New Delhi, India- October 16, 2018: Bitcoin India
India’s latest decisions governing cryptocurrency portend turbulent times ahead for the country’s nascent but booming digital currency industry.
During its launch event in India on April 7, American cryptocurrency giant Coinbase announced that its Indian investors would be able to use the country’s popular online payments system, UPI, to transfer funds to its local exchange. The pronouncement effectively operationalized the exchange in the world’s second-largest internet market.
But hours later, the National Payments Corporation of India (NPCI), the regulatory agency overseeing UPI, released a terse, one-sentence statement claiming it was unaware of any cryptocurrency exchange using the payments system.
Just three days later, Coinbase was forced to suspend all crypto payment services in India. The swift and dramatic about-face deprived Coinbase customers the means to fund their accounts with rupees, jeopardizing the company’s expansion plans before they had begun.
The debacle is the latest example of the regulatory uncertainty cryptocurrency exchanges are confronting in India despite—or perhaps as a result of—their popularity in the country.
Cryptocurrency in India has gone a long way in a short time. Digital currency exchanges were virtually nonexistent in India five years ago. Now, approximately 15–20 million investors are holding more than $5.3 billion in crypto, according to a Reuters report, citing industry estimates, representing the second-largest number of crypto traders worldwide. Virtual assets have garnered particular traction among India’s millennial population.
Cryptocurrency’s growing success in India has spawned several successful indigenous exchanges, such as WazirX, ZebPay and CoinDCX. It has prompted foreign heavyweights like Coinbase to establish operations in the country and invest significantly in their domestic counterparts.
According to a report released last year by blockchain data platform, Chainalysis, India ranked second among nations witnessing the fastest growth in digital currency use, with the Indian market growing 641% over the period from July 2020 through June 2021.
Cryptocurrency’s rapid success in India has triggered calls for industry regulation, including from the industry itself. The crypto sector has sought a stable business environment governed by clear and predictable regulatory and policy regimes.
“Regulators on an international level recognize legitimate uses for cryptocurrency, and are developing normative standards for countries to use as guidelines for regulating the sector,” explains Laurel Loomis Rimon, partner and crypto expert at Paul Hastings LLP.
Instead, New Delhi has created a byzantine regulatory framework that leaves basic questions unanswered, chief among them whether cryptocurrency trading in India is even legal.
In 2018, India effectively banned all crypto trading, instructing the country’s banks not to service customers exchanging digital currencies. Although the Supreme Court overturned the ban in 2020, the government, led by the Reserve Bank of India (RBI), continued to make no secret of its discomfort with crypto. Top officials voiced concerns that cryptocurrency could jeopardize India’s economic stability while facilitating terrorist financing and money laundering.
Last November, Indian lawmakers drafted legislation seeking to bar cryptocurrency trading, but tabled it following industry-wide panic and plummeting digital token prices.
In February, Indian Finance Minister Nirmala Sitharaman announced plans to launch its own cryptocurrency next year, while unveiling two new taxes on digital currencies: a staggering 30% tax on income generated from crypto transactions and a separate 1% tax on “source on all transactions,” which would be imposed on the exchange itself.
“There’s been a phenomenal increase in transactions in virtual digital assets,” Sitharaman said. “The magnitude and frequency of these transactions have made it imperative to provide for a specific tax regime.”
The impact has been swift. Trading volume of India’s exchanges plummeted by nearly 70% according to industry data, with some exchanges experiencing plunges greater than 90% in recent weeks.
Industry experts have begun to warn of other far-reaching consequences for the cryptocurrency sector, including a brain drain and a liquidity crisis across the country. Despite this, many insiders asserted that the government had finally legitimized cryptocurrencies in India by imposing the new taxes.
On Twitter, Binance triumphantly declared, “Crypto just became legal in India! The Indian government has cleared confusions in the form of a crypto asset tax law.”
Nischal Shetty, founder and CEO of WazirX, was more measured, but maintained that “India is finally on the path to legitimizing the crypto sector in India,” and expressed his hope that the new taxes would remove “any ambiguity for banks, and they can provide financial services to the crypto industry.”
Shetty’s hope appears misplaced. Sitharaman noted that the government’s decision to tax digital currencies did not mean they were suddenly legal. “I don’t wait [until] regulation comes in for taxing people who are making profits,” she noted.
Finance Secretary TV Somanathan went further saying, “Bitcoin, Ethereum or NFT will never become legal tender” and reflected New Delhi’s position by noting the government was taxing earnings at the exact same rate as “winnings from horse races, or from bets and other speculative transactions.”
Deputy RBI Governor T. Rabi Sankar was even more direct, warning in a recent speech that digital currencies “may even be worse…than a Ponzi scheme,” and concluded that “banning cryptocurrency…is the most advisable choice for India.”
What do crypto companies need to know given the absence of a clear regulatory framework guiding India’s digital currency sector?
First, it is unlikely that exchanges operating in India will obtain clarity from the government anytime soon. Relevant draft legislation remains dormant and the central government has yet to release any actual regulations concerning digital tokens. Speaking recently at Stanford University, Sitharaman summed up the sentiment in New Delhi succinctly, simply noting that the government’s approach toward crypto “can’t be rushed.”
Second, crypto exchanges would be wise to engage external counsel given this regulatory ongoing uncertainty in conjunction with the government’s willingness to tax the sector. Just recently, New Delhi signaled its intent to levy an additional 20% tax on gains earned on cryptocurrencies from platforms outside of India. What this means long-term for the industry remains unclear. “One of the early challenges of regulatory oversight of cryptocurrency is the need to identify which existing laws and rules apply, and where there is a need for entirely new laws,” Rimon noted. The right law firm can help companies navigate the evolving tax and regulatory regime and help the exchange avoid expensive operational and legal mistakes.
Third, despite these formidable challenges, India continues to offer significant promise for cryptocurrency exchanges. Companies like Coinbase recognize that India’s population is shifting younger while Internet penetration and digital asset adoption rates will only continue to climb. Exchanges will have to evaluate how long they are willing to wait and what they are willing to tolerate from New Delhi in light of recent developments.
(Disclosure: Binance announced a strategic investment in Forbes on February 10, 2022.)