"Cryptos have no underlying assets, not even a tulip."
Ouch. That's the RBI Governor, not mincing his words.
Like everyone else, we've been poring over the Budget announcements on crypto-assets. The euphoria in the crypto-verse was short-lived. Crypto-assets haven't been outlawed; but that's about it. The proposed tax-rates and structure aren't – to put it mildly – kind to the crypto-ecosystem. To be fair, regulating this industry is a case of 'damned if you do' and 'damned if you don't'. So, we travel back in time to document a conversation between Akbar and his trusted minister Birbal, about 'magic coins'. Perhaps it rings a bell.
[Scene I]
Birbal is furiously scribbling. Other ministers, gathered around, befuddled by the furore. Magic coin traders and minters anxiously await commencement of the proceedings. Some of them have been hauled up by sainiks (security forces). Commoners throng the court, eager for Akbar to arrive. They are speculating if the emperor himself owns a few magic coins. "I'll bet you 5 magic coins he does".
*Akbar enters * all rise.
Birbal: Jehanpana, the heavens are falling. They're all buying some magic coins, and the scene's appalling.
Akbar: Pray tell, what are these magic coins?
Birbal: Jehanpana, they come in many cases and types. They can't be seen, and we should curb this hype.
Akbar: Why, then must one buy them? Are they worth more than the tulips in my garden?
Birbal: Some use them to lend; others to pay. Some claim they will be dearer than gold one day.
Akbar: Birbal, the world knows of your wisdom. I leave it unto you to do what is right.
Birbal: Let your people trade away. Trust me, Jehanpana, it will be okay.
*Magic coin traders erupt with joy. They glare at the sainiks, trying to break free. Birbal smiles wryly*
Akbar: Birbal, I want your advice to set things right. Pray tell, do you rejoice at my plight?
Birbal: Fret not, Jehanpana. We will tax magic coin trades at the highest rate. You will soon see our coffers inflate.
* Commoners gasp. Akbar, now relieved, breaks into a wide smile *
Akbar: O wise Birbal, you know the cure to my pain. You have proven your loyalty once again.
[End Scene]
Hopefully our government, unlike Akbar, will see the value that crypto-assets bring to the digital economy, beyond tax revenue.
Welcome to the February edition of FinTales. Here's your familiar four-course fintech meal:
Appetizers: snackable updates about recent fintech developments.
Main-Course: meatier stories about the crypto-tax's impact on investor behaviour. And excerpts from our interview with Avinash Godkhindi, CEO of Zaggle. We spoke about fintech's role in financial inclusion, sustainable business models and the USP of neo-banks.
Palate Cleanser: a break from the fintech menu.
Dessert: a breakdown of a delightful experiment called UPI Lite.
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Appetizers 🍟
💸 Budget proposals to bridge the gap between India and Bharat
The 2022-23 Union Budget proposes two key measures to boost financial inclusion. The first is the establishment of 75 Digital Banking Units in 75 districts by scheduled commercial banks. These Units could potentially use vernacular languages to increase digital and financial literacy, adapt processes to help customers who lack formal documentation, and offer sachetized products to suit local needs. The second proposal is integrating all post-offices with core banking systems. This move will provide 35 crore post office accounts – many of whom are held by rural and elderly customers – access to services like net banking, mobile banking, and ATM withdrawals.
🚦 With great power comes great responsibility
There was a time when unregulated technology service providers were performing back-office roles for their regulated counterparts (banks, NBFCS et. al.). But increasingly, these tech players provide essential infrastructure to banks and NBFCs. They also control the customer experience. To ensure outsourcing regulations address the risks posed by this market reality, the RBI plans to release two draft regulations for public consultation: (i) RBI (IT Outsourcing) Directions 2022, and (ii) RBI (IT Governance, Risk, Controls and Assurance Practices) Directions 2022.
📖 RBI asks digital lenders to show their hand
The RBI has reportedly sought information from BNPL providers about their arrangements with e-commerce platforms involving transfer of loan exposure. Which suggests the RBI may be looking into first-loan-default-guarantees that let unregulated fintechs assume credit risk. And that's not all. The RBI is also reportedly asking fintechs about the algorithms they use. Regulation of digital lending now seems imminent. And we hope all this information-gathering will help the RBI craft nuanced and balanced rules for the sector.
✔️ Digital lenders body seeks RBI's stamp of approval
To promote best industry practices and keep rogue players in check, digital lenders have formed self-regulatory bodies. The RBI Working Group's report on digital lending also recommended creating a self-regulatory organisation (SRO) for digital lenders. So, the Fintech Association for Consumer Empowerment (FACE) – a self-regulatory body for digital lenders – has applied to the RBI seeking formal recognition. But FACE may have to wait a little longer for approval. RBI is yet to create a legal framework which prescribes the eligibility criteria and functions for the SRO. And FACE's application can be approved only after the SRO norms are notified.
