The cryptocurrency market is gaining prominence across the globe, with several countries passing legislation to regulate its use in order to attract investors and boost innovation. This year saw South Korea passing anti-money laundering laws to reduce tax evasions associated with cryptocurrency, following the suit of other countries, such as the USA, the UK, Canada and Australia. Emerging markets, such as India, require similar development of their cryptocurrency regulations in order to realise the investment potential of this new technology. However, cryptocurrency brings new challenges such as the lack of a central issuing authority, the encrypted nature of blockchain technology, and the potential for the system to be misused for crimes such as terrorism. In spite of these challenges, financial regulators have resorted to new techniques for regulating these expanding technologies in finance. One such way is the use of regulatory sandboxes. This piece advocates the use of regulatory sandboxes in order to promote innovation in the cryptocurrency market in emerging economies.
II. Regulatory Sandboxes
A regulatory sandbox is a framework established by a financial regulator to permit fintech innovations to experiment in a live environment, over which it exercises supervision. It is essentially a test-mechanism which enables firms to try new financial products or services in a controlled consumer environment before it enters the real market. Relaxations of varying kinds are usually provided in the form of exemptions from fines and penalties. It benefits all stakeholders, such as fintech inventors (who can test the profitability of their products and engage with the customers), and customers (who can explore new financial products). Most importantly, it benefits regulators themselves. New investments/products emerge with new sets of risks. Instead of directly launching them under traditional compliance frameworks and facing incalculable risks, regulators can experiment with different sets of laws within the controlled structure of a sandbox. This ensures that any new system can be managed and, if required, new regulations can be implemented to control them.
Cryptocurrency, due to its decentralised and coded nature, brings new challenges to conventional finance. The lack of knowledge and expertise regarding this technology attracts skepticism and most countries lack sophisticated regulatory frameworks in order to govern its operations. However, if this industry, which is worth billions of dollars and is gaining increasing momentum, is left unregulated, countries will lose out on a significant source of potential investment. It has already become apparent that crypto-platforms have started shifting to countries which are more crypto-friendly. Emerging economies, due to fears regarding cryptocurrency, place heavy restrictions on the working of such companies, which makes it unprofitable for them to operate. Examples include limitations on payments, banking, licences, etc. These restrictions disincentivise crypto-companies from emerging market economies, preferring to locate in more investment friendly environments. In light of this, it is submitted that an understanding of sandboxes can help test the perceived risks surrounding cryptocurrency and allow for their investment potential to be unlocked for emerging economies.
III. Regulatory Sandbox for Cryptocurrency
Due to the advantageous features of sandboxes, several countries have already adopted its framework to experiment with crypto-platforms and their regulations. For instance, the UK’s Financial Conduct Authority, in 2019, permitted several blockchain and distributed ledger technology-related companies to access its sandbox services. The USA has taken a similar approach, with other countries such as Switzerland, Canada and Australia following suit. Additionally, steps have been taken to build a global sandbox as well. More than twenty regulators from nations including the UK, the USA, Canada and Australia are working with related organisations such as the Global Financial Innovation Network to develop this global platform.This highlights how this innovative technology is gaining prominence at international as well as domestic level.
Emerging economies on the other hand, appear reluctant to use sandboxes for regulating cryptocurrency. The Reserve Bank of India, for example, unveiled a fintech regulatory sandbox in 2019, yet explicitly left cryptocurrency out of its scope. Similarly, Kenya does not cover crypto-firms within its sandbox framework. This reluctance appears to be due to the fear that cryptocurrency might expose economies to new financial, legal, operational or consumer-related risks. These fears stem from factors such as the lack of a central issuing authority, the inability to track the transfer of crypto-assets, and difficulties in monitoring and valuing these assets. However, it is submitted that the very purpose of a sandbox is to manage and control such risks, ensuring that when crypto-firms finally enter the system, the environment remains secure and largely risk-free.
IV. Conclusion: Cryptocurrency Sandbox for Emerging Economies
Emerging economies appear reluctant to embrace cryptocurrency due to the risks they can pose to their financial systems. Most of these countries do not recognise and regulate cryptocurrency even after it has attracted billions of dollars of investment. Marcus Swanepoel, while speaking in favour of regulating cryptocurrency in Africa, highlighted that crypto remittances totalled USD 40 billion in 2019 with 10% as fees. He claimed that regulation could increase GDP by 1–2% in some African countries, while also stimulating inter-African trade. Therefore, non-regulation is problematic as it opens an entirely new form of parallel economy, enticing tax evasion, misappropriation, and the facilitation of further financial crimes. Instead of leaving it entirely unregulated, emerging economies can instead use sandboxes as an experimental framework to test the working of cryptocurrency.
This would not only generate greater inward investment, but development might also be enhanced through the promotion of greater innovation in the market. Additionally, sandboxes provide regulators with ample time to understand the system, find and cure its loopholes, discover new avenues for growth, make the required changes in regulations to suit the new environment, and promote the working of new products. The aim should be to utilise fintech to boost economic growth in these countries. This would also facilitate greater financial inclusion, improve competitiveness, and consequently, accelerate the development of domestic financial institutions.
About the Author
Ashika Jain is a 3rd year student at the WB National University of Juridical Sciences, India. She is a Senior Associate Member of the NUJS Law Review and has a keen interest in matters of finance and company law. She represented NUJS as a speaker at the 27th Willem C. Vis International Commercial Arbitration Moot, 2020 where they were adjudged the winners and awarded the Eric E. Bergsten award for the Best Team Orals. She was also adjudged the Best Oralist at the 12th NLS-Trilegal International Arbitration Moot, 2019.
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