Crypto Carnage Spooks Investors

The fall in the prices of most cryptocurrencies by almost a third of their November highs is making investors anxious

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After rallying spectacularly in 2021, Bitcoin and other cryptocurrencies have seen a steep fall. Since November 2021, when Bitcoin hit its all-time high of $68,789, it has lost one-third of its value to reach the current price of $22,948. Ethe­reum, another popular crypto currency, has seen a fall of more than 65% since November to reach the present price of $1,724 (as of July 28, 2022).

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Triggers driving the crypto crash

Industry insiders blame the recent crypto crash on major sell-off by investors, owing to rising inter­est rates. High inflation and economic uncertainty caused by Russia's invasion of Ukraine are also re­sponsible for the current crash in the crypto market. Other factors include the fall of well-known crypto projects including Terra LUNA and Celsius.

Says Rajagopal Menon, Vice-President, Wazir X, "All asset classes have done terribly since the start of the new year. Governments across the world have been pumping money due to Covid. It hoped that inflation could be controlled for sometime but it realised it's not easy. Controlling inflation requires an increase in interest rates. And when you do that, all the free money gets sucked out of the system. People transfer to safe harbours like gold and other commodities, and this affects the riskiest commodi­ties like crypto the most." "Crypto investment runs in 4-year cycles and the current drop is nothing new. It is similar to stock markets, which are also in bear territory," says Vineet Budki, Managing Partner, Cypher Capital, a Dubai-based VC firm.

According to Khallelulla Baig, Co-founder and CEO, Koinbasket, the crash is different this time. He tells Entrepreneur India, "This is because the traditional Web 2 institu­tions had a first-time experience of crypto market volatility and the crypto traders had acknowledged how traditional institutional players react to it."

Many 'bear and bull' runs before

This isn't the first time that cryptos have crashed. These currencies are highly volatile and have wit­nessed various 'bear and bull' runs before. In 2018, Bitcoin plummeted as much as 80 percent, and has lost more than 50 percent seven times in the past. But unlike earlier, the falling prices this time seem to have a larger impact as more people and institu­tions hold these currencies. "People are worried because they have not seen anything like that but it has happened many times in the past. Volatility is the feature of this asset class because most markets shut down over the night, over the weekend, but crypto markets remain open for 365 days a year and 24/7," says Menon.

Investors panicky

The recent crypto crash has turned out to be a test even for long-term investors, who are los­ing their sleep after seeing their gains be­ing wiped out overnight. The big question on their minds right now is: is the crypto market safe?

Explains Budki, "A person has to understand if he is a speculator or an investor which means the view on time on investment. If one is looking for a 10x return tomorrow, it is not going to happen but over the next 4 to 10 years, crypto will give massive returns compared to stocks, real estate, gold or any other asset class." Menon agrees, "When Bitcoin was at $67000, people were lining up to buy it and now it is trading below $20,000, they are saying it will go down to zero. It's the irrationality of the herd. Price is a senti­ment. When there is blood in the water, all sharks come in."

However, industry experts recommend investing in smaller lots. "If one wants to diversify the portfolio and stay committed for 5-10 years, investing in mutual funds will likely give 12-15% returns, but if one wants a kicker then one can put in at least 5% money in Bitcoin. But one should buy consistently over a period of time as you cannot time the market," adds Menon. "It's a once in a 5 years opportunity where investors can find seasoned crypto proj­ects at two-third discount. The best way to optimise one's portfolio is to allocate more funds to blue-chips such as Bitcoin, Etherium, Polkadot, Polygo and Chain­link. Beginners should not allocate more than 10% of their savings towards crypto­currencies as they are highly volatile and risky asset classes," adds Baig.

While it remains unclear how long crypto carnage will last, one must con­sider the fact that Bitcoin along with other crypto currencies have always rebound­ed. In the 2017-2018 bear market, Bitcoin plunged a whopping 83%, from $19,423 to $3,217. But by November, 2021, it hit a high of $68,789. During the same period, Etherium fell from $1,448 to $85. But it jumped to $4,850 in November.

Converting cryptos to stablecoins: A wise idea?

While cryptocurrencies like Bitcoin and Ethereum are highly volatile, rising and falling by the day and even hour, stablecoins promise to maintain their value because they are pegged 1:1 to the value of a fiat currency, meaning that, for example, every 1 USDT (USD Tether, the biggest market cap stablecoin) is worth 1 US Dollar. There are numerous stable coins in circulation, with different coins having different mechanisms for col­lateralizing their stablecoins. The article by Boxmining titled Stablecoin Compari­sons: Which is the Best? states that many have converted their cryptocurrencies to stablecoins instead to "lock in" the price of their cryptocurrencies and as a spring­board to cashing out crypto to fiat. This allows one to keep their dollar-pegged coins in exchanges or cold/hot wallets, so when the moment to jump back into the bull run comes, they can do so within minutes without having to deal with fiat on-ramps. Alternatively, to easily convert their stablecoins to fiat currencies for spending. However, the article also warns that stablecoins can be quite tricky to unpack and analyze, especially when talk­ing about non-collateralized algorithmic stablecoins, which sound too good to be true, and in some cases, are.

Crypto regulations around the world

Crypto regulations differ across the world. Unlike the fiat currencies, which are government-issued currencies having the backing of the sovereign, cryptocurren­cies, on the other hand, are decentralised digital coins or assets that are held to­gether through the blockchain technology.

