other sensitive data.”

One can easily make out that all the above three concepts are interlinked and interconnected. With the increasing rise in digital transactions especially digital payments which are growing at an estimated 12.7% annually, and are forecast to reach 726 billion transactions annually by 2020[vi], an estimated 60% of world GDP will be digitalized by 2020[vii], its corresponding effect would be a playing field for fraudsters to deploy techniques of committing the financial crime.

Hence, it is vital to note that interalia; the usage of digital ID to fight financial crime is gathering momentum, driven by inter-connected factors such as greater connectivity and participation from the government. Amongst the examples, such as India’s Aadhaar ID system and New Zealand’s RealMe system which not only authenticates digital transactions but going further allows the opening of bank accounts smoothly with zero fraud risk and the possibility of financial crime. It is fascinating to note that digital identity and digital identity system plays a pivotal role in putting a stop to fraud risk of all kinds.

3. That’s done!

 As we move ahead in this journey, it is time to project an existing use case of a digital identity program. While there are various such programs that are successfully implemented across the globe, I would cover the Aadhaar[4] program in India as an existing use case. The testimony of the program was made when, Mr Paul Romer, Chief Economist, The World Bank commented that “The (Aadhaar) system in India is the most sophisticated (ID system) …………………………….[viii]”.

 The use of biometric technology in Aadhaar has made a compelling impact as far as the reduction in financial crime is concerned. The primary aim of bringing this system was to digitize the cash economy and allow the smooth flow of government benefits and transfers to the end users. With the gaining momentum, the Aadhaar ID system has made to use for various other purposes which include usage by Banks for providing banking services such as customer onboarding, etc. Likewise, Telecom Operators used the Aadhaar authentication facility to reach the masses by enabling and connecting them to the world.

Under the Aadhaar ecosystem, UIDAI[5] was created with the objective to issue Unique Identification numbers (UID), named “Aadhaar”, to all residents of India. The UID is (a) robust enough to eliminate duplicate and fake identities, and (b) verifiable and authenticable in an easy, cost-effective way.

UIDAI is responsible for Aadhaar enrolment and authentication, including operation and management of all stages of the Aadhaar life cycle, developing the policy, procedure, and system for issuing Aadhaar numbers to individuals and performing authentication and the security of identity information and authentication records of individuals.

So far more than 1.24 billion Aadhaar numbers are issued to the residents of India.

4. Let’s do it!

 Proposed digital identity with possible technology features – In today’s scenario, worldwide, there are various digital ID programs that are running successfully and they have been created with a sense of commitment to ease the functioning of both public as well as private sector units. For instance, GOV.UKVerify is a secure way for UK residents to prove who they are online. Similarly, Realme is another secure way for New Zealand residents to prove their identity.

It is wise to envisage a digital identity system or a program that caters to the varied needs of the organization or the country at large. Any proposed program must fulfill the following contours viz., (A) Uniqueness – a digital identity platform that has unique features to distinguish every single enrolment, (B) Scalability –  to allow the possibilities of usage in all the fields/services including an extension to financial services sectors to authenticate and on-board the customers, (C) Effective – to act as countermeasure towards preventing financial crime & corruption including curbing the digital identity thefts, which are on the rise due to technological advancements. While there are a few challenges in implementing digital ID programs which are on account of risks such as impersonation risks and synthetic IDs (involving cyber-attacks, data protection, and/or security breaches), etc. Nonetheless, the advantages are overpowering as compared to the risks associated.

So, the ideal proposed digital identity system or program should comply with the “The Power of Thrice…” which means it should pass the test each time after meeting all the three parameters viz., (a) Static parameter, (b) Dynamic parameter, and (c) Sub-dynamic parameters.

 To explain, every time to records the identity, the system will match and measure the (a) Static parameters such as fingerprints, IRIS scan, face recognition, etc., and then it moves to the second stage which is (b) Dynamic parameters such as an OTP in the linked mobile device and finally (c) sub-dynamic parameters such as IMEI No. of the mobile handset of the user.

The above approach will go beyond the routine and use the specification of mobile handsets as an additional factor in the system. It is more about creating a third layer of authentication.

