Digital Assets and National Security

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Currency by definition is a medium of exchange which provides a universally accepted value in the market place of a region. The value depends on users’ trust. A national government taxes by debiting currency and spends by expending it. It controls the supply of the currency through its monetary policy. The crux of this policy is the ability of a nation-state to control its money supply aimed at curbing inflation and maintaining price stability; alternatively, it may be used to expand the supply for boosting growth and employment. Monetary sovereignty is thus an essential component of national sovereignty.

Decentralised finance is a system by which financial products become available on a public decentralised blockchain network as digital assets, making them available for anyone to use. For the purpose of this article, only digital assets independent of the Government are being considered and include any digital assets which may be exchanged as a symbol of value like crypto currencies and Non-Fungible Tokens (NFTs) etc. Such assets can cause disruption in a nations financial system and adversely impact national security.

Digital Assets and Blockchain

Most discussions on digital assets invariably extol the virtues of blockchain and how it can potentially revolutionise innumerable aspects of governance. However, digital assets and blockchain are different. Blockchain is essentially an enabling technology for record-keeping systems. Post its appearance in 2008, the technology has evolved and has become the foundational core of systems where data integrity is key. Many large companies have already adopted the technology, while national governments and/or their departments have been experimenting with it. Recent advances in (what is claimed as virtually unbreakable) encryption technology further boosts digital data storage. Within India, Niti Aayog, in a pilot project, optimised the fertiliser subsidy supply chain using blockchain and has recommended its use for other sectors where data integrity of immutable records are essential such as land records, organic farming, etc.^[1]

Digital assets are essentially powered by blockchain and are independent of the state. The independence is maintained by encryption and removing government’s control over creation and circulation quantum. The latter has the potential to jeopardise a nation’s monetary policy while the former promotes anonymity.

Impact on Security

The inbuilt anonymity of digital assets makes them ideal for moving value incognito across borders, defeating national constraints on them. Increasingly, such assets will be made use of by terrorists, smugglers of banned and illicit goods, money launderers, those attempting to buy influence etc. Reportedly. some terrorist organisations like al-Qassam Brigade (Hamas’s military wing), al-Qaeda, and Islamic State of Iraq and the Levant (ISIL)^[2] are using cryptocurrencies to raise funds. While some accounts have been seized, it is suspected that many more are still operating. With India’s adversaries increasingly attempting to use money power to subvert society^[3] and paralyse politics, digital assets will provide them with a novel method to do so with increased anonymity.

Debt diplomacy is today accepted as a tool of our adversary at the international level. At the micro level, cases of corporate debt hostage are also known. While the former aims to entrap nations, the latter lays a debt trap for corporates and individuals who are then used for technology transfer, influence buying as also using the local system against the state. Many justify this as permitting small business access to international finance. However, it defeats the national capital controls imposed and thereby aids in subversion of the national economy. This can be done by transferring excess liquidity created outside the nation or infusing excess liquidity when aim is to contract the money supply. This can hamper both employment generation and inflation control. The experiment of Auroracoin^[4] of Iceland is one such example.

Ransomware attacks have been on the rise in the world, with ransom being demanded in digital assets. Its anonymity aids the attackers in concealing their identity. Infrastructure used for digital assets is based on blockchain and encryption technology. Widespread availability of digital assets would lead to unregulated availability of such infrastructure, which could be used for storing data and plans by groups inimical to the state. This would render the security effort much more difficult. Reportedly AQAP and ISIL have been distributing their English language magazine Inspire and Dabiq respectively, using blockchain. Both have been on the forefront of radicalisation and spread of the terror ideology.

Such infrastructure can also be used to launch attacks into other networks with which it is connected. The anonymity such infrastructure provides makes detection of the attacker’s identity almost impossible. In addition, the computerised pool used for mining cryptocurrencies are ideal architecture to support a cyber-attack. Trading digital assets require that the system is linked to the banks, which in turn have access to most of the national cyber infrastructure. The arrangement thus renders the national cyber infrastructure at a much higher risk.

Separatist movements historically have asserted their political and economic control by issuing alternate currency in the areas they control. While non-state actors are as of now, not using cryptocurrencies, this could change in the near future. Scottish separatists are already experimenting with the Scotcoin – a cryptocurrency.^[5] Other experiments towards this include Pesetacoin, Spaincoin, Greeccoin etc. Not only can the separatist’s movement issue their own but also mandate use of an existing cryptocurrency to erode trust in the national currency. While, the trend is on the rise, the world’s richest, most powerful and industrialised countries, have largely managed to keep their population shielded and have amongst the least users worldwide^[6].

