Mapping the Potentiality of ESG and Crypto-Regulations: A Value-Driven Approach

[By Simran Lunagariya & Unnati Jain

The authors are students at the Institute of Law, Nirma University. 

Introduction

Covid-19 has created unprecedented and irreversible business and regulatory disruptions across the globe. At this juncture, India is in dire need to stabilize its global economic position. The Indian economy has been adversely affected, and the GDP for the year 2020-21 went down by 7.7%. Also, a job loss of 20% was witnessed in Urban India during 2020-21. The loss of jobs has attracted people to generate side income creating a greater spike in crypto trading.

Additionally, the institutional investment wave is also increasing at a greater pace; in such a scenario, the Environmental, Social and Governance regime of the crypto industry must be addressed with a comprehensive approach in India. For mitigating the value-driven uncertainty from this emerging asset class. Especially when India is aspiring to become a $5 trillion economy, however, the co-existence of cryptocurrency and the ESG has often been debated globally. In the Indian scenario, this would be a nightmare in the absence of an effective regulatory framework. This blog explores the avenues of potential regulatory requirements that could address the ESG aspect of Cryptocurrency in India.

Environment 

The mining of cryptocurrency involves proof-of-work methods to transact and verify the transactions. This method requires high-power systems to solve the complex calculations, thereby creating a highly energy inefficient system. The amount of carbon dioxide released by such power-hungry systems is considerably high and affects the environment negatively. Although massive energy consumption of crypto-mining forms to primary environmental issue, the increasing usage of coal for this energy driven process also proves to be analogous to this issue. According to a study the annual carbon footprint of cryptocurrency is almost parallel to the carbon footprint of Mumbai. Moreover, cryptocurrencies account for 0.40% of the world’s total electricity consumption. Hence, these digital assets undoubtedly oppose the principles of Environment sustainability.

Various responsible investors are withdrawing from investing in cryptos at the global level due to their catastrophic environmental effects. Recently, Elon Musk, CEO of Tesla, affirmed that the Bitcoin consumes a great amount of fossil fuels, hence making it an environmentally weak crypto. Consequently, he suspended the use of Bitcoin for trading. However, until now, India has not taken any steps to regulate cryptocurrency mining for its harmful effects on environmental sustainability. Although SEBI recently, in March 2021, had issued new guidelines on disclosure norms on sustainability-related reporting for the top 1,000 listed companies by market cap, which includes Environment-related disclosure, the regulation of crypto mining seems not to be affected by the SEBI guidelines. In India, despite the speculation of banning cryptocurrency, the trade is subsequently rising. The matured growth of crypto as an asset class in India needs strong regulation to force market players to create portfolios attracting greater environmental benefits. The regulations must include :

  1. Stricter Disclosure Regulations with respect to crypto-mining methods would foster a greater sense of responsibility in the minds of market players. For instance this can be done under the aegis of the SEBI norms on sustainability-related reporting released in March,2021.
  2. A guidance mechanism and up to date database displaying the on-going mining operations (for market players and investors respectively) would make crypto-mining a transperant process with respect to environment. Eventually, this would attract responsible investors towards crypto-trading/investing.
  3. A comprehensive and stringent compliance mechanism promoting environmental friendly crypto-mining would help in avoiding alarming situation in future. Inclusion of monetary penalties and prohibiting crypto-trading for the entity who performs severe non-compliance would imbibe sense of responsibility in the minds of crypto investors/traders.
  4. Promoting more intelligent methodologies like Proof-of-Stake (PoS) method would reduce the ill-effects of Proof-of-Work method. Also, a guide to PoS methodology would make it an approachable and performable method for market players. This shift would help in restricting the entry of crypto-miners and motivate more responsible and well-equipped crypto-miners.

Social 

On the social front swift transacting ability of the crypto has attracted the masses due to economic disruptions in recent times. The cryptocurrency network provides flawless transactions across the world along with minimal hindrance from the financial regulators. However, the conflict between private and sovereign propriety over crypto is primary to the cryptocurrency struggle in India. The lift of the RBI ban and Supreme Court verdict of 2020 has raised the hopes of Private Crypto start-ups. Almost 300 start-ups in India have created huge job opportunities for youth, boosting tech infrastructure. The Indian government’s stance to centralise the crypto in order to transfer stability to crypto investing/trading in India would make the industry more restricted. Eventually, this would keep India behind other countries and adversely affect Indian economy. The swift transacting capacity and no hinderance from intermediaries is characteristic to crypto. Centralisation of crypto would highly affect this unique feature, juxtaposing it to a car without fuel. Hence, promoting a decentralised crypto is equally important as the centralised crypto to create a balance in the industry and cope up with worldly developments in crypto regime.