Some nations have recognized this de­centralisation power of cryptos, and have made Bitcoin a legal tender. These include nations like El Salvador and the Central African Republic. Back home, the crypto investments have grown despite any precise regulation from the government or the central bank. In 2018, RBI tried to impose a ban by restricting banking facili­ties to the crypto exchanges. However, it was ruled out by the Supreme Court on constitutional grounds and virtual exchanges fundamental rights. Of late, the RBI governor Shaktikanta Das described cryptocurrencies as a "clear danger" and said that anything that derives value based on make-believe, without any underlying, is just speculation under a sophisticated name.

Says Nirmal Ranga, CRO, Zebpay, "This has been a constant long-time discus­sion that has been happening in India for years now and I am of an opinion that any regulation howsoever stiff that may be is better for the ecosystem in India and anywhere around the world. The policy makers and industry runners should collab and co-ordinate efforts to make this a better regulated ecosystem." The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which seeks to prohibit all private cryptocurrencies in In­dia is yet to be tabled by the government in the Parliament.

Crypto TDS another threat?

While there is no clear regulation regard­ing crypto, the government of India has imposed 30 per cent income tax on cryp­tocurrencies from the new financial year. Further from July 1, the government has imposed one percent TDS on all crypto transactions. But this has not gone down well with the traders.

In a trader Sentiment Survey involv­ing 9,500 respondents by WazirX, India's crypto exchange, and Zebpay, 83% of traders believed that the recent tax implementation deterred their trading frequency. In addition, around 24% of respondents are contemplating shifting their trading activities to international exchanges owing to the high taxation. Further, 29% of the respondents traded less than the pre-tax period.

According to the survey, 27% of the re­spondents sold over 50% of their portfolio before 1st April, whereas 57% sold under 10%. In the current scenario, revenue from tax collections for the government will decline as 27% of customers (34% traders and 23% holders) said they will trade less than earlier owing to the current taxa­tion policy. "The tax regime needs to be balanced to encourage participation and revive trading volumes." said Menon.

The report further indicates that the worst impacted were millennials com­pared to their senior counterparts. 28% of the respondents aged between 18 and 35 have sold more than 50% of their hold­ings before 1st April. Also, 23% wished to move their holdings to an international exchange to avail a more favorable tax climate. The holders had continued to retain their positions, with 45% saying they would hold on to their positions. This signifies their faith that the tax provisions will be made more conducive in the longer term.

However, tax levied on crypto is being seen as a positive move by some industry experts. Says Srivar Harlalka, co-founder, flippy, "It was the first step of acknowledg­ing crypto in one's balance sheet and the entire industry saw it on a positive note. However, the finer prints made the taxa­tion similar to the gains from gambling, where unlike in case of equities, losses are not allowed to be set off against gains."

CBDT addresses concerns

While the plea to lower the TDS rate to 0.01 or 0.05 per cent has been disregarded by CBDT, the authority has clarified the applicability of the TDS provisions. It addressed the concerns raised by the in­dustry and helped traders and exchanges steer through the uncertainty that sur­rounded the crypto space in India. Accord­ing to CBDT, one percent TDS is applicabe on payments towards cryptocurrencies beyond INR 10,000 in a financial year or INR 50,000 a year for a specific group of people, namely individuals or HUFs who are required to get their account audited.

Exchanges are supposed to provide a statement each quarter for all transactions and include them in the income tax return of that exchange. Peer-to-peer transac­tions would require the buyer to deduct the tax before paying consideration. If the transaction is facilitated by an exchange, then the exchange can deduct the TDS. Crypto-to-crypto trades would witness tax deduction on both the assets in the pair. The Central Board of Direct Taxes suggests the deduction of tax in kind must be converted immediately to either Bitcoin, Ethereum or stablecoins namely tether or USD coin and this accumulated balance should be converted into Indian Rupee at midnight every day.

Crypto Tax: USA vs India

There is a stark contrast when it comes to how India and the USA handles the clas­sification of crypto assets. The Indian gov­ernment classified crypto assets as 'virtual digital assets' in the Union Budget session FY2022-2023. The new income tax provi­sion is only applicable for virtual digital assets as these assets are not considered similar to other assets. 30 per cent tax must be paid on the profits earned from the transfer of crypto assets. No deduc­tion from the asset's sale price is allowed to be adjusted except the cost of acquiring it. The lack of indexation in the Indian taxation system is a bane for the Indian crypto investors as they face the full 30 per cent tax rate and the one percent TDS irrespective of the holding period.

However, the cryptocurrencies are treated as capital assets in the US. Transferring a cryptocurrency at a profit makes a person liable to pay tax depend­ing on whether the assets are long-term crypto assets or short-term crypto assets. If the crypto asset is sold after one year, it makes it long-term crypto assets that are subjected to lower tax. A crypto asset that is sold within a year is classified as a short-term crypto asset which is subject to higher tax.

Road ahead for crypto

Given the tough stance of the RBI and Fi­nance minister lately, what does the road ahead for crypto look like in the coun­try? "Slow and murky in the near term. However, in the long run the crypto wave driven by public sentiment may push the government to take a dovish stance. I also see the total market cap of the crypto market crossing $10 trillion within the next five years. I think India must take a leaf out of Canada, Singapore and Japan's neutral stance to ensure that our country doesn't end up scuttling crypto innova­tion at the cost of short term challenges, while ignoring long term benefits," said Baig.