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How to Make Sense of the Chaos in India’s Crypto Space

How to Make Sense of the Chaos in India’s Crypto Space

From payment disruption to the crypto bill getting delayed, there are many challenges when it comes to investing in virtual currencies. In the absence of formal regulations and guidelines, how wise is it to buy or hold cryptos in India?

Illustration: Nilanjan Das Illustration: Nilanjan Das

What do you do when your entire life’s savings vanishes in a puff of smoke? Or, when you can no longer access the money you have painstakingly saved for a rainy day?

Netflix’s latest documentary—Trust No One–The Hunt for the Crypto King—answers parts of these questions and serves as a cautionary tale for people invested in the cryptocurrency market. Watching the documentary and understanding its implications can make you grasp your Bitcoin a little closer to your chest or withdraw from the market entirely.

The true crime documentary depicts the story of a 30-year-old Canadian, Gerald Cotten, Co-founder and CEO of QuadrigaCX—a Canada-based cryptocurrency exchange—who died under mysterious circumstances in Jaipur.

Cotten’s death due to complications from Crohn’s disease, while leaving his customers in a financial lurch, raised as many questions as the amount of money it rendered inaccessible for his customers. Investigations into his death carried out by financial regulators, journalists and QuadrigaCX’s customers in Canada and the US revealed many sordid details. foremost among them was the allegation that he had been defrauding his customers since long before his death in December 2018.

While his death not only rendered nearly $250 million in cash and cryptocurrencies inaccessible, since he stored them in a wallet protected by a unique key—which apparently only he knew—it also highlighted how vulnerable cryptocurrency users’ money really is.

A closer look at the ledgers of the wallets revealed that he had many fake accounts within QuadrigaCX and used fake funds to buy real cryptos from other customers which he traded on other exchanges in the hope of making a quick buck. What’s more distressing is that the documentary reveals that he lost all the money he siphoned off QuadrigaCX’s customers, rendering the company unable to honour withdrawal requests following the 2018 cryptocurrency crash.

While Cotten’s shenanigans not only left millions of people in limbo with their cryptos lost forever, it also opened a Pandora’s Box of questions relating to the safety and security of crypto exchanges across the world.

“With crypto wallets that hold large sums of crypto, it is important to distribute the keys and have very clear access, backup and recovery protocols in place. Most of the popular exchanges today have highly evolved security measures and protocols in place. At CoinDCX, we have a 24-hour cooling off period, withdrawal passwords, trusted addresses, etc., which are considered best practices for security globally,” says Manhar Garegrat, Executive Director of Policy and Special Projects at CoinDCX.

While so far no such default has happened in India, things are more than chaotic when it comes to cryptocurrencies. From high tax rates and a lack of regulations to payment disruptions, crypto exchanges in India are grappling with multiple challenges. Given the peculiar nature of questions surrounding cryptocurrencies, the one question that most people ask is: Is it worth investing in crypto now?

Crypto markets are in turmoil in India and across the world. With liquidity drying up due to the Reserve Bank of India’s (RBI) rate hike and the rising dollar index, trading activity in cryptos has fallen and so has its price. The US-based crypto exchange Coinbase’s recent Q1 earnings report, too, shows a sharp dip in retail trading volumes. Bitcoin’s year-to-date return has also come down by 40 per cent while Ethereum is down 50 per cent. Bitcoin and Ethereum are currently trading at around $28,000 and $2,014, down from the highs of $68,000 and $4,891 in 2021. The carnage in smaller coins is much steeper. Take the price of Luna that has dropped from above $100 a few months ago to near zero in the current price crash. While trading volumes and crypto prices are down globally, there are several domestic factors as well that put a question mark on the future of cryptocurrencies in India.

The Wall of Payment

In India, banks and mobile wallets have stopped supporting crypto exchanges, leading to a sharp decline in trading volumes. The services were disconnected because of the RBI’s strict stance against cryptos. Recently, speaking at an earnings call to discuss their first quarter financial results, Coinbase CEO Brian Armstrong said that it disabled its Unified Payments Interface (UPI) services because of “informal pressure” from the RBI.

“India is a unique market, in the sense that the Supreme Court ruled that they can’t ban crypto, but there are elements in the government, including the RBI, who don’t seem to be as positive on it,” he said.

Soon after Coinbase’s announcement that it would allow users to purchase cryptos using UPI—an instant, real-time payment system—it came under the regulatory lens. The National Payments Corporation of India (NPCI), an umbrella organisation for operating retail payments and settlement systems that oversees UPI, released an official statement clarifying, “we are not aware of any crypto exchange using UPI”.

The sudden suspension of UPI services has left the exchanges in the lurch. Exchanges are now resorting to peer-to-peer (P2P) transfer of cryptos in the absence of banking services. “There is a significant decrease in volume but much of it can be attributed to a lack of support from banking channels. We have re-launched P2P trading to ensure customers are able to access crypto seamlessly,” says Vikram Subburaj, CEO of Giottus Crypto Exchange.

Given the RBI’s clear stance on cryptos, payment services are keeping a safe distance from cryptocurrency exchanges in India. “We, as an intermediary and a soon-to-be licensed payment aggregator, are very clear that we are not processing any payments of any crypto exchange,” says Vishwas Patel, Executive Director at Infibeam Avenues.

After the Supreme Court’s judgement, crypto exchanges flourished in the country, but their expansion plans hit a wall when banks pulled their payment API integration from the exchanges. Though there was no notification from the RBI after the ruling, banks were informally told to stop their services to exchanges.

“We are all aware that a regulatory framework for emerging technology will require deliberations and take time. However, to constrict an Indian extension of a global industry that is making honest efforts at self-regulation and compliance comes across as disproportionate,” says Garegrat of CoinDCX.

