Regulating Cryptocurrency in Nepal

When someone talks about cryptocurrency, we think of bitcoin which is known by different names like crypto, bitcoin, digital currency, virtual currency, future of money, etc. A cryptocurrency is a type of digital currency(a software) that utilizes cryptographic techniques to ensure its security, making it extremely difficult to duplicate or spend the same funds twice. Unlike traditional currencies, cryptocurrencies are not controlled by any central authority, making them resistant to government intervention or manipulation which operate on decentralized networks that rely on blockchain technology and enable secure online payments without the use of third-party intermediaries.

Bitcoin is the world’s first successful decentralized cryptocurrency and payment system, launched in 2009 by a mysterious creator named Satoshi Nakamoto who published his Bitcoin whitepaper A Peer-to-Peer Electronic Cash System.

Bitcoin made its entry into Nepal in 2013, at that time very few people knew about bitcoin. The devastating earthquake of magnitude 7.8 that struck Nepal on April 25, 2015, brought about a significant impact. Interestingly, during that time, Bitcoin held a unique significance in Nepal. During the aftermath of the 2015 earthquake in Nepal, the Bitcoin community and various other groups came together to provide relief funds using Bitcoin as a means of assistance. This charitable act was crucial in introducing many Nepalese to the concept of Bitcoin.

However, the positive momentum was short-lived as Nepal Rastra Bank, on August 3, 2017, issued a notice declaring that activities like Bitcoin trading, and mining were deemed entirely illegal. The notice warned that individuals engaging in such activities would face legal consequences. Since then, Nepal Rastra Bank, Nepal Telecom Authority, and the Department of Commerce and Supplies have continuously released multiple notices, instructing Nepalese to refrain from engaging in cryptocurrency-related activities. According to the notice, both Nepalese citizens within the country and Nepalese residing abroad are prohibited from conducting any transactions involving virtual currencies/cryptocurrencies. Additionally, Internet Service Providers (ISPs) in Nepal have taken the measure of blocking access to all apps, websites associated with cryptocurrencies. And cryptocurrency has been declared illegal in Nepal, despite the absence of any specific law concerning cryptocurrencies in the country’s constitution. The regulatory authorities’ actions have created a stringent environment, discouraging people from involvement in the cryptocurrency space, and have taken legal actions against people involving those activities.

Nepal Rastra Bank has the authority to regulate financial institutions and their transactions in Nepal. Similarly, the right to decide whether or not to consider what is currency, its exchange rate, or nominal value also remains within the bank. According to the Nepal Rastra Bank, engaging in cryptocurrency transactions is not given legal recognition due to various reasons. The foremost concern is the prevalence of fraudulent activities when dealing with cryptocurrencies. Moreover, in countries like Nepal, where capital is scarce or in short supply, the unauthorized outflow of funds through cryptocurrencies and the potential flight of domestic capital have contributed to its lack of legal acceptance.

According to Nepal Rastra Bank: The Potential Risks Posed by Cryptocurrencies in Nepal

