This article is written by Jubal Raj Stephen, pursuing a Diploma in Cyber Law, Fintech Regulations, and Technology Contracts from LawSikho.com.This article has been edited by Dipshi Swara (Senior Associate, Lawsikho).
The crypto market, reaching the recent peak of $1 trillion market capitalisation, has scope for exponential growth in the legal market. This has not been a purely speculative enterprise with more than 2,300 businesses across the US accepting bitcoin (without including bitcoin ATMs) and major traditional final institutions such as JP Morgan and Goldman Sachs, who were once famously critical towards bitcoin and cryptocurrencies in general had changed their tune. The time has not been ripe for the adoption of cryptocurrencies by businesses and corporate houses in either funding, payment, and beyond.
Why should corporate houses venture into crypto?
The blockchain, the underlying technology behind cryptocurrencies, has the potential to be a collaborative technology that promises to improve the business processes that occur between companies, radically lowering the “cost of trust.” Thus, offering substantially higher returns for each dollar of investment spent than most traditional internal investments. Widespread adoption from financial institutions could potentially upend everything from clearing and settlement to insurance.
Large payment companies such as Visa, Mastercard, and PayPal have embraced cryptocurrency in various ways, after considering the reduction in transaction fees from around 1.5% – 3.5% in conventional payment methods to the 0.5% – 1% provided by crypto. While currently, Indian companies are unlikely to attract domestic investors, they seem to have a very good chance of attracting foreign investors for funding.
According to Deloitte the following benefits could also be gained from adopting crypto:
- Cryptocurrencies may provide access to younger and tech savvy demographic groups. Such customers tend to value transparency in their transactions. One recent study found that up to 40% of customers who pay with crypto are new customers of the company, and their purchase amounts are twice those of credit card users.
- Introducing crypto now may increase awareness within the company on crypto-based technologies. It also may help position the company in this important emerging space for a future that could include central bank digital currencies.
- Crypto could provide firms access to new capital and liquidity pools through traditional investments that have been tokenized, as well as in virtual asset classes.
- Cryptocurrencies provide certain opportunities that are unavailable with traditional fiat banking transactions. As example crypto can be used as programmable money that enables real-time and accurate revenue-sharing while ensuring transparency to facilitate back-office reconciliation.
- Cryptocurrencies provide important opportunities with pre-existing clients and vendors who want to engage by using crypto. Thus, it becomes essential for firms to enable themselves to receive and pay-out crypto to assure smooth experience for key stakeholders.
- Crypto provides a new avenue for enhancing a host of more traditional treasury activities, such as:
- Enabling simple, real-time, and secure money transfers.
- Helping strengthen control over the capital of the enterprise.
- Managing the risks and opportunities of engaging in digital investments.
- Crypto may serve as an effective alternative or balancing asset to cash, which may depreciate over time due to inflation. Crypto is an investable asset, and some, such as bitcoin, have performed exceedingly well over the past five years. There are, of course, clear volatility risks that need to be thoughtfully considered.
Routes of funding
There are multiple ways to fund a corporate business such as:
- Directly receiving crypto funds in the form of payments and grants,
- Tokenized issuance of crypto in return for funding through ICOs (Initial Coin Offerings), IEOs (Initial Exchange offerings).
- Through DEFI (Decentralised finance) loans if the firm is already in possession of crypto assets or more recently through issuance of NFTs (Non fungible tokens).
While these are some known ways through which companies can receive which will be discussed in the article, it is the nature of cryptocurrencies being a cutting-edge technology there are infinite customizable means of funding that can be tailored to each firm needs, especially on the basis of smart contracts.
While crypto funding is a novel means of funding, corporations and businesses must remember that crypto projects can still be funded through traditional means of funding and the use of crypto for funding still reflect traditional forms of funding such as venture capital, grants, and crowdfunding. Thus, funding through cryptocurrencies still requires efforts to be made to show the investor that the firm is capable of being successful.
The most direct way to get crypto funds is to start by receiving crypto in the form of payments for goods and services. There exist fundamentally two approaches in employing crypto payments, “hands-off” approach which is the 1st simpler approach and is based on using a third-party vendor to handle payments and immediately converting crypto payments to fiat. This shifts the burden of most technical and compliance risk to the vendor providing the crypto payments, while the firm might still be on the hook for AML(Anti Money Laundering) and KYC (Know your Client) compliance issues especially for large payments from foreign sources. It is important for the firm availing such services to do its due diligence on the vendor’s capabilities particularly with their ability to handle the volatility of crypto prices and compliance with global jurisdictions.