The wide usage of Etherium Crypto has fostered investment opportunities like Decentralised Finance (DeFi). Consequently, smart contracts have brought in the innovation-driven Non-fungible Tokens, a more secured and un-replicable asset with unique identities. DAO is another trending avenue for investment with great scope to boost the economy and shrink the externalities like inflation and depreciation. Amongst all these innovations, fintech and DeFi regimes of crypto have certain associated risks of their own. For the Indian scenario, an intact mechanism addressing investor safety, market integrity, and prevention of financial crimes to boost crypto’s social and financial credibility are vital. The mechanism must include :

  1. Guidance and infrastructure along with resources must be provided to the market participants through efficient policies.
  2. Strict enforcement regime for market players would help foster financial safety in the industry accompanied by KYC and anti-money laundering mechanisms in DeFi.
  3. Stricter capital rules regarding crypto may include minimum capital standards for private banks to maintain liquidity and prevent a shortage in the market.
  4. Similar conservative prudential regime for highly volatile private cryptocurrencies can attract investors inviting a greater social good.
  5. There is a great scope for the market regulator to regulate future transactions by including neo-banking in cryptocurrency.

Governance 

The lack of regulatory oversight is an obstacle to govern the cryptocurrency industry.  Owing to the serious governance concerns regarding cryptocurrency, several countries have laid down measures to make it easier to regulate cryptocurrency. For instance, recently, El Salvador became the first country to recognize bitcoin as legal tender, making it more regulated than ever.

However, in India, no legal position of cryptocurrency has yet been decided, and it has been running into several problems with the banks and investors. In the year 2018, RBI issued a circular directing not to deal in virtual currencies. However, in 2020, the Supreme Court, in the case of IMAI v RBI, lifted the ban on trading virtual currencies in India. Owing to vague regulations, several banks and payment gateways did away with crypto transactions. The circular proved to be an irrelevant document subsequently, however the banks and other entities were mandated to perform the Due-Diligence with respect to crypto-currencies. “Due Diligence” must be in line with regulations governing standards for Know Your Customer, Anti-Money Laundering, Combating of Financing of Terrorism, and obligations of regulated entities under Prevention of Money Laundering Act 2002.

A comprehensive portfolio addressing environmental, social, sustainability, tax, financial crimes, and cybersecurity issues of cryptocurrency is essential to have effective governance in the corporations. The regulatory measures that could be adopted to make the governance of cryptocurrency an opportunity includes:

  1. To regulate crypto with a multi-stakeholder approach, it becomes necessary to set up a central issuer or network operator so that a strong regulatory model is developed.
  2. Watchdog networks must be set to scrutinize the actions of cryptocurrency stakeholders in the economy and safeguard the key standards set by the community network.
  3. It is crucial to implement light and customer-friendly regulation that allows the crypto industry to grow and prevent the customers and intermediaries from the aftermath of black marketing.
  4. Formation of formalized governance disclosure norms to foster shareholder activism and shareholder’s democracy to keep a watch on governance portfolios of the board.

Conclusion 

The scale of adoption of digital assets in India is increasing swiftly. Having been hit by the economic recession, the government has an opportunity to take optimal advantage of digital transformation. To reduce ESG and Crypto conflict stringent compliance-based regulatory framework would make crypto trading/investment effective for corporations. To increase the creditworthiness of crypto, globally acceptable regulation would create more safety and security in investors and governance of companies from external threats. The nascent wave of sustainable investment has fostered many investors to undertake ESG driven investment portfolios. A holistic approach to the ESG aspect of crypto would foster market players to develop ESG compliant portfolios. In the long term, this would help combat volatility and uncertainty issues, transferring more credibility to these digital assets.

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *

Contact Us

Kerwa Dam Road., 
National Law Institute University, Bhopal
Madhya Pradesh, India. 462044​.

write to us at – cbcl@nliu.ac.in