1. Lack of overall economic stability: The existing economic, monetary, and financial system involves multiple stakeholders, including the government, central banks, financial institutions, depositors, borrowers, and other relevant parties. Policies and regulations are designed to benefit all these stakeholders. However, in cryptocurrency transactions, the absence of intermediaries makes the cryptocurrency market more vulnerable to risks.
2. Financial vulnerability: As the usage of cryptocurrencies grows, its influence on the financial sector can be considerable, and it may have adverse effects on overall financial stability. The extreme fluctuation in cryptocurrency prices and the lack of clarity regarding how these prices are determined can pose significant risks for consumers and investors. Additionally, the high fees associated with cryptocurrency transactions and the challenge of assessing their intrinsic value can lead to unforeseen and substantial financial losses for those involved.
3. Risks associated with implementing monetary policies: As cryptocurrencies fall outside the purview of the central bank’s control, their usage may have negative implications, including possible disruptions in the monetary supply and the dissemination of monetary policies. The adoption of cryptocurrencies could also affect various financial transmission mechanisms, leading to potential adverse effects.
4. Foreign exchange reserve risks: one of the primary sources of foreign currency earnings in Nepal is remittances sent by Nepali citizens living abroad, Nepali individuals residing outside the country may be exposed to various temptations and influences to invest in cryptocurrencies. Such speculative investments in cryptocurrencies can pose risks to the country’s economy, impacting the interests of investors and potentially leading to challenges in the financial system.
5. Risks of asset laundering: The anonymity of parties participating in cryptocurrency transactions increases the potential for challenges to existing customer identification and compliance with anti-money laundering and terrorist financing regulations.
6. Customer protection and investment insecurity risks: In a country like Nepal where financial literacy is low, problems such as customers being cheated and losing money, and not having enough knowledge to handle crypto wallets may arise when dealing with cryptocurrency.
7. Risk of fraud and tax evasion: Since there is little anonymity about the origins and usage of cryptocurrencies, it becomes easy for fraudulent activities to occur. Both the general public and large companies might unknowingly use cryptocurrencies, believing in their advantages, even if they are used for purposes like tax evasion.
8. Risks arising in financial intermediation and international cooperation: When cryptocurrencies facilitate financial transactions without the need for conventional financial intermediaries like banks and financial institutions, it raises concerns about the relevance and sustainability of banks and financial institutions in terms of deposit mobilization, credit creation, and the provision of various financial services.
9. Challenges in currency issuance: In Nepal, only the Nepal Rastra Bank (NRB) has the exclusive authority to issue currency. However, with cryptocurrencies, since NRB does not have the power to issue them, it poses a challenge in terms of regulation and control.
10. Concerns about capital flight: Nepali citizens residing in Nepal are prohibited from making any form of investment abroad, except as allowed by the Nepal government or Nepal Rastra Bank. If cryptocurrencies were to be legalized, there would be a challenge in enforcing the laws that restrict investment abroad and prevent the capital flight of Nepali currency.

Current laws of Nepal against cryptocurrency

1. Nepal Rastra Bank Notices Prohibiting Cryptocurrency: The first notice, released on 13 August 2017, banned the use of Bitcoin in Nepal for two primary reasons. Firstly, it is against the law for Nepalese citizens to conduct transactions involving foreign currencies without obtaining explicit permission from the central bank, as outlined in the Foreign Exchange (Regulation) Act, 1962 (2019) (FERA). Secondly, bitcoin, along with other cryptocurrencies, is not recognized as a legal currency within Nepal. NRB’s second notice, issued on 9 September 2021, went further in its restrictions by not only banning the use of cryptocurrencies but also prohibiting their mining and trading within the country. In their latest and third notice, NRB has expanded the scope of their prohibition to include foreign citizens who reside in Nepal and Nepalese citizens who reside outside the country. NRB cites concerns about illegal financial transactions using cryptocurrencies, which can lead to fraudulent activities and the potential decline of the local economy’s capital.
2. Nepal Rastra Bank Act, 2058 (2002): The Nepal Rastra Bank Act,2058 (2002), defines currency as a narrow set of financial instruments, including currency notes, postal orders, postal notes, money orders, cheques, drafts, travelers’ cheques, letters of credit, promissory notes, bills of exchange, and credit cards, etc. Cryptocurrency, on the other hand, is a digital currency that is not issued by any central bank or government. Because cryptocurrency does not fit within the traditional definition of currency, it is not recognized as a legal tender in Nepal. This means that it cannot be used to pay for goods or services, and it cannot be used to settle debts.
3. Restricting Investment Abroad Act, 2021 (1964): Under the Nepal Rastra Bank Act, 2058 (2002), both Nepalese citizens residing within Nepal or abroad are prohibited from engaging in various types of investments in foreign countries like securities, foreign partnerships, foreign real estate, and any other cash or non-cash investments in foreign lands. The main objective behind this restriction is to safeguard Nepal’s domestic economy by controlling the outflow of Nepalese currency.
4. Foreign Exchange (Regulation) Act, 2019 (1962): Under the Foreign Exchange Regulation Act (FERA), it lays down stringent restrictions preventing any person, firm, company, or institution from sending Nepalese currency beyond the borders of Nepal without obtaining explicit permission from the Nepal Rastra Bank (NRB). Consequently, if Nepalese investors wish to invest in cryptocurrencies mined in foreign jurisdictions, they would be required to send their Nepalese currency to those overseas locations, and this action is strictly prohibited under FERA.
5. Foreign Investment and Transfer of Technology Act, 2075 (2019): Under Foreign Investment and Transfer of Technology Act (FITTA),Under Foreign Investment and Transfer of Technology Act (FITTA),A foreign investor can invest in any permitted industry individually or jointly, or through joint investment with Nepalese citizens or a company established in Nepal . Foreign investment in Nepal includes the following types of investments made by a foreign investor (a)Investment in shares of a company using foreign currency (b)Reinvestment of earnings from previous foreign investments (c )Lease financing in various assets, such as airlines, ships, plants, machinery, construction equipment, etc (d)Investment in venture capital funds (VCF) by institutional foreign investors, subject to approval from the Securities Exchange Board of Nepal (SEBON). The VCF’s operations will be governed by prescribed procedures (Section 9) . (e)Investment in listed securities through the secondary market by Venture Capital Funds as established in Section 9 (Section 10). etc.
   But there isn’t any specific law for foreign investors to invest in cryptocurrencies mined in Nepal.

