Our Blogs

Cryptocurrency | Aug. 1, 2024

REGULATION OF CRYPTOCURRENCIES AND BLOCKCHAIN

Cryptocurrency enthusiasts in India, hoping for a favourable decision from the government to allow investing and trading in cryptocurrencies with certain restrictions, might have to wait a bit longer. "The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021" which was supposed to be presented in the winter session of 2021 in Parliament, did not proceed as planned.

The bill was designed to create a framework for an official digital currency issued by the RBI and to prohibit all private cryptocurrencies in India, with certain exceptions to promote the underlying technology and its uses. However, the government has decided to delay the bill, opting for wider public consultation and alignment with global standards, which are still evolving. 

Over the past decade, cryptocurrencies have grown in popularity, with numerous cryptocurrency exchanges emerging in India. These digital transactions bypass traditional financial institutions, relying instead on digital identities. 

In 2018, the Reserve Bank of India (RBI) issued a circular preventing banks, NBFCs, and payment system providers from dealing in virtual currencies or providing services to entities dealing with them. This circular was challenged in the Supreme Court of India in the case of Internet & Mobile Association of India v. Reserve Bank of India & Ors. The Supreme Court struck down the circular on March 20, 2020, stating that cryptocurrencies are unregulated but not illegal in India, based on the RBI's consistent position that it had not banned virtual currencies.

Amid ongoing debates about banning versus regulating cryptocurrencies, the Indian government announced in the Budget Session of 2023-2024 a 30% tax on income from the transfer of crypto or digital virtual assets and a 1% TDS. 

Also as published in today’s The Economic Times, 21^st July, 2024, in recent years, there has been a positive shift in the regulation of cryptocurrency in India, with the government providing clarity on taxation and including crypto exchanges under the Prevention of Money Laundering Act (PMLA). However, high tax rates are hindering the growth of the crypto ecosystem, leading to a migration of trading volume to international exchanges, which poses compliance and customer protection risks. 

The industry suggests aligning crypto taxation with other businesses, reducing the TDS from 1% to 0.01%, and allowing the set-off of losses. Promoting awareness of crypto benefits and risks and developing comprehensive Web3 regulations are also recommended.

Concerns have been raised about the current 30% flat tax on crypto, which is higher than traditional asset classes and discourages long-term investment. This, along with the 1% TDS, has led to a decline in domestic trading volumes and a shift to offshore exchanges, depriving the Indian government of potential tax revenue and undermining the growth of the domestic Web3 ecosystem.

Despite these challenges, the Web3 sector in India has the potential to significantly contribute to the economy, with estimates suggesting it could add USD 1.1 trillion to GDP by 2032. Other countries, like Singapore and Portugal, have adopted lower crypto tax rates, offering a competitive advantage that India could emulate.

The government’s concerns about the volatile nature of cryptocurrencies and their potential misuse for money laundering and tax evasion are acknowledged. A balanced approach, involving a well-designed tax framework, open dialogue, and collaboration between the industry and the government, is essential to encourage responsible innovation while ensuring fair tax revenue.

The Indian crypto industry is hopeful for more favourable tax regulations in the upcoming budget of 2024-2025, coming on 23^rd July 2024, which could unlock the sector's potential and propel India to the forefront of the global digital revolution.

This move could indicate the government's intent to recognize cryptocurrencies as assets rather than currencies. The finance minister clarified that this should not be seen as the government legalizing or recognizing virtual and cryptocurrencies. While some investors might find the tax implications high, it could help the government track users and holders.

India's approach contrasts with China's outright ban on cryptocurrency, which led to a shift of crypto mining to the United States. Instead, India seems to be adopting a stance similar to the UK and Singapore, where cryptocurrencies might not be considered legal tender, but exchanges must comply with financial regulations.

 

Understanding Cryptocurrency and the Regulatory Challenge

Cryptocurrency is created through crypto mining, which involves solving cryptographic equations using high-powered computers to verify data blocks and add transaction records to a public ledger, known as a blockchain. This process employs complex encryption techniques and decentralized methods for verification and distribution, eliminating the need for a central authority or centralized ledger.

While blockchain records transaction data, it does not link it to names, addresses, or other identifying information, making transactions anonymous and untraceable. This raises concerns about user identity, as transactions could be conducted by individuals hiding behind cryptographic pseudonyms.

The Financial Action Task Force (FATF) has highlighted several potential AML/CTF risks associated with cryptocurrencies:

1. Anonymity: Anonymous transfers enable transactions to occur without names, account numbers, or verification checks, making KYC checks challenging.
2. Source/destination of funds: Lack of identification and verification checks increases the potential for abuse.
3. Cross-border transactions: Global reach with minimal requirements (e.g., a mobile phone) heightens AML/CTF risks.
4. Lack of oversight: Without AML systems, suspicious trading activity can go undetected, complicating law enforcement and asset seizures.

Governments and financial institutions worldwide struggle to assess the risks associated with cryptocurrency investments. The absence of sound global regulation has allowed creators of digital assets to deceive investors, who often fall into traps without realizing the inherent risks. 

Cryptocurrencies and blockchains are not backed by assets, are extremely volatile, and can lose value rapidly. Additionally, if a cryptocurrency promoter ceases trading, investors could be left with worthless tokens. The Squid Game Crypto Scam, where promoters allegedly scammed $3.38 million by halting trading and leaving buyers with worthless tokens, exemplifies such risks.

Advertisements touting no third-party interference, transaction anonymity, no regulatory interference, and easy cross-border payments lure investors into cryptocurrencies. Former RBI Governor Raghuram Rajan compared many cryptocurrencies to unregulated chit funds, warning that only a handful of the 6,000 cryptocurrencies in existence might survive. He emphasized that cryptocurrencies cannot be eliminated but can be prevented from becoming a significant part of the payment system.

The need for a global regulatory framework for cryptocurrency dealings is urgent. Governments worldwide are recognizing the gravity of the issue and working toward stricter regulations. The U.S. Securities and Exchange Commission (SEC) has increased its crypto-related enforcement actions, and Binance Holdings Ltd., the world's largest cryptocurrency exchange, is under investigation by the SEC.

 

Also Refer: Analysis of Internet and Mobile Association of India vs. RBI (linkedin.com) – To know more about the case and its following consequences.