5. That’s needed!

 Now that we know, digital IDs play a paramount role in curbing the potentialities of fraud and corruption, it is all the more important that the following 4 Tier regime is implemented to reduce financial crime & corruption:

Tier 1 – Government led Model for digital ID system with the private sector as facilitators	Digital IDs created	Reduces Identity Theft, Risk of impersonation, and data theft
Tier 2 – Digital IDs must be for all Government dealings	Schemes, transfers, subsidies, grants, insurance, claims, etc.	Reduces corruption, duplicate payments, and less cash economy
Tier 3 – Digital IDs for must for BFSI dealings	CDD, Transaction monitoring, tax evasion, insider trading	Reduces tax evasion, anti-money laundering, impersonation, corruption, cash-less economy, fraud, bribery
Tier 4 – Act as an indicator for the Citizenship of the Sovereign	Identity and status	Human trafficking, drugs and arms dealing, terrorist financing, infiltration, and smuggling

6. That’s it!

 Research by the McKinsey Global Institute[ix] found that countries implementing good digital ID could unlock economic value equivalent to 3-6 % of GDP on average by 2030, making digital ID a potential force for inclusive growth, especially in emerging economies. In order to promote transparency and integrity in the financial sector a digital ID system enables an efficient means of due diligence of its customers.

For example, in India, The Reserve Bank of India (RBI) has permitted the Entities regulated under it to accept an Aadhaar identification number issued by the Government of India as an officially valid document (OVD) to further act as proof of identity as well as address in order to meet the regulatory CDD requirements of opening accounts. With the introduction of a digital ID, it solves the issue of costs as well as the security and reliability concerns.

However, according to Transparency International’s Global Corruption Barometer[x], “57% of the world population thinks their government is doing badly in the fight against corruption. Further, the United Nations estimates that every year globally, US $3.6 trillion is paid in bribes or acquired by other corrupt means.”

Thus, in order to tackle fraud and financial crime effectively, individuals, governments, and organizations must have the necessary knowledge, systems, and processes in place to deal with delinquent behaviors. Digital ID and Digital ID system/s will be the most powerful tool for fighting financial crime & corruption.

References

[1] Banking, financial services, and insurance (BFSI) is an industry term for companies that provide a range of such financial products or services.

[2] Aadhaar is a 12-digit unique identity number that can be obtained voluntarily by residents or passport holders of India, based on their biometric and demographic data.

[3] General Data Protection Regulation, European Union (EU)

[4] Aadhaar – meaning “foundation” in several Indian languages – is the largest biometric identity programme in the world. (Launched in the year 2009). Each Aadhaar recipient receives a unique 12-digit ID number, and submits their photo and their biometric data in the form of fingerprints and iris scans.

[5] The Unique Identification Authority of India (UIDAI) is a statutory authority established under the provisions of the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016 (“Aadhaar Act 2016”) on 12 July 2016 by the Government of India.

[i] Kyle Marchini, Al Pascual (2019), 2019 Identity Fraud Study: Fraudsters Seek New Targets and Victims Bear the Brunt (Report)

[ii] Rudra Srinivas, 2019, 6 Times Data Regulators Churned Out High Penalties in 2019 (Article)

[iii] “Digital identity,” Wikipedia, https://en.wikipedia.org/wiki/Digital_identity

[iv] FATF (p12, 2019), draft guidance on Digital Identity

[v] Ron Teicher, CEO, EverCompliant, New York, NY, USA, Emerging Financial Crime Threats for 2019 (Jan, 2019), ACAMS Today

[vi] Capgemini & BNP Paribas (2018), World Payments Report 2018, accessed online at: https://worldpaymentsreport.com/wp-content/uploads/sites/5/2018/10/World-Payments-Report-2018.pdf

[vii] International Data Corportation (IDC), IDC FutureScape: Worldwide IT Industry 2019 Predictions

[viii] Media & Resources Media Quote/Unquote (2020) https://uidai.gov.in/media-resources/media/quote-unquote.html

[ix] “Infographic: What is good digital ID?” McKinsey Digital, April 2019, https://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/ infographic-what-is-good-digital-id

[x] Les Dobie, Head of Counter Fraud Training, CIPFA (January 6, 2020), https://www.ifac.org/knowledge-gateway/building-trust-ethics/discussion/tackling-fraud-and-financial-crime-global-public-sector-through-training-and-education

 

Note: This research paper was first submitted to NBD, in Jan 2020. Re-produced by the Author –  Abhishek R. Sharma