How can cryptocurrencies be regulated?

1. Financial Education and Consumer Protection Measures : In Nepal, to address the challenges posed by cryptocurrency investments due to low financial literacy, it is crucial to launch comprehensive financial education and awareness campaigns specifically targeted at cryptocurrencies. These initiatives should be designed to educate the general public about the potential risks, benefits, and best practices associated with dealing in cryptocurrencies. The campaign’s focus should be on improving the public’s understanding of how cryptocurrencies work, the volatility and speculative nature of the market, the importance of conducting thorough research before investing, and the significance of secure cryptocurrency wallet management etc. Integrating materials on cryptocurrencies and bitcoin into the school curriculum will empower students with essential knowledge of financial literacy. To safeguard cryptocurrency users, consumer protection measures should be implemented, such as creating a dedicated dispute resolution authority which will handle customer complaints and assist in recovering funds in cases of fraud or scams, ensuring a secure and transparent environment for cryptocurrency transactions.
2. Specific regulation for cryptocurrency: In addition to consumer protection, the proposed cryptocurrency regulation should include measures to trace stolen cryptocurrencies and hold wrongdoers accountable. The regulation should address various aspects, including (a) defining rules for cryptocurrency ownership and licensing, (b) determining whether and how cryptocurrencies can be considered as personal property, (c ) exploring the applicability of possession and bailment concepts to cryptocurrencies, (d) establishing guidelines for granting security interests over cryptocurrencies, and (e) specifying how cryptocurrencies should be treated in cases of insolvency or bankruptcy. These provisions will create a comprehensive legal framework to govern cryptocurrencies, protect investors, and ensure the integrity of the cryptocurrency market.
3. Valuation of cryptocurrency: Cryptocurrencies are widely used as a means of exchange for various products and services. However, determining the exact value of cryptocurrencies when exchanging them for specific items can be challenging. For instance, if someone uses a cryptocurrency to purchase a smartphone, the number of units of the cryptocurrency required to cover the smartphone’s cost may vary due to market fluctuations. This lack of standardized valuation is a result of the unregulated nature of the crypto market . In the absence of clear guidelines, the value of cryptocurrencies for specific goods or services is influenced by supply and demand dynamics, investor sentiment, and market sentiment. To ensure consumer protection and establish stability in cryptocurrency transactions, there is a need to develop a regulatory mechanism that defines price formation and pricing practices of cryptocurrencies
4. Provision for investors to invest in cryptocurrencies : The Prohibiting Investment in Foreign Country Act of 2021 (1964) currently restricts Nepalese citizens from investing in cryptocurrencies like bitcoin that are mined in foreign countries. Therefore, in order to pave the way for the utilization of cryptocurrencies in Nepal, it is essential to amend both the Prohibiting Investment in Foreign Country Act and the Foreign Exchange (Regulation) Act of 2019 (1962) to enable Nepalese citizens to invest in foreign cryptocurrencies. This amendment would serve as a crucial initial step towards embracing the use of cryptocurrencies within Nepal.
   Similarly, allowing foreign investors to invest in cryptocurrencies mined within Nepal would result in an increased inflow of foreign currency into the country, thereby bolstering Nepal’s foreign exchange reserve. As a result, it becomes imperative to make appropriate amendments to the Foreign Investment and Transfer of Technology Act of 2075 (2019) to officially recognize investments made by foreign investors in cryptocurrencies within Nepal as a form of foreign investment.