Various attempts are also being made by corporates towards this end – the most famous being Elon Musk announcing that payment for Tesla would be accepted in Bitcoins^[7] as also Amazon too planning on the same^[8]. Potentially, it can permit them to hide transactions, evade taxes and also deal in illegal products. This would further be accentuated by emerging decentralized exchanges.^[9] Such exchanges would increase the anonymity by countervailing the “know your customer” guidelines of the Government.

Need for Regulation

The regulators seemingly are conscience of the dangers. In April 2018, RBI had banned banks from supporting crypto transactions after cases of fraud through virtual currencies were reported. However, the Supreme Court struck down the ban in March 2020. Among the reasons cited was that cryptocurrencies were not illegal though unregulated in India^[10]. Hence, legislation for regulation of these are essential and urgent.

March of technology cannot be stopped and hence digital assets will remain a reality; banning them will only shift them underground. Hence, it’s important that they be regulated and their linkages be adequately controlled. This should include:

• Proscribe the use of non-government digital assets as a symbol of value, thereby any sale using the same be considered illegal.
• All digital assets should be held electronically but exchanges or intermediaries should not be permitted to hold the same.
• Gifting or receipt of digital assets be proscribed. This would ensure that all asset purchased are either held or a sold through a money trail which in turn can be tracked in the event of illegal activities.
• Digital assets have no intrinsic value hence, gains from the same be taxed at par with gambling gains.
• Crypto Exchanges should be registered as corporates and pay taxes on transactions at par with others. Those crypto exchanges dedicated to a single digital asset should be banned as in the quest for additional customers, these may resort to illegal operations.
• Crypto exchanges should have limited registered intermediaries only who should be able to place own/customers’ orders. In turn, the exchanges must have full knowledge of the intermediaries and maintain records of their transactions, for scrutiny if required. Intermediaries in turn should have full knowledge of their customers and be responsible for any illegal activity using their accounts.

Conclusion

Digital finance is a developing area at the intersection of blockchain, encryption, digital assets, and financial services. Its unregulated availability in society has the potential to undermine and destabilise the nation. Adequate legislation to channelise it into an asset class is therefore urgently warranted. Any delay would only auger poorly for national sovereignty and governance.

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^[1] “Blockchain The Indian Strategy Part 1” available on https://niti.gov.in/sites/default/files/2020-01/Blockchain_The_India_Strategy_Part_I.pdf accessed on 10 Jan 2021.

^[2] ‘Global Disruption of Three Terror Finance Cyber-Enabled Campaigns’ The United States Department of Justice available on https://www.justice.gov/opa/pr/global-disruption-three-terror-finance-cyber-enabled-campaigns

^[3] ‘ED probes media portal’s funding from businessman ‘linked’ to China regime’ Times of India 18 July 2021 available on https://timesofindia.indiatimes.com/india/ed-probes-media-portals-funding-from-businessman-linked-to-china-regime/articleshow/84514212.cms

^[4] ‘Auroracoin’ Investopedia available on https://www.investopedia.com/terms/a/auroracoin.asp

^[5] ‘Can Virtual Currencies Increase Political Power?’ JSTOR available on https://www.jstor.org/stable/10.7249/j.ctt19rmd78.9?seq=2#metadata_info_tab_contents

^[6] ‘Which Countries Are Using Cryptocurrency the Most?’ Yahoo Finance available on https://finance.yahoo.com/news/countries-using-cryptocurrency-most-210011742.html

^[7] Jon Porter (2021) “You can now buy a Tesla with bitcoin in the US’ The Verge 24 March 2021 available on https://www.theverge.com/2021/3/24/22347905/tesla-bitcoin-payment-us-cryptocurrency-elon-musk

^[8] See Business Standard 26 July 2021 “E-com giant Amazon may soon allow digital currency as payment mode” available on https://www.business-standard.com/article/companies/e-com-giant-amazon-may-soon-allow-digital-currency-as-payment-mode-121072500226_1.html accessed on 28 July 2021

^[9] See “The Economic Times” 28 July 2021 “WazirX to launch decentralised exchange next month” available at https://economictimes.indiatimes.com/tech/technology/wazirx-to-launch-decentralised-exchange-next-month/articleshow/84806149.cms accessed on 28 July 2021.

^[10] Sandeep Soni (2021) ‘RBI: Banks can’t cite 2018 crypto-ban order quashed by SC to caution customers against virtual currencies’ Financial Express 31 May 2021 available on https://www.financialexpress.com/market/rbi-banks-cant-cite-2018-crypto-ban-order-quashed-by-sc-to-caution-customers-against-virtual-currencies/2262513/