• Concerns over a digital version of undial system
• Crypto transactions fall out of CBSL’s purview

In Sri Lanka, as inflation surges and the rupee continues to be volatile, an increasing number of citizens are turning to cryptocurrencies like Tether (USDT) to safeguard their wealth. Unlike traditional savings, which steadily lose value alongside the weakening currency, these digital assets – pegged to the US Dollar – offer a sense of stability. 

Through platforms such as Binance, locals convert rupees into crypto, later selling these assets for profit via local bank transfers that effectively mask the transaction’s crypto origins from financial institutions.

However, experts caution that beyond merely protecting personal finances, the growing crypto trend is fuelling a digital version of the old undial system, with billions of rupees potentially moving out of the country while bypassing official foreign exchange channels. They warn that the expanding shadow economy not only weakens Government control over capital flows, but also deprives the State of significant tax revenue from undeclared profits made by Sri Lanka’s crypto traders.

In the absence of clear regulatory frameworks, the Government risks losing both taxable income and oversight as capital flight quietly gathers pace beneath the surface.

Digital version of undial?

When contacted by The Sunday Morning, KPMG Sri Lanka Tax and Regulatory Principal Suresh R.I. Perera explained that the Central Bank of Sri Lanka (CBSL) had issued two notices regarding cryptocurrency.

Both notices asserted that crypto transactions fell outside its regulations and individuals engaged in such transactions at their own risk. Another key point from the notices was that commercial credit cards could be used for crypto transactions and any facilitation of such payments through cards was prohibited.

Perera also noted that crypto, including Bitcoin, was being used in some establishments like shops and hotels in Sri Lanka, a trend that could be easily verified online.

Additionally, there is a growing crypto community in the country, with many individuals actively trading and investing in digital assets. Cryptos are also increasingly being used as a means to move money out of Sri Lanka, similar to practices in India, bypassing conventional methods. “This has become an alternate method for moving money overseas, much like the old hawala system,” Perera explained.

He went on to categorise countries’ stance on crypto into three groups: those that expressly permit it (like Australia and the US), those that prohibit it (like China and Russia), and those with no clear regulations where neither permission nor prohibition is defined. “Sri Lanka falls into this third category,” he said.

Perera further noted that during former President Gotabaya Rajapaksa’s administration, a committee was formed to study crypto. However, its focus was more on the potential introduction of a Government-backed digital currency rather than regulating existing crypto assets. He also pointed out that foreign parties had attempted to introduce their cryptocurrencies in Sri Lanka, but the Government had not approved these proposals.

He cited Ukraine, which received significant foreign donations via crypto during the war, as an example, and suggested that although the Government might be hesitant, it should consider keeping an open mind and establishing clear regulations.

“Perhaps the Government should look at regulating it, especially since money is being moved out of the country through crypto in a way similar to the old hawala system. I’m not sure whether the Government has fully grasped that aspect yet,” Perera said.

Discussing the three primary uses of crypto – trading for profit, mining, and moving money out of the country – Perera highlighted that Sri Lanka did not have much crypto mining activity but faced concerns about capital flight. “For example, India hasn’t explicitly prohibited crypto, nor has it permitted it, but what the country has done is taxing it. Sri Lanka needs to consider this approach,” he noted.

Perera pointed out that many Sri Lankans used USDT, a stablecoin pegged to the US Dollar, to safeguard their wealth against inflation and currency depreciation. Since buying US Dollars locally is restricted, people turn to USDT as an alternative.

“Transactions typically happen on platforms like Binance. You can open an account, check coin prices, and trade. If you invest Rs. 5 million and buy Bitcoin, after six months, its value might rise to Rs. 8 million. You can then sell it and the payment is made via a local bank transfer even without the bank knowing it’s crypto-related,” he explained.

This method allows the entire transaction – from the original Rs. 5 million to the Rs. 8 million received, to happen without any crypto identification. “If you sell your crypto to someone overseas, say in Japan, and tell them to deposit the money into your brother’s Australian bank account or your own overseas account, large sums of money can move out of Sri Lanka without going through official exchange channels,” Perera said.

He added that this method was becoming increasingly popular among Sri Lankan politicians and high-net-worth individuals to shift funds abroad. On a smaller scale, younger people, especially those aged 18-25, are also involved in crypto, often trading for fun or speculative profit, sometimes using their parents’ money.

Perera concluded that Sri Lanka’s crypto user base could be broadly divided into two groups: high-net-worth individuals using it for large cross-border transfers and younger individuals trading for profit or as a hobby.

CBSL issues warnings, stays passive

As previously highlighted by Perera, the CBSL has issued warnings regarding the risks associated with virtual currencies (VCs) and cryptocurrencies, emphasising the lack of regulatory oversight and the potential for significant financial losses.

In a 12 July 2022 notice, the CBSL stated that virtual currencies were unregulated digital assets and had no safeguards in Sri Lanka. It reiterated that no licences or authorisations had been granted to entities for operating cryptocurrency schemes, Initial Coin Offerings (ICOs), mining operations, or virtual currency exchanges.

The notice also highlighted that under Directions No.3 of 2021, Electronic Fund Transfer Cards (EFTCs) such as debit and credit cards were not allowed for transactions related to virtual currencies. 

The CBSL warned the public of the considerable financial, operational, legal, and security risks posed by cryptocurrency use and advised against falling victim to crypto-related schemes advertised online and through other media.

A further warning was issued on 29 March 2023, when the CBSL again stressed the dangers of investing in cryptocurrency. It reminded the public that cryptocurrencies were not recognised as an asset class or legal tender in Sri Lanka and that they operated without any regulatory oversight. 

