The tech holes that ensure that crypto can never be effectively banned

It is estimated that $1.25 billion worth of cryptocurrency transactions have happened on decentralised finance platforms from India

It is not possible to enforce an effective proscription on cryptocurrency in a foolproof manner, say experts in the fledgling industry even as India vacillates between a ban and no ban.

“It is like wanting to ban file-sharing through torrents. Gove­r­n­ments all over the world have tried doing it for 20 years, but it is very difficult to stop a peer-to-peer network,” said Harsh Rajat, co-founder of blockchain start-up EPNS (Eth­e­­reum Push Notification Service).

At present, there are two major examples of countries that have banned crypto and evidence shows that both of them have not succeeded.

First, Nigeria’s central bank curbed local banks from working with cryptocurrencies in February, warning of “severe regulatory sanctions” and freezing accounts of companies and users using them. But a Reuters report in October said that crypto adoption in the country increased following the ban.

In March, just after the central bank ban, the dollar volume of cryptocurrencies sent from Nigeria rose to $132 million, up 17 per cent from the previous month, research firm Chainalysis said. Transactions in June were 25 per cent above the same month last year.

Incidentally, this ban was similar to the restrictions that the RBI had put on Indian banks in 2018, which was overturned by the Supreme Court last year. “What happened in the aftermath was that crypto investors carried out their transactions using peer-to-peer networks and fiat money (INR) corresponding to the transactions changed hands on other payment platforms,” said Tanvi Ratna, founder of Policy 4.0, a tech policy advisory.

The same thing is happening in Nigeria now, say experts.

In May this year, China first cracked down on crypto mining operations in the country and then followed it up with a blanket ban on all crypto related activities, including trading, in September.

But, at the same time, there has been an increased activity on decentralised finance (DeFi) platforms that operate on block­chains — and which can be used to trade in crypto without any intermediaries like banks or standard cry­pto exchanges.

According to data from Chainalysis, 49 per cent of the $256 billion worth of crypto ac­t­ivity in China in the 12 mon­ths leading up to June 2021 was already being carried out through DeFi platforms. User sign-ups are completely anon­ymous on these platforms, without any identity markers like name, email id or location.

This is a risk in India, too.

“The Indian government must realise that the top crypto exchanges in India are doing KYCs, which means there are eyes on the transactions happ­e­ning. If the millions of crypto users in India adopt DeFi platforms, which don’t have any KYC barriers, wouldn’t it be more dangerous?” the founder of a crypto exchange based in In­dia asked. 

Many Indian users are already flocking to such DeFi platforms, according to a report by Policy 4.0. It estimated that $1.25 billion worth of crypto transactions have happened on such platforms from India and around 2.5 million users visited DeFi websites from India in November. If DeFi platfor­ms are an iss­ue, one might ask: What’s keeping the gover­n­ment from banning them too?

The first issue is that unlike crypto exchanges like CoinSwitch Kuber, WazirX or CoinDCX that are based on the respective servers of the companies, decentralised platforms are not controlled by a single server or group of servers.

In essence, these are much like cryptos themselves: distributed peer-to-peer networks that are run by computers across the globe. This means that there is no single point of failure, too: shutting down a few computers would not lead to blocking access for others.

“One way to block these DeFi platforms and cryptos would be to ban the ports, which are the interfaces that allow computers to communicate regarding a software with each other. But this would mean blocking other genuine software that use a particular port,” explained Rajat. “For example, port 8333 is used by Bitcoin but also by cloud computing major VMware.”

The simplest option for a ban is to block local crypto exchanges in the country. In that case, the exchanges would move abroad and attract users through virtual private networks (VPNs) that help users mask IP addresses.

“This is the same method through which people watch Netflix shows not meant for India or download torrents. It would just reduce the government’s ability to track and tax transactions. There will be money laundering and scams,” said the crypto exchange founder quoted earlier.

Another thing that experts point out is that a ban on crypto in India would not stop people from amassing such assets in other jurisdictions. For example, if a crypto user rendered freelance services to a company abroad and chose to take the payment in crypto, the assets could sit in the foreign jurisdiction untouched until they are traded in lieu of INR transactions in India.

This would also mean that while the RBI ban three years back was successful in drying crypto liquidity in the country to a large extent, it won’t succeed this time as more and more people start doing “gig work” for companies abroad.

“Any outright ban would not yield any effective solution, for personal jurisdiction might not extend to the users situated in foreign jurisdictions. Also, as per Financial Action Task Force re­cently issued Guidance on Virtual Assets and Virtual Asset Service Providers, the proliferation of these instruments req­uires accommodation in any go­vernance model,” said Abhishek Malhotra, managing partner of TMT Law Practice.