Taxation Tales

Another reason for the decline in trading volumes and turnover has been the imposition of a 30 per cent tax on crypto gains from April 1, 2022. The Finance Bill, 2022, inserted a new section—115BBH—to tax the income arising from the transfer of Virtual Digital Assets (VDA) with no provision for setting off and carrying forward unclaimed losses. Market players say that while taxation is a welcome step as it gives a kind of passive acknowledgement from the government, they fear that such a high tax rate can impact the liquidity in the market. “Taxation is welcome as it brings clarity to the ecosystem. However, we don’t quite agree with the quantum of tax levied,” says Subburaj of Giottus.

There is a bigger problem for exchanges that can potentially reduce the liquidity from the market: the 1 per cent Tax Deducted at Source (TDS) for every transaction. Exchanges argue that frequent traders may fall short of capital if TDS is deducted for every trade. Traders might have to resort to trades below the TDS trigger limit to circumvent it or operate in foreign exchanges. “Crypto is all about anonymity. So now with the 1 per cent TDS, the anonymity of crypto has gone,” says Patel of Infibeam Avenues.

Subhash Chandra Garg, a former finance secretary, is blunt: “This argument is very flawed. Crypto transactions are transactions where everything is recorded and nothing gets unrecorded. So, to trace or get the record, the government should figure it out or even mandate exchanges to provide the trail of transactions. Taxation is a very harsh, lumpy and blunt kind of measure.”

Companies in Flight

Another emerging trend after high taxes were levied on crypto trading in India is exchanges shifting their base of operations outside the country. Founders such as Nischal Shetty of WazirX have already shifted their base to Dubai while others are considering the idea.

“The current tax framework does make it extremely onerous for crypto start-ups. As far as CoinDCX is concerned, we are committed to India and are looking at building a strong crypto ecosystem in the country. To support this, we are setting up an innovation centre, which will help start-ups and developers further blockchain adoption. In addition, we have plans in the pipeline to expand our crypto investor base but such plans are in the early stages of discussion,” says Garegrat.

In case of any untoward event in the future, companies with a significant customer base in India, but operating from foreign shores, could be a disaster in the making since unprotected customers would be left holding the bag if the exchanges go bust, as it happened in the case of QuadrigaCX. Such a risky outlook necessitates tighter laws around companies that operate in the country. “The right set of regulations can reverse the brain drain and bring the Indian start-ups back that are currently based outside India for tax/lack of policy clarity reasons. We should create incentives to make India the crypto capital of the world. It is not hard to imagine crypto as the future of the internet and India should not lose out,” adds Subburaj.

The RBI has been quite clear about its stance on cryptos, but the government has been ambiguous, and due to the taxes imposed on them, a lot of volume is shifting to international destinations. “Without passing the crypto bill, they decided to tax the trading—that too with no clause for offsetting losses. Only investors/traders with deep pockets are likely to take any meaningful position post this set-up,” says Amit Gupta, Founder and CEO of Fintrekk Capital, a financial research firm.

The Bill Hangs fire

Designed initially to function as a currency, cryptos are now used more as an asset given their extraordinary returns over the past few years. So, the vexing question yet to be answered is, is crypto a stock, a commodity or a currency? Policymakers need to address these questions and then some. They need to figure out who should regulate the sector. Whether it should be treated as an asset and be regulated by the Securities and Exchange Board of India (Sebi), or whether it should be treated as a currency and brought under the purview of the RBI, or whether a new entity should be created, given their complex nature?

The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, was listed in Parliament last year but is yet to be tabled for discussion. The bill deals with three issues, one is the Central Bank Digital Currency (CBDC); the second is promotion of blockchain technology; and the third is about banning private cryptocurrencies. So, the question is, when will the crypto bill be passed in India?

“The government is more concerned about currencies and taxation, which have already been dealt with separately. So in my judgement, that bill which was being prepared is a meaningless piece of draft now. I don’t see any reason or possibility that the government will come out with any law,” says Garg. Incidentally, the crypto bill was designed by a committee headed by Garg.

In the absence of any clarity on regulations, cryptos are still traded on exchanges in India, leaving millions of people exposed to the risk of losing their money.

“You have the Prime Minister saying that crypto poses an imminent threat and the world should come together to solve it. The RBI is also very clear in its stance against crypto exchanges. Everybody agrees that crypto coins have no underlying assets,” says Patel of Infibeam Avenues.

Having said that, while across the world, many countries such as Japan, Singapore, the UK, and the US have implemented regulatory frameworks for cryptos, when it comes to India, the authorities are still trying to find answers. The fact that taxing cryptos does not make them legal and it is still an unregulated market leaves the possibility of banning or regulating the sector wide open.

Indian exchanges, meanwhile, claim that they have been following a self-regulatory approach, which includes abiding by KYC verification and anti-money laundering (AML) compliance policies. “Crypto exchanges in India, registered as part of BACC (Blockchain and Crypto Assets Council), adhere to mandatory KYC measures as well as other security measures such as transaction monitoring to ensure a safe environment for all investors. There are always risks with respect to wallets owned by exchanges, which we try to mitigate. We encourage users to keep their funds in hard wallets (key-sized physical devices which store private crypto keys offline and connect to a computer via USB) where possible,” says Subburaj. BACC is an industry body of crypto exchanges in India and a part of the Internet and Mobile Association of India (IAMAI).

Given that exchanges have full ownership of virtual tokens and there have been umpteen instances where exchanges were shut down or hacked, experts say there is an urgent need for stringent regulation of crypto exchanges. They are currently self-governed, but that may not be enough given the large user base of these exchanges.

Going back to Cotten, he ran the business from his laptop and had exclusive access to the majority of funds. The same chapter should not be repeated in India. A clear regulatory environment can help millions of Indians in making the right decision.

 

@teena_kaushal