EVOLVING REGULATORY FRAMEWORK FOR CRYPTOCURRENCIES AND DIGITAL ASSETS

Introduction

Cryptocurrencies are a form of virtual or digital currency, created using encryption algorithms that operate on decentralized networks using blockchain technology. They are not issued by any governmental authority or institution and hence the value of these currencies are controlled by market factors of demand and supply.

The following are a few examples of popular cryptocurrencies:

• Bitcoin
• Ethereum
• Litecoin
• Peercoin
• Dogecoin etc.

Evolution of Regulatory Framework

The Reserve Bank of India (RBI), Ministry of Finance and the Securities and Exchange Board of India (SEBI) are the regulatory bodies of cryptocurrencies and digital assets in India. The RBI in 2013 issued a Press Release cautioning users of Cryptocurrency about the potential financial, operational, legal, customer protection and security related risks that they are exposing themselves to. This marks the first time the RBI has addressed concerns regarding the surge in the use of cryptocurrencies. The RBI further issued 2 more cautions in 2017, highlighting that no license or authorization was provided to any company that deals with any Cryptocurrency.

Consequently, in April 2018 while the Government formed an Inter Ministerial Committee (IMC) to address issues pertaining to Cryptocurrency, the RBI imposed a Prohibition on dealings in virtual currencies and providing services for facilitating dealing with VCs based on which the Government submitted a Draft Bill “Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019”, proposing a blanket ban on generating, holding, selling, dealing, transferring of Cryptocurrencies in India. This has still not been enacted.

However, in 2020, the Supreme Court reversed the ban on use of cryptocurrencies in the Internet and Mobile Association of India v RBI case, allowing banks to resume services in cryptocurrency. The Government proposed another bill, “Cryptocurrency and Regulation of Official Digital Currency Bill, 2021”, aiming to ban all private cryptocurrencies and facilitate the creation of a single, regulated and official digital currency issued by the RBI. The bill has not been passed by Parliament till date.

Current Regulatory Framework

1. Income Tax Act, 1961

The Finance Bill, 2022 amends Section 2 of Income Tax Act, 1961 to include the definition of Virtual Digital Assets, comprising of cryptocurrencies and NFTs. The government further inserted the following Sections in the Income Tax Act, 1961:

• Section 115BBH: Imposes 30% tax on income generated from cryptocurrencies.
• Section 194S: Imposes 1% tax deductible at source on transfer of cryptocurrencies.

2. Prevention of Money Laundering Act, 2002

The Ministry of Finance in 2023 brought Virtual Digital Assets (VDAs) under the ambit of Prevention of Money Laundering Act, 2002 (hereinafter referred to as the “PMLA”). Hence, the act will have the power to govern:

• Exchange between VDAs and fiat currencies,
• Exchange between one or more forms of VDAs,
• Transfer of VDAs
• Safekeeping or administration of VDAs, and
• Participation in and provision of financial services related to an issuer’s offer and sale of a VDA.

3. AML & CFT Guidelines for Reporting Entities Providing Services Related to Virtual Digital Assets

These guidelines were issued by the Government to provide a summary of provisions of the applicable anti money laundering, counter-terrorism financing and proliferation financing legislations in India, viz. the PMLA, the Unlawful Activities (Prevention) Act, 1967, The Weapons of Mass Destruction and Delivery Systems (Prohibition of Unlawful Activities) Act, 2005 and rules thereunder. These guidelines are applicable to Service Providers relating to VDAs. It reiterates the Anti-Money Laundering, Countering the Financing of Terrorism and Combating Proliferation Financing (AML/CFT/CPF) obligations of the Service Providers.

4. Indian Companies Act, 2013

In March 2021, The Ministry of Corporate Affairs issued a notification directing Companies that have traded or invested in Virtual Currency to disclose the following:

• profit or loss on transactions involving Cryptocurrency or Virtual Currency
• amount of currency held as at the reporting date,
• deposits or advances from any person for the purpose of trading or investing in Crypto Currency/ virtual currency.

5. Information Technology Act, 2000

The Ministry of Electronics and Information Technology (MeitY) issued directions under sub-section (6) of section 70B of the Information Technology Act, 2000 requiring Virtual Asset Service Providers to mandatorily maintain all information obtained as part of Know Your Customer (KYC) and records of financial transactions for a period of five years.

6. ASCI Guidelines for Advertising and Promotion of VDAs

The Advertising Standards Council of India issued guidelines requiring that advertisements for VDAs must contain the following disclaimer:

“Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions.”

Such a disclaimer must be made in a manner so that it is prominent and unmissable by an average consumer.

The Path Forward

In 2024, India led the Cryptocurrency adoption for the second time in a row, in spite of the Government imposing new guidelines and regulations. The cryptocurrency market is projected to witness a significant growth in revenue, reaching a staggering amount of US$6.4bn by 2025.

However, cryptocurrency has still not been recognized as currency by RBI and no binding laws have been introduced till date. India is more focused on creating its own digital currency i.e. Central Bank Digital Currency (CBDC), introduced by RBI in its Press Release dated October 7, 2022.  The Reserve Bank even entered into an agreement with the Central Bank of the United Arab Emirates (CBUAE) to collaborate on FinTech initiatives, including cross-border CBDC payments.

The absence of a clear definition on cryptocurrency poses great uncertainty about the legality of cryptocurrency. In the absence of comprehensive legislation on VDAs the potential misuse of VDAs are restricted under the existing regulatory framework which is a fragmented approach to provide safety and stability for investors and businesses.