The 2nd more complicated approach is for the firm to directly take crypto payments into their possession. This can be done either by creating their own digital wallets or by relying on custodial service, in either case, this approach is helpful if the firm has a goal to deploy cryptocurrencies more than just as a tool to receive payments. This approach requires the development of in-house crypto treasury management expertise to handle the crypto assets of the firm, this also opens up the business to multiple compliances and technical risks and the firm might need to obtain a license to handle crypto depending on the jurisdiction. Further Tax & accounting concerns, thus the firms should maintain a systematic and rational methodology for establishing and tracking basis and for keeping detailed and appropriate documentation.
This is not a far-off reality for India with small businesses and gig workers already accepting cryptocurrency payments from foreign clients. At least for small businesses, it makes sense to reserve cryptocurrency payments only for big-ticket luxury purchases rather than frequent smaller payments. Firms taking up crypto payments must also make sure that they keep up with laws and regulations given the quick pace of change in the industry.
If the firm or business is working in research and development or a field of public interest it might be able to acquire grants for such new technology or initiative in the form of cryptocurrencies. A few examples of such grants that could be claimed are Ethereum research grants for work being done in the Ethereum ecosystem, The UNICEF crypto fund for crypto-based projects that have the potential to impact children on a global scale, and the Human Rights Foundation.
ICOs, STOs & IEOs
Initial coin offerings (ICOs) are the IPOs of the world of cryptocurrencies. Start-ups and existing firms who are unable to raise capital through conventional sources such as Banks or traditional investors, find refuge through ICOs. The firm or start-up issues a token representing equity in the blockchain like an IPO. The investors, hoping for an increase in the value of the token in the short term purchase of these tokens, provided a solid and valid business idea typically described by the ICO issuers in a white paper. However, ICOs have had a reputation of being used for fraudulent activities perpetrated by unscrupulous actors, as unlike conventional modes of funding there is very little accountability. The ICO market has topped $22 billion since its beginning in 2017 but 76% if ICOs did not even meet their minimum funding goal. So, firms should accordingly weigh their options in proceeding with an ICO.
Some other mechanisms of crypto fundraising similar to ICOs, are as follows:
- STO (Security token offering) – Security tokens represent an investment contract into an underlying asset such as stocks, bonds, funds and real estate investment trusts (REIT). They are regulated as securities and are popular among long term investors.
- IEO (Initial Exchange Offering) – An alternative to ICOs in which the tokens of the offeror are sold directly through a centralised cryptocurrency exchange. IEOs are thus only open to those with accounts in the exchange, this can operate as a layer of safety against frauds as the exchange might be able to perform due diligence on the tokens offered.
- IDO (Initial Decentralised Offering) – It is identical to an IEO, except that it occurs on a decentralised exchange.
Firms need to be aware that such offerings might be regulated in certain jurisdictions such as the US, increasing the compliance burden on the firm.
NFTs(Non-Fungible Tokens) are a unique representation of objects as a token in a blockchain, not interchangeable like cryptocurrencies and the blockchain token is the verifiable provenance of the object. Though used mainly in digital art sales, it is a potential avenue for corporations young and old to raise funds for specific projects by selling the NFT for some cryptocurrency. A few ingenious attempts by institutions to raise funds highlighting the possibility are Edward Snowden selling an NFT for $7M in support of the Freedom of the Press Foundation and New York Times journalist Kevin Roose raised nearly $1M for the sale of an article about minting an NFT. More recently by UC Berkeley University by selling NFTs of internal forms on the discovery of Nobel-Prize-winning Cancer research for almost $50,000.
This has not been something unique to the US, Indian crypto-enthusiasts have also started a similar venture called Fable to sell NFT art and collect funds for COVID relief. Another venture with a more radical monetization of NFTs would be Omi Iyamu’s venture ACE which is poised to allow talented performers to sell access tokens to their fans which allow them to have varying levels of access to the performer.
The true revolutionary promise of blockchain and cryptocurrencies is to replace regular financial institutions with decentralized money, DeFi (decentralised finance) loans are a step in that direction. DeFi loan or loans that can be taken on the use of cryptocurrencies as collateral. Such loans are issued without the need for disclosure of identity to a bank or any legal paperwork. This form of funding might be useful for corporations who have pre-existing crypto-assets in their balance sheet and would like to use the same without selling.
Regulations in India
The Indian government has had a history of ambiguous regulation in the cryptocurrency space. Recently it has shifted from a ban-everything approach to a “calibrated approach” towards digital assets. This was followed by a note from the Reserve bank of India (RBI) reaffirming the 2020 Supreme Court order, that its old circular banning payments related to cryptocurrencies is no longer valid. Though more clarification is required on the regulation of cryptocurrencies this is a much more hopeful starting point.
