Virtual Digital Assets (VDAs), more popularly known as cryptos, have experienced explosive and unfettered growth over the past few years. In India, these instruments were largely unregulated till the early part of 2022. The Wild-West-like frenzy surrounding crypto assets led to an estimated 100 million people (85% of them under the age of 35) investing in these assets. As a result, Virtual Asset Service Providers (VASPs) such as crypto exchanges, platforms, and other intermediaries mushroomed.
For the first time in 2022, the central government started tightening the noose around crypto assets, with earnings being brought under section 2(47A) of the Income Tax Act, 1961 and taxed at 30%. In addition, recently, these assets have been brought under the purview of the Prevention of Money Laundering Act, 2002 (PMLA) as well. It denotes a significant regulatory shift and the determination of the government to tame this wild horse of the digital frontier. Consequently, the VASPs are now in the same bracket as financial institutions, intermediaries, and banking companies.
PMLA enables the central government to confiscate property and money earned through illegal proceeds and sources. The act covers any and all information, code, number or token (that is not a currency of a sovereign nation) that is generated through cryptographic processes and can be transferred, stored, or traded electronically. It also includes a non-fungible token (NFT) or any other token of similar nature. All cryptocurrency exchanges, NFT platforms, cryptocurrency custody solutions and wallet providers, crypto lending and borrowing platforms, crypto launchpads, crypto payment gateways, crypto staking platforms and service providers facilitating initial coin/token offerings and executing SAFTs, among others, are now regulated entities under the PMLA.
After the introduction of taxation in 2022, an estimated 1.7 million Indian VDA users and cryptocurrencies worth over $3.8 billion in trading volume have switched from domestic centralised VDA exchanges to their foreign counterparts. In a recent Lok Sabha session, the Minister of State for Finance informed the lower house that the enforcement directorate (ED) was investigating several cases of crypto fraud wherein crypto exchanges have been indulging in money laundering. It was further revealed that assets worth INR 936 crore have been attached as proceeds of crime. By bringing VDAs under PMLA, the authorities have now been enabled to monitor their transfer from India to foreign countries.
From hereon, VASPs will be required to perform Know Your Customer (KYC) on their clients. In addition, these VASPs are now obligated to report suspicious activity to the Financial Intelligence Unit India. As such, people found guilty of money laundering under the guise of digital assets now face imprisonment for a term of anywhere between 3 years and 7 years, along with a fine. They also carry the risk of their property being seized and attached during the course of proceedings. With this, the government has tightened its grip on individuals abusing VDAs by prescribing punishment for money laundering on offenders.
VASPs will now be required to build appropriate internal infrastructure in order to comply with the new requirements. They are required to conduct client KYC at the time of account opening and whenever a transaction or connected transactions equal to or above the value of INR 50,000 take place and for all international transactions. An electronic copy of the KYC must then be filed with the Central KYC Records Registry within 10 days of account opening.
These enterprises are now required to maintain records of all transactions, including cash transactions above INR 10 lakh, for at least 5 years. These transactions include any exchange between VDAs and fiat currencies, any exchange between one