🌎 RBI cracks the whip on unauthorized forex trading
The RBI has clarified that using unauthorized forex trading platforms and offshore remittances for margin trading will attract criminal penalties. These platforms have allegedly been circumventing payment restrictions on forex trading by accepting payments in INR or using international wallets like PayPal or cryptocurrencies. To put the genie back into the bottle, the RBI is now considering blocking these websites and apps, and banning their advertisements. These platforms have been on an advertising blitz which may be an effective way to scale, but it's also a sure-shot way to land on the regulator's radar.
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Main Course 🍱
🔎 Crypto tax: what the hassle?
American political commentator, Chris Hayes talks about "hassleocracy" – making something such a hassle that less people do it. The Budget proposal to tax virtual digital assets or VDAs (like cryptos and NFTs) could change the way Indians interact with the VDA ecosystem. It's hassleocracy, at its best.
All VDA headlines from the Budget have centred around the one big change: 30% flat income tax. Less talked about is the seemingly innocuous 1% withholding tax (popularly, TDS or Tax Deduction at Source). The rule is simple, every time you pay someone (in cryptos or good old fiat money) to buy VDAs, you must withhold a 1% tax on the transaction amount. This withholding tax will be cumbersome and takes away money available in the hands of traders. Centralised exchanges may make it somewhat easier to collect it. But what about P2P trades? Or about decentralised exchanges? That makes it a hassle enough for lesser people to make these trades.
And where does this leave the other side of this equation – crypto-exchanges, crypto-advisory platforms and NFT marketplaces?
Let's look at the crypto-exchanges first. A large chunk of their revenue comes from active traders – people who make multiple trades a day and pay a fee on every trade. But with the Budget changes, there will likely be a dip in transactions and speculative active trading. So, crypto-exchanges who have relished having short term active traders, may need to recalibrate. Many newer centralised exchanges have raised money on the promise of the millions of new users that will join the crypto-bandwagon. There is a race to provide the simplest, most efficient trading experience to these new users. But the 1% withholding tax distorts the simplicity of crypto-trading, and the promised users may never show up. And while speculative trading may reduce, advisory platforms – home to the low-risk, long term value seeking investors – may benefit.
And amidst others, NFT marketplaces find themselves in a unique bind. The volume of trades of an NFT is an apparent indicator of its value. And increasing volumes add to an NFT marketplace's commissions. With a potential decrease in volumes, NFT marketplaces are also likely to take a hit. However, in the long run, if only serious NFT connoisseurs remain, the NFT marketplaces will likely win. For instance, a tedious tax process may reduce price manipulation through wash trading (making false trades to drive up value of an NFT), an activity rampant on NFT marketplaces.
That said, the Budget announcements led to a 30-50% increase (from previous day) in user sign-ups on crypto-exchanges on the day of the Budget. How this translates into everyday trading behaviour is yet to be seen. At the end of the day, economic behaviour isn't rational, it's simply human, as behavioural economist Richard Thaler would say.
For a more detailed analysis of all the Budget announcements on VDAs, you can read our blog here.
🏦 Building for Bharat and the Promise of Neo-banks
What can fintech platforms learn from TikTok's run-away success in small-towns and villages? Turns out a lot. This was one of the many aha moments in our conversation with Avinash Godkhindi, CEO of Zaggle. You can hear the full interview here and read on for highlights from our conversation.
The India/Bharat Dichotomy
There are 6.3 crore MSMEs in India, but many remain excluded from 'digital India'. This is where Avinash believes fintech and SaaS companies can make a difference. But to do this, they need to tailor their products and processes to suit the needs of Bharat, and not just the urban elite. He goes on to cite the example of TikTok which gave Indians space to experiment and express themselves. The lesson here, he insists, is that tech platforms must not intimidate first-time users. "How many banking apps have a good Hindi interface?" Avinash asks. His solution: products which are simple, vernacular friendly and mobile-first. Concerns about data privacy and customer poaching are also hindering tech adoption by MSMEs, Avinash adds. But he hopes that the upcoming data protection bill will address these fears. According to Avinash, building for Bharat is where the most potential lies. Fintech, according to him, can't cater only to India's California users (hat-tip to the Ken for adding this to our vocabulary).