5. Taxation of cryptocurrency: It is essential to impose taxes on the income and profits obtained from activities related to cryptocurrency like revenue from various parties, such as miners, crypto-exchanges, and wallet providers and ones who engage with it as part of their business operations. This goal can be accomplished by introducing modifications to the prevailing Income Tax Act, 2058 (2002), and Income Tax Rules, 2059 (2002). By incorporating provisions that treat earnings and profits from cryptocurrency businesses and investments as taxable income, the taxation of these financial activities can be appropriately addressed within the existing legal framework. Miners should be mandated to obtain a license from the relevant authority before engaging in mining operations to ensure transparency and accountability in the mining sector.
6. Regulation of crypto-exchanges and wallet holders : In order to incorporate cryptocurrency trading into the Nepalese capital market, a comprehensive assessment needs to be jointly conducted by the Securities Board of Nepal and the Nepal Stock Exchange. This thorough evaluation should encompass several critical aspects, notably the alignment of a crypto-exchange with the existing definition of a stock exchange as per the current securities and listing regulations. Additionally, the study must delve into the potential opportunities and feasibility of introducing cryptocurrency trading on the crypto-exchange platform. By authorizing public cryptocurrency trading, Nepal’s financial market can unlock a vast array of new financial possibilities and explore the potential advantages of using cryptocurrencies as a means of financing. Similarly, Wallet holders play a crucial role in managing cryptocurrency operations on behalf of system users. The system users entrust their system address and private key to these wallet holders. However, this arrangement carries certain risks. There is a possibility that wallet holders may impose high and fluctuating fees on consumers and could also expose them to cyber threats by not implementing appropriate security measures. Cybercriminals may target wallet holders to gain access to consumers’ private keys, which would grant them control over their cryptocurrencies. To address these concerns, it becomes essential to establish regulations that govern and safeguard the activities of wallet holders, potentially through licensing mechanisms.
7. Financial crime compliance : It is imperative for the regulations governing cryptocurrency to proactively address and mitigate the potential risk of its exploitation for money laundering and terrorist financing purposes. To achieve this, necessary adjustments should be made to the existing Money Laundering Prevention Act, 2064 (2008), with the specific objective of preventing the illicit use of cryptocurrency in money laundering and terrorist financing activities. By enacting these amendments, authorities aim to effectively combat the misuse of cryptocurrencies for illegal activities, ensuring the security and integrity of the financial system.

It is vital for the authorities to explore and understand the positive impacts that embracing cryptocurrency trading, and mining can have on the nation’s financial landscape. While there might be concerns about currency outflow, it is equally essential to appreciate the opportunities presented by the inflow of foreign currency which has the potential to bolster the foreign exchange reserve. As the foreign exchange reserve grows, it can contribute to a stronger and more robust economy. By taking a proactive approach and conducting thorough research, the authorities can make informed decisions in adopting a prudent and well-informed strategy toward cryptocurrencies can pave the way for economic growth, diversification, and increased resilience in Nepal’s financial system. It is crucial to strike a balance between embracing innovation and managing risks to foster a sustainable and prosperous economy in the face of evolving global financial trends.

Merely imposing a blanket ban on cryptocurrency, without conducting thorough research and analysis of its potential benefits and drawbacks, is not a viable solution. The Nepal Rastra Bank (NRB) should adopt a forward-looking approach rather than confining itself to outdated legislation.

Happy Surfing !