Need for regulatory oversight
Being a fairly new and predominantly unregulated sector, crypto-assets/cryptocurrencies can be a pathway to a whole new world of innovation as it introduces newer ways of how one interacts on the internet. On the other hand, virtual currencies, like any other human invention, are not free from the risk of misutilization. Such risks in the crypto industry include market instability and illicit financing. Furthermore, controversies such as the FTX failure and the OneCoin ponzi scheme have caused a setback to the sector, and thus there is a need for regulatory guardrails in this industry to create a secure environment for users while promoting innovation under blockchain technology.
Protection of the consumer and addressing pseudonymity in the crypto ecosystem are two areas of concern for governments all over the world, as they strive to maintain stringent oversight over virtual assets. European Union’s (EU) bill titled Markets in Crypto Assets (MiCA) pending in the European Parliament seeks to formulate a harmonized crypto regulation in the Union for three sub-categories of crypto assets (‘e-money’ tokens, ‘asset-linked’ tokens, and ‘all others’ such as utility tokens) while also seeking to regulate service providers & issuers of such crypto assets. Even in the United States, a new bill to regulate the crypto sector has been proposed – the Responsible Financial Innovation Act – which seeks to tackle wide-ranging issues such as the environmental impact of virtual assets, the creation of a tax structure, as well as regulating decentralized autonomous organizations (DAOs) that use virtual assets for managing activities in the operation of firms.
Keeping in mind the varied regulatory moves initiated by governments the world over, an effective, globally coordinated, and well-thought-out regulation will hold the key to ensuring a balance between the negative impacts (money laundering & terrorist financing) and the positive potentials (financial inclusivity & advanced cross-border transactions) of the blockchain technology.
Steps already being taken by India At present, virtual assets are neither banned nor governed under any special act of law in India. While a bill titled “The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021” is under discussion, India has chosen to amend some of its existing laws as a move to have some regulation on virtual currencies. In a series of measures taken, the country has incorporated the following key changes:
- Direct Tax implication: The Income Tax Act, 1961 was amended last year to introduce a new phrase, “Virtual Digital Assets” (VDAs), to define cryptocurrencies and other similar emerging technologies like Non-Fungible Tokens (NFTs). Further, a 30% income tax and a 1% TDS were also introduced last year on the transfer of VDAs from one entity to another. Additionally, VDAs given as “gifts” were also covered in the taxation regime.
- Directions under the Information Technology Act, 2000: All virtual asset service providers, virtual asset exchange providers and custodian wallet providers need to mandatorily maintain all information obtained as part of “Know Your Customer” (KYC) processes and records of financial transactions for a period of 5 years.
- Pilot launch of the Digital Rupee: On 1 December 2022, the RBI pilot launched it’s Central Bank Digital Currency (CBDC) to test the robustness of the digital rupee creation and its retail usage in real-time. This has been done in a phased manner starting with four banks in four cities while keeping the same denominations as the paper currency. The Digital Rupee will be regarded as bank notes.
- Advertising alerts: the Advertising Standards Council of India shared its guidelines for advertisements of virtual currencies in February 2022, which included the requirement of a prescribed disclaimer, and prohibited the depiction of minors as well as the usage of words such as “currencies”, “securities”, “Custodian” & “Depositories”, amongst other features.
The above-mentioned measures have certainly brought a lot more clarity for entrepreneurs and investors alike in the crypto ecosystem in India. However, considering the unique nature of the crypto industry there are still several factors that need further clarification. To start with, it is still an open question as to whether VDAs are to be classified as goods or services. In any case, clarity needs to be brought in regarding the taxation of VDAs in GST and the treatment of overseas exchanges.
Way forward
A consistent thought amongst the Indian leadership has been that emerging technology such as the blockchain must be dealt with in a globally harmonized manner rather than inadequate piecemeal approaches in different national jurisdictions given the inherent borderless nature of VDAs.
One way of doing so is for India to recognize the VDAs as “commodities” or a separate asset class under the regulatory control of an independent body, either an existing one or creating a new one. That will help in creating a well-established ecosystem for investor protection with its time-tested protocols, disclosures, and certifications, it would be a well-placed regulatory authority to overlook the smooth functioning of the transfer and trading of VDAs. This may be an interim measure until further clarity on the crypto assets is reached at an international level.
Furthermore, the government may take other measures to create more transparency in transactions and to this extent, certain scenarios can be carved out where the exchanges may be required to provide information on their users.
The forthcoming Union Budget can reflect the regulatory approach that India would like to favour, and this can be taken up further as part of the G-20 deliberations. Needless to say, regulations will bring transparency and accountability to the crypto ecosystem and protect the interest of consumers.
(The author is a tax partner at EY India. Views expressed are personal)
