Regulation of Cryptocurrency Exchanges in India

The judgment of the Supreme Court on March 2020 quashing the Reserve Bank of India’s (RBI) ban relieved many stakeholders in the crypto-ecosystem[1]. One such player was crypto exchanges. Crypto exchanges or digital asset exchanges essentially allow the user to buy or sell crypto assets (popularly known as cryptocurrency[2]) using their fiat money like INR. Currently, there are around 400 known exchanges that globally trade digital assets including cryptocurrencies. Unlike for any bank or financial institution, there are no specific regulations for these exchanges in India.

A well-known crypto exchange provides in its terms and conditions that it is not a financial institution, bank, credit union, trust, hedge fund, broker or investment, or financial advisor, and is not subject to the same laws, regulations, directives, or requirements applicable to such persons. Further, it is merely a technology platform and the user is solely and entirely responsible for the legal, regulatory, and tax compliance of all transactions carried out by the user.

This contractually seeks to takes away from the user various remedies the user could have if the exchanges are classified as any of the above institutions. So far, neither the government of India has brought these exchanges under the purview of any existing law nor is there any judgment defining, determining or classifying what these institutions are? This article seeks to clarify the nature of these exchanges, explore what existing laws may govern them, and possible treatment under existing and new legislation.

Modus Operandi of Crypto Exchanges

Crypto exchanges or digital asset exchanges are virtual places where one can buy or sell crypto assets or other digital assets via a bank or credit card or from various coins on the open market. The primary function of the crypto exchange is to provide a platform to buy and sell crypto assets or crypto currencies. When a user resident in India (according to terms and conditions of the aforesaid crypto exchange) transfers money on the app of the exchange, (s)he gets cryptocurrencies worth of the deposited amount after deducting the exchange fee. In the same way, (s)he can withdraw money by selling her/his cryptocurrency to the exchange. However, a crypto exchange has other functions too. Initial Exchange Offering (IEO), for instance, is a way to seek funds for your company in a process supervised by a crypto exchange. Unlike an Initial Coin Offering (ICO), where the tokens are offered to the general public, under an IEO, only users of the exchange platform administering the IEO are allowed to participate in the process. For example, WazirX launched the first Indian IEO on a crypto exchange Binance in February 2020. These offers are screened by the exchange, thereby creating a verification process (which is not available in the process of the ICO leading to the higher risk of scams). These exchanges can also hold custody of assets or funds. In addition to this, they are also involved in the clearing and settlement of cryptoassets.

Tatva Legal, Hyderabad has an experienced team of corporate lawyers who, amongst other services, advise on niche areas of law involving crypotocurrency, blockchain technology, AI and machine learning and other such areas involving [TL1] information technology law.

Cryptocurrency is not a legal tender in India, but so far it has not been prohibited under any law. There is no clarity concerning who would be the regulator for the industry. That largely depends upon the classification of the crypto asset, something which the Indian government has been shying away from, till now. For instance, if it is classified as a security, then the Securities and Exchange Board of India (SEBI) would be the regulator and if it is recognized as a legal tender, then the Reserve Bank of India (RBI) would be the regulator.

As any for-profit organization, they are required to comply with various commercial laws, labour laws, tax laws (though it is not clear what is the nature of cryptoasset, according to the CEO of one cryptocurrency exchange, the income of the exchanges are taxed under ‘income from other sources’), PAN (Permanent Account Number) requirements and other relevant local laws. However, there no special regulations for crypto exchanges.

Generally, these exchanges voluntarily perform certain banks’ obligations like ‘Know Your Customer’ (KYC) norms to prevent offences like money-laundering and terror financing. Further, to comply with the provisions of the Foreign Exchange Management Act, 1999 (FEMA), these exchanges provide disclaimers in their User Policy like the one given below:

“Foreign Users cannot in any circumstance receive or make payments in Indian Rupees or equivalents or any other fiat currency or equivalents (otherwise referred to as ‘real money’ or ‘fiat currency’). Foreign Users can only use the Services to trade between Supported Cryptocurrencies without any interface to fiat currency.”

Such provisions prevent foreigners from transferring value (currency) across the borders without complying with Indian laws.

Reserve Bank of India has issued regulatory guidelines on Know Your Customer (KYC) norms / Anti Money Laundering (AML) Standards / Combating of Financing of Terrorism (CFT) from time to time[3]. However, they may currently not include crypto exchanges under their ambit. Prevention of Money Laundering Act, 2002 is the primary anti-money laundering legislation in the country. The reporting entity (i.e., banks, financial institution, etc.) are required to perform certain obligations such as record-keeping. Unlike countries like Australia, which have expanded their anti-money laundering legislation and counter-terrorism legislation to include such exchanges, the government of India has not yet brought them under the scope of the Act.

How Do Foreign Jurisdictions Treat Crypto Exchanges?

While undoubtedly different countries approach crypto assets differently, those who are pro-regulation, generally require registration or licencing of crypto exchanges (by whatever name they are called). Singapore passed the Payment Services Act, 2021 on January 1, 2021 which requires any entity that facilitates the transmission, exchange, or storage of digital payment tokens (DPT) (alternatively known as cryptocurrencies) to be licensed as a standard payment institution before operating and dealing with digital payment tokens[4].

Certain countries like Australia and Canada have expanded their laws on money laundering, counterterrorism, and organized crimes to include cryptocurrency markets, and require banks and other financial institutions (which include such exchanges) that facilitate such markets to conduct all the due diligence requirements imposed under such laws.

Conclusion: Need of Regulation rather than a Ban

India is at the nascent stage of crypto asset regulation. The Government of India has stated in the 1st phase of the 2021 Budget session of the Parliament that it shall bring a bill to completely prohibit the mining, buying, holding, selling, dealing in, issuance, disposal or use of cryptocurrency. While it is yet to be seen if such a ban is enforceable or not (given that you only need a computer and internet to do a cryptocurrency transaction), cryptocurrency exchanges in fact allow the government, to some extent, to regulate the cryptocurrency industry (by providing information about the users under KYC norms) and ensure that laws like FEMA are complied with. An outright ban has the possibility of bringing this entire industry underground. Regulation rather than a ban, thus, appears to be a more suitable way to deal with crypto assets. Enlarging the scope of anti-money laundering and counter-terrorism laws would be a good start. A specific law providing how should these exchanges operate, a procedure to select the crypto assets to be traded on their platforms, a disputes resolution mechanism for the users, educating the general public to avoid scams in the industry, and probably a regulator to deal with the industry would address a lot of issues and facilitate the Indian economy to take advantage of this remarkable invention of the century. T

The views and opinions expressed in this article belong solely to the author and do not reflect the position of Tatva Legal, Hyderabad.

[1] (2020)10 SCC 274

[2] The phrase “Crypto currency” is used the generic popular sense. In the previous article, we have discussed in detail regarding the nature of crypto assets @ cryptocurrency (will hyperlink the Karan/Rishi’s article here).

[3] RBI/ 2008-2009/72

[4] Section 6, The Payment Services Act, 2021.