Regulating digital gold
In August, NSE and BSE asked all its registered members to desist from selling digital gold either offline or online. Indian brokers were accounting for about 10-12% of the total digital gold sold in India. The biggest chunk of digital gold was still sold through the digital wallet platforms like Paytm, PhonePe and Google Pay. However, the regulator was more worried about the spread of this product in retail wallet share.
According to estimates, prior to the ban, nearly Rs4,000cr worth of digital gold was sold in India annually. But the problem was it was becoming a hard core retail product. Most people with digital gold accounts were investing in denominations as small as Rs250 or Rs500. As a result, there were about 12 crore digital gold accounts and about 9-10 crore investors were active on the platform.
While that was a good starting point, the ban on brokers selling digital gold only addressed 10% of the problem. As a result, in October 2021, SEBI also advised all the registered investment advisors (RIAs) to desist from selling digital gold to customers. This had a much bigger impact as the likes of Paytm who were suggesting digital gold as part of financial plans, could no longer do so.
What exactly is digital gold?
To understand why SEBI was particular about regulating digital gold, let us understand the product. Digital Gold is typically issued in India by institutions like MMTC-PAMP and Augomont. Of course, now there are a plethora of players offering digital gold but these players have a dominant market share.
An investor can decide to invest an amount as low as Rs250 and fractional digital gold would be credited to their digital gold accounts based on market price. This could be sold at any point of time and the money can be realized immediately. For the Indian market used to centuries of gold investing, this was a truly appealing product.
Apart from allowing investment in gold in fractions and SIPs in gold, digital gold also was a lot simpler and did not entail elaborate KYC. Most investors bought in small tickets so they were happy with the assurance that an organization like MMTC-PAMP had stored sufficient gold in its vaults to back all the digital gold issued.
That was precisely the problem with digital gold
The reason NSE and BSE barred brokers from selling digital gold was that it was not a security. Now securities are defined under the Securities Contract Regulations Act (SCRA) and registered members of stocks exchanges can only deal in such securities. Since digital gold was not a security, exchange members could not deal in digital gold.
But the problem was more fundamental. While the existing gold products like sovereign gold bonds and gold ETFs were regulated by SEBI and RBI, digital gold was outside the purview of regulation. Also, while MMTC-PAMP assured that there was physical gold backing the digital gold units, there was no regulatory verification or audit trail of the entire process. SEBI felt that in an extreme event it could expose investors to counterparty risk.
How is digital gold regulation likely to shape up?
Here is what you need to know about regulating digital gold.
a) As the first step, the exchanges asked brokers to desist from offering digital gold on their platforms. This was followed up in October with SEBI barring RIAs from offering digital gold as an investment option to investors.
b) This did create a dichotomy since the regulated players were barred from selling digital gold while the unregulated entities continued to sell digital gold. Many brokers had found digital gold as a good gateway to onboard clients and then diversify them.
c) The next step would be to classify digital gold also as a security under the SCRA and the SEBI Act. This will give it the same status as equities, bonds and F&O, in that registered entities will be allowed to deal in digital gold and offer to customers.
d) The next piece of regulation is insisting that all entities offering digital gold be made liable to some form of compliance, regulation and periodic submissions to SEBI, with respect to net worth, liquidity etc.
e) The big challenge will be make digital gold as part of the investment ecosystem by offering it on regular platforms and including it in the trade guarantee framework. That would require a better hang on the entire process of creation of digital gold, redemptions, evaluating physical gold etc.
If digital gold must not become another of those products like plantations, chit funds and unregulated FDs, it is essential that digital gold be regulated. There is no better assurance of orderly growth of a product than a regulated ecosystem.