The notice pointed to recent instances where individuals had lost significant amounts of money through crypto investments and scams. The CBSL once more advised the public not to engage in crypto schemes and highlighted the prohibition of EFTCs for crypto transactions. The bank also urged individuals to refrain from promoting or facilitating crypto trading and investments due to the wide range of risks involved.

Laws silent on crypto?

Sri Lanka’s financial sector is governed by several key laws. The Monetary Law Act No.58 of 1949 establishes the CBSL and defines its regulatory powers over banking and non-banking financial institutions. The Banking Act No.30 of 1988 regulates banks, ensuring proper licensing and risk management, while the Finance Business Act No.42 of 2011 oversees finance companies, including leasing and other financial services.

The Securities and Exchange Commission (SEC) Act No.19 of 2021 governs capital markets and securities trading through the SEC. Additionally, the Financial Transactions Reporting Act (FTRA) No.6 of 2006 addresses Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) obligations. 

The Payment and Settlement Systems Act No.28 of 2005 regulates payment service providers, while the Foreign Exchange Act No.12 of 2017 governs foreign currency transactions. Lastly, the Inland Revenue Act No.24 of 2017 covers taxation of financial transactions.

However, as observed by The Sunday Morning, none of the primary financial laws explicitly cover virtual currencies (cryptocurrencies). Instead, there are only indirect regulations and guidelines that address certain aspects of virtual currency activity, mostly in relation to financial crimes and AML/CFT measures.

For example, under the FTRA No.6 of 2006, while cryptocurrencies are not directly regulated, financial institutions are required to report suspicious transactions, including those potentially involving virtual currencies as part of Sri Lanka’s AML/CFT framework.

The Monetary Law Act No.58 of 1949 empowers the CBSL to issue warnings about the risks of virtual currencies. Although cryptocurrencies have not been formally banned, the CBSL discourages their use in official transactions due to concerns about volatility, security risks, and potential links to illicit activity.

Similarly, while the Payment and Settlement Systems Act No.28 of 2005 regulates payment service providers and electronic money issuers, it does not specifically address cryptocurrencies. However, the CBSL’s oversight of payment systems allows for some indirect scrutiny of digital currency activities under the country’s financial infrastructure laws.

Sri Lanka currently has no specific laws directly regulating virtual currencies. Their use is only indirectly addressed within broader financial crime prevention and financial stability frameworks, leaving a regulatory gap in the face of the country’s growing crypto activity.

No crypto for SL for now

In such a backdrop, University of Colombo (UOC) Department of Economics Lecturer Umesh Moramudali stated that cryptocurrencies were not directly regulated by any central bank. 

The fundamental concept behind cryptocurrencies is that they exist outside traditional regulatory systems, including those of governments or central banks. This is why central banks often claim that they are not responsible for cryptocurrencies, and the claim is accurate because they do not manage or control them. If individuals face difficulties while trading these currencies, central banks cannot be held accountable.

“Individuals involved in cryptocurrency transactions are generally not licensed entities. Licensed entities, such as banks, typically do not engage in these kinds of transactions. Therefore, cryptocurrencies operate outside the normal financial system, which is referred to as the ‘money supply.’ 

“There are two primary ways people can profit from cryptocurrencies. The first is through mining, which requires significant technical expertise, powerful computers, and considerable electricity. Considering Sri Lanka’s ongoing electricity issues, including an unstable grid and expensive electricity, I don’t believe cryptocurrency mining is feasible or beneficial in our context,” he explained.

Moramudali addressed the second way in which people made money from cryptocurrencies: speculation. Many individuals buy and sell these digital assets in the hope of making quick profits. However, as explained by him, this comes with high risks. Unlike tangible assets like cars, land, or houses, which have inherent value and are regulated, cryptocurrencies are highly volatile. Using them as speculative assets introduces substantial risks.

“In my view, this kind of speculation is unhealthy for an economy like ours. Some countries have already taken action: China has banned cryptocurrencies, India has imposed a 30% tax on crypto-related activities, and the US is attempting to integrate them into its local financial system. 

“But as of now Sri Lanka should stay out of crypto; given that we do not have clear laws or regulations regarding cryptocurrencies, it is better for us to avoid them, particularly as our economy continues to recover. Engaging in short-term speculative ventures in this space is risky and does not offer stability,” Moramudali said.

He expressed concerns about the broader macroeconomic impact of cryptocurrencies, stating: “Cryptocurrencies often lead to market bubbles, and when those bubbles burst, they affect the wider economy. I am more concerned about the macroeconomic consequences than about individuals seeking quick profits. 

“If crypto gains prominence in Sri Lanka without regulatory oversight, it could lead to problems similar to those experienced in other countries, including India. The lack of regulation could harm the economy.”

Authorities avoid media scrutiny

Repeated attempts by The Sunday Morning over several weeks to reach out to key officials, including Finance Ministry Secretary Mahinda Siriwardana, Deputy Minister Prof. Anil Jayantha Fernando, and Deputy Minister Dr. Harshana Suriyapperuma were unsuccessful.

Suriyapperuma, when contacted, demanded media IDs as proof of legitimacy, yet evaded further queries.

Prof. Fernando directed The Sunday Morning to his Media Secretary, who remained unaware of any questions asked.

Similar attempts to engage with the CBSL’s Financial Intelligence Unit, Department of Foreign Exchange, Currency Department, and Bank Supervision Department were met with silence.