One relatively recent phenomenon that has taken governments all over the world by surprise is the exploding popularity and value of cryptocurrencies. The combined value of cryptocurrencies recently breached half a trillion dollars, in fact, higher than the GDP of several top-20 world economies.

Considering their sudden rise (10X-20X increase in market cap in last one year), governments all over are scrambling to formulate a coherent strategy to deal with such currencies considering the unique challenges and opportunities they present.

Cryptocurrencies challenge governmental control on economy. Governments like to know everything about the currency and monetary transactions of its populace (whereabouts, ownership, purpose, etc.). Such knowledge allows governments to provide fiscal stability, target policies, increase tax base, track crime and prevent leakage. Cryptocurrencies allow anonymous, peer-to-peer financial transactions, thereby loosening governmental monitoring and control.

Also, cryptocurrencies are not fiat currencies; this makes governments nervous. Lack of a sovereign guarantee makes such currencies and therefore the corresponding investments excessively volatile (though one can point to the robustness such currencies have shown to bans, regulations, and fraud).

Excessive volatility in investments tends to have social and political costs (for example, erosion of public trust in government and investments). Lack of a sovereign guarantee also makes it difficult to provide insurance against fraud, etc.

Unsurprisingly, many countries have either instituted outright bans on cryptocurrencies or put significant curbs on their promotion and growth as evidenced by recent bans on ICOs, cryptocurrency exchanges, advertisements, etc.

India must, however, have a more accepting approach to deal with cryptocurrencies. The popularity of cryptocurrencies has been growing rapidly in India due to benefits in terms of anonymity, accessibility, speed, and cost (some recent reports say that one in ten cryptocurrency transactions is now done in India). This aligns well with the government’s goal of promoting a less-cash society.

Second, heavy-handed methods such as bans are ineffective for cryptocurrencies. As a recent example, Chinese ban on cryptocurrency exchanges simple led to the Chinese transactions moving to exchanges elsewhere. There is no reason to believe that such methods would be more effective in India.

Third, cryptocurrency transactions may represent a large potential source of revenue. An accepting approach may help tap into this source. Cryptocurrencies also promote investment into decentralised infrastructure, tools, and applications – such investment may spur innovation in other domains that require scale. Blockchains and smart contracts are simply the beginning.

How then does one balance the genuine fear of excessive volatility and loss in oversight and control against the potential benefits in terms of revenue, innovation, and digitization? The key could be a careful combination of education about the volatility and non-insurance risks of cryptocurrencies, and careful and selective regulation to encourage structure, disclosure and tracking.

Specifically, cryptocurrency exchanges should be recognised officially as money service businesses and provided a stable, regulatory framework to operate in. They should also be provided necessary support to succeed so that a dominant fraction of cryptocurrency transactions flow through these exchanges.

At the same time, like other money service businesses, they should be required to keep records, enforce registrations and share information with governmental agencies to help with oversight and control. They should also be required to invest some fraction of their profit into educating potential users and investors about the risks.

Another fraction of profit must be required to be invested in detecting and preventing crimes, fraud, collusion, and cyber attacks. Exact mechanism for these investments (e.g., in-house investments vs supporting regulatory bodies) should be allowed to evolve. Self-reporting must be required for both individuals and institutions involved with cryptocurrencies.

Cryptocurrencies themselves should be considered as property for taxation purposes. Every sale should trigger a capital gains tax. Miners, traders and exchanges should pay corporate income tax. Investors must be required to complete some online training about risks before transactions are allowed.

Banks and financial institutions should not be allowed to hold or trade cryptocurrencies or provide loans to cryptocurrency exchanges; further exposure is not helpful considering their already stressed assets. ICOs (initial coin offerings) should be allowed; such instruments have the potential to accelerate innovation. However, ICO investments should be allowed only after proper understanding of risks.

All the while, the use of fiat currency should be made more attractive. There is no true substitute to fiat currency since supply can be controlled carefully to manage economic variables, minimise volatility, and target inflation and unemployment.

Use of blockchain should be promoted to improve transparency, accessibility, and cost for fiat currency transactions. Feasibility of supporting fiat cryptocurrencies (such as the rumoured J-coin) should be studied for frictionless e-payments and direct money transfers. Privacy and usability of existing digital payment systems should be improved.

Cryptocurrencies have shown extraordinary resilience during their short history and are likely here to stay – a pragmatic approach to promote and regulate them can yield significant dividends.

The writer is Associate Professor in the Electrical and Computer Engineering Department at the University of Illinois.