The Journey Of Virtual Digital Assets In Indian Context

The virtual digital asset (VDA) sector, primarily encompassing cryptocurrencies and virtual currencies, has gained significant popularity among investors and technology enthusiasts over the years. In fact, in India itself, an estimated number of 115 million crypto investors represent 15 per cent of the Indian working age population.

However, ever since the emergence of the first VDA (i.e., the Bitcoin in 2009), financial regulators globally have been extremely wary of giving a legal stamp of approval for VDAs, citing a strong threat they pose to the financial stability of global markets. 

Soon after the Hon’ble Supreme Court of India set aside the Reserve Bank of India’s (RBI) controversial 2018 circular prohibiting dealing in ‘virtual currencies’, the Indian market saw a sudden boom in investments and emergence of multiple startups in this space. That is - until the introduction of the 30 per cent tax on income from the transfer of VDAs and 1 per cent TDS on the sale of crypto in the Finance Bill of 2022, which elicited a collective groan from crypto investors. Aside from the number of ambiguities that were presented which warranted clarification as soon as this dropped, it also raised an existential question on the future of the VDA industry and doing this business in India. As a result, a flurry of businesses moved out from India to foreign shores. 

VDAs operate on blockchain networks that are decentralised and governed by smart contracts. Hence, traditional regulatory approaches, that rely on centralised control and intermediaries, are not easily applicable to crypto regulation. Further, VDAs operate across borders and their decentralised nature poses jurisdictional challenges for governments. Regulatory arbitrage, where market participants exploit regulatory gaps or opt for jurisdictions with more lenient regulations, further complicates the situation.

The pseudonymous nature of cryptocurrencies and the difficulty in tracking transactions across decentralised networks make it hard to detect and prevent financial crimes. VDAs have, as is well known, been used for illicit activities, including money laundering, terrorist financing, and tax evasion. In November 2022, hackers held servers of the All India Institute of Medical Sciences (AIIMS) for ransom and demanded Rs 200 crore in cryptocurrency as ransom. In 2017, the WannaCry ransomware attack globally had the same modus operandi. 

While India can pride itself on leading the digital payments race globally, its regulators must gear up to effectively prevent the abuse of cryptocurrency by white collar criminals and enable its law enforcement agencies to double down on such threats.

Given that several regulators of other jurisdictions are stepping up and attempting to bring in constructive regulation (as opposed to a blanket ban), at this juncture, if India ignores its thriving VDA sector, it will be neglecting a major part of the Indian economy. Countries like the United States, United Kingdom, and Singapore have proposed or enacted laws to regulate cryptocurrencies and VDAs. Regulatory bodies such as the Financial Action Task Force (FATF) also provide recommendations to combat money laundering and terrorist financing in the VDA sector. That said, India has also taken a few baby steps to regulate crypto assets. For example, the Advertising Standards Council of India has issued guidelines for promotion and advertising of crypto assets. Most recently, the Finance Ministry brought crypto assets within the scope of the PMLA. 

Any attempt towards crypto regulation must be marked by clarity and a technocratic attitude. For India, a specialised regulator that focuses on crypto regulation alone, and is aligned with CERT-In and the National Informatic Centre will make India a model for crypto regulation. The Indian government should provide clear definitions and classifications of cryptocurrencies within existing legal frameworks and enact new ones to establish appropriate regulatory measures and fill in regulatory gaps. 

Investor protection is crucial and regulators should enforce transparency, disclosure requirements, and robust KYC/AML procedures to ensure accurate information and prevent financial crimes. Interestingly, the more the crypto regulation and stability of such regulations, the less will be the volatility of crypto and other digital assets which in turn itself enhances investor protection. However, consumer education and awareness programs are essential to help individuals understand the risks, benefits, and responsible use of cryptocurrencies. Educating the public about scams, security practices, and market volatility promotes responsible participation.

Both penal measures and self-regulatory protocols should be adopted and encouraged by regulators. Effective AML and CFT measures should be implemented, necessitating compliance by cryptocurrency businesses, registration with regulatory authorities, and reporting of suspicious transactions. Regulators must develop technical expertise and understanding of blockchain technology and cryptocurrencies to make informed decisions and design effective regulatory measures without stifling innovation.

Maintaining market integrity is key to the success of any industry, and cryptocurrency is not an exception. Regulators should monitor and oversee cryptocurrency exchanges and trading platforms to ensure fair and transparent trading practices. Further, access to law enforcement agencies through warrants that allow them to take intermediary servers in custody and intervene at the server level will be critical to prevent manipulation, insider trading, and fraudulent practices in crypto assets. Another tool in the regulatory toolkit is that regulatory sandboxes. They can provide controlled environments for testing new crypto-related products, services, and business models. This will enable information sharing between the regulator and the industry.

International cooperation is vital for developing consistent regulatory standards, combating cross-border financial crimes, sharing best practices, and reducing regulatory arbitrage. India’s ongoing G20 presidency is a golden opportunity for India to lead the charge in crypto regulation, and harvest synergies from like-minded nations of the G20 for knowledge sharing and collaboration.