The Search for Profitability
Regardless of which demographic you are targeting, building a fintech business in India isn't easy. With the government's zero MDR policy and intense competition, the scope for monetisation is limited. And many fintech companies incur high customer acquisition costs, doling out discounts and cashbacks. Which is why for so many fintech companies, all paths to profitability lead to 'lending'. But Avinash remains sceptical of business models which rely on lending as a path to monetisation. Especially when lending to segments which are untested and not fully understood. According to him, while it's possible to make money by lending to these borrowers in the short-run, NPAs will spike when the credit cycle turns. Instead, Avinash suggests, businesses must figure out alternative revenue streams like transaction fees, float income, advertising revenue or subscriptions. Even if the business model is cross-selling, he believes there are opportunities beyond lending like insurance, investments, and other value-added services. To effectively cross-sell, he emphasises that the entrepreneur must understand the customer and her needs. He also cautions against accepting high customer acquisition costs as the norm because this can pressurise fintech companies to make short-sighted decisions.
Betting on Cards
Burning cash to achieve scale and lending as the default strategy are not the only issues where Avinash disagrees with conventional industry hype. When asked about products that he is most bullish on, he has a surprising answer: cards (virtual or plastic). He argues that the average Indian understands and trusts cards, especially after debit cards were distributed to millions of Indians through the Jan Dhan program. People already know the risks associated with credit cards and there are regulatory guardrails present to protect borrowers, he explains. He contrasts credit cards with new-age products like BNPL which may be more convenient but lack clarity about consequences of late payment and protective regulation. "For credit cards, you must give at least 15 days to cardholders to re-pay before charging interest. There is a very clear RBI directive. But what's there for BNPL? I can offer BNPL with a repayment period of 8 hours," he quips. He emphasises that BNPL is fundamentally a lending product and regulation is inevitable. He points out that monthly credit card spends crossed Rs.1 trillion last year and he expects this figure to rise. His wish-list for 2022 features NBFCs being allowed to issue credit cards. Till now, this product category has been the monopoly of banks. Avinash's wish may be granted soon. The RBI reportedly plans to allow large NBFCs to issue credit cards subject to net worth, liquidity, and cyber-security requirements.
A Clean Slate
Besides credit cards, Avinash is long on neo-banks. As a former software consultant for banks, he has a deep understanding of where the bottlenecks lie. "There are 600 platforms talking to each other through archaic flat-files and main-frames. Systems are not built for APIs. There is no micro-services architecture. It's all AS/400, iSeries and Cobol running in the background. If that's your backbone, RBI will not wait for you to update your architecture to ensure compliance," Avinash explains. He believes a licensed neo-bank can engage with the regulator and industry veterans to build a modern tech stack which makes compliance easy and preserves agility. When asked about how these new entrants will build trust, Avinash points out that banks are trusted because they are RBI regulated entities. He also draws a parallel with e-wallets which show that customers are willing to trust new entrants if the RBI recognises them. For the customer, he argues, the value proposition of a licensed neo-bank is that it's not bogged down by outdated technology, NPAs and history of fines. This clean slate, he emphasises, is valuable because neo-banks won't have a chequered legacy which constantly needs to be managed. We can't help but be optimistic about Avinash's vision for neo-banks. After all, who doesn't want the opportunity to turn over a new leaf?
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Palate Cleanser 🍧
Are you still getting used to Zoom weddings? Well, you better get ready for metaverse weddings too. Check out this couple's big fat (virtual) Indian wedding in a Hogwarts themed castle.
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Dessert 🍰
📱 UPI (de)Lite
The RBI recently finalised a framework for offline digital payments. To implement the framework, the NPCI is working on an offline digital payment solution called UPI Lite. The NPCI is reportedly testing two technologies to enable UPI Lite, both of which rely on existing telecom networks. Offline payment solutions have been successful in boosting rural financial inclusion in developing economies. But solutions like UPI Lite also make payments more convenient.
Imagine you're scrolling dog memes on Instagram and your internet goes down. It'll pain you, but you'll be fine (unless you're an influencer). But patchy internet connectivity can disrupt online payment systems, which have more serious consequences. And quite simply, cash will persist if such disruptions exist. Offline UPI solves for this.
All forms of digital payments have one necessary evil – security features. For example, online card payments must be authenticated by a PIN or OTP. A testament to customers' dislike of these security features is the success of Buy Now Pay Later – which offers a 1-click checkout. However, the RBI has waived these security requirements for offline digital payment solutions (like UPI Lite). Which means that these payment solutions can cater to the rather impatient urban user (like me). At the moment, however, the upper cap for an offline digital payment transaction is Rs. 200. The RBI may consider increasing the upper cap if it sees wider adoption of payment solutions like UPI Lite.
UPI Lite has the potential to enhance financial inclusion and bring convenience. We hope it delivers.
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That's it from us.
We'd love to hear from you. Tell us what you think about the stories we covered. You can write to us at contact@ikigailaw.com
See you in March.
Yours,
Ikigai Fintech Team
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
