Investing in bitcoins? Exercise caution until regulatory cloud blows over

Limit your investment in cryptocurrencies and make sure to have your current holdings in your own custody

Cryptocurrencies are currently under regulatory fire from several directions. Until there is greater certainty about their status, investors need to exercise caution in dealing with this asset class.

Towards the end of December 2017, the Finance Ministry said that cryptocurrencies are not legal tender and have no regulatory permission or protection and that investors dealing in them are doing so at their own risk. The Ministry added that there is a real risk of an investment bubble similar to the Ponzi schemes, with investors risking a sudden and prolonged crash.

The Income Tax Department has sent tax notices to thousands of people investing in cryptocurrencies, asking them to pay tax on capital gains and reveal their total holdings and source of funds. The Registrar of Companies (RoC) has stopped registering businesses that have names indicating that they will deal in cryptocurrencies. 

Most recently, the Reserve Bank of India (RBI) has asked banks to step up scrutiny of financial transactions by companies and exchanges dealing in cryptocurrencies. It did not explicitly ask banks to stop dealing with them, but its warning could cause many to close down their accounts. Says Ashish Agarwal, founder of Bitsachs, a cryptocurrency exchange: "The regulators have to decide whether to allow cryptocurrencies. At present there is no clarity, so banks are uncertain about what to do."

One point in favour of Indian cryptocurrency exchanges is that many of them do complete KYC (Know Your Customer) before opening an account. "We ask for Aadhaar, PAN card, and a cancelled cheque from customers," says Agarwal. Hence, the fear that one can trade anonymously in cryptocurrencies does not exist for customers of these exchanges. In the light of RBI's warning, each bank is likely to do its own assessment. The more risk-averse ones may stop dealing with cryptocurrency exchanges, but others may decide that if an entity does adequate KYC and is well capitalised, the risk in dealing with it is acceptable.

The bigger risk, say, experts, is for customers who trade on international exchanges. According to Udbhav Tiwari, policy officer at the Centre for Internet and Society, Bengaluru, "Most of the trading in initial coin offerings (ICOs) happens on exchanges situated abroad. In future, banks may not allow money to go from your account to that of the exchange, or in the opposite direction. Since these exchanges are foreign entities, Indian banks don't know what kind of KYC norms they follow. There is also a greater probability of illegal activities happening through them."

Investors need to tread with caution "Don't invest more than 5 per cent of your total portfolio in cryptocurrencies at this juncture," says Agarwal. Given the high risks in ICOs which do operate like Ponzi schemes--promoters and early investors make money while those who come in late bear the losses--and the regulatory risk surrounding foreign exchanges, avoid them.

Risk-averse investors should encash their crypto currencies right away. Any profit made should be reported and tax paid on it. Those who have some risk appetite may hold on to their cryptocurrencies but not buy more. Only those with high risk appetite should add to their positions. "Since prices have fallen, this is a good time to enter bitcoin," says Agarwal.  

Some promoters of exchanges may wilt under regulatory pressure and decide to shut down their business. Investors who have stored their cryptocurrencies in their exchange's wallet should take possession of them."Have the private keys in your own custody. If your exchange closes down, you will be able to sell your holdings on another exchange. But if you don't have the private keys and the exchange shuts down, you could well lose your holdings," says Tiwari.

These are the 5 factors you need to keep in mind before investing in cryptocurrencies 

1. Many banks have closed down accounts of cryptocurrency exchanges

2. They may also clamp down on money transfers to accounts of foreign exchanges
 

3. Don't invest more than 5 per cent of your portfolio in cryptocurrencies

4. Avoid investing in initial coin offerings through foreign exchanges

5.  Have the private keys of your cryptocurrencies in your own custody  

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