While no overarching regulation exists, entities engaging with cryptocurrencies should ensure compliance with know your customer (KYC), and anti-money laundering (AML) and foreign exchange management Act (FEMA) laws. ICOs are the next technology that requires legislation, while currently, no concrete regulation exists the Inter-Disciplinary Committee chaired by the Special Secretary (Economic Affairs) is contemplating enforcing compulsory cryptocurrency norms on entities investing in crypto. ICOs bring a whole host of legal issues that need to be addressed as they can function as a ‘security’ thus requiring SEBI intervention. A possible future path for Indian regulation can be seen in the Swiss Financial Market Supervisory Authority, FINMA guidelines regarding ICOs. FINMA has divided cryptocurrency tokens into four categories:
- Payment tokens,
- Utility tokens,
- Asset tokens, and
- Hybrid tokens.
Each needing its own regulations and Hybrid tokens indicating the non-mutually-exclusive tokens needing the cumulative application of regulations. A core norm to which FINMA bases its regulation is, “assessment on the underlying economic purpose of an ICO, most particularly when there are indications of an attempt to circumvent existing regulations.” The Indian government could emulate this norm in regulating crypto in India and the government should also consider regulations such as Prevention of Money Laundering, Collective Investment Schemes, Deposits under the Companies Act in finalizing its approach towards ICOs.
Another regulatory concerns that corporates must consider is the Ministry of Corporate Affairs(MCA) requirement that the corporates must disclose cryptocurrencies in which they have traded, profit and losses in such trades, and deposits or advances taken from other persons in these currencies. This is essential to corporate houses in India as this is the first regulation squarely aimed at corporates. Also while engaging with NFTs firms must consider the general principles of the Indian Contract Act and should consider using peer-to-peer decentralized exchanges to prevent the adverse consequences of NFTs being considered as derivatives under the Securities Contract Regulation Act.
Indian Crypto Relief : an Indian success story?
An example of successful deployment of crypto in India has been the ‘Crypto Relief’ Covid fund started by Sandeep Nailwal, co-founder of Polygon, initially receiving 22 crores Rupees with nowhere to go. The project has presently successfully deployed more than $1.8 million into NGOs working in COVID relief.
Though not a corporate house, the project’s ability to handle the present lacuna and bringing in such large funds into India can serve as a model to firms hoping to work with crypto. The potential for the Crypto relief fund to be revolutionary is clear when the world-famous Ethereum Co-Founder Vitalik Buterin donated $1 billion in SHIB coin. The fund was able to transfer crypto into funds in Indian bank accounts within 7-8 days and co-operated with the Indian navy in providing oxygen cylinders to people in need. The process through which the Crypto Relief Fund was converted into rupee donations is as follows:
- Receive crypto donations from around the world.
- Convert various cryptocurrencies into stable coins.
- Register as a legal entity in the UAE backed by a US bank to convert stable coins into US dollars.
- Send the US dollars to FCRA-approved NGOs through their bank accounts too.
- NGOs disperse the funds on the ground to COVID patients and other projects
The multi-jurisdictional approach taken by the Crypto Relief Fund with crypto conversions being undertaken in a foreign jurisdiction and then the funds being sent to India could be emulated by corporate houses. This approach will definitely be more helpful when the corporate house is not in a place to complete KYC and AML due diligence on every crypto transaction or until clear regulations are seen in India.
Regulations in other Jurisdictions
Other Jurisdictions outside India also offer interesting opportunities for firms willing to engage in crypto. El Salvador has become the first country to declare bitcoin as legal tender leading to projects such as ‘Bitcoin Beach’, a small coastal community that has experimented with bitcoin payments, and potential projects such as ‘volcano mining’, Bitcoin mining using geothermal power. El Salvador thus can be useful for corporations who want to use cryptocurrencies actively as cash in their daily transactions.
Various regulators and states in the US are updating their policies regarding cryptocurrencies. The Federal Deposit Insurance Corporation (FDIC) has officially published its request for information about how banks are using digital assets and what the federal regulator could do to assist entities. The Federal Reserve chairman Jerome Powell reminded that the Fed’s first research paper about a digital dollar would be published this summer, reiterating that a U.S. central bank digital currency should prioritize consumer privacy and protection. The SEC(Securities and Exchange Commission) Chairman Gary Gensler warned bad actors in crypto of enforcement actions. The Treasury Department devoted an entire section of its Tax plan to cryptocurrencies, warning there was a “significant detection problem” with crypto use for illicit activities. It suggested that exchanges receiving over $10,000 in crypto in a single transaction should report it. Nebraska and Illinois also passed laws that allowed for the creation of chartered digital asset banks and special purpose trust charter for digital assets, respectively. Corporate houses need to pay attention to changes in the US regulation if they need to survive in a multi-jurisdictional crypto works
The various means of dealing in cryptocurrencies have been elaborately discussed along with examples of corporation houses that undertake payment or donations in cryptocurrencies. With large corporations like Facebook, Google, and Coinbase actively engaging in crypto, it is only time before Indian corporate houses do the same. This is clearly evident from the immensely positive effect of India’s Crypto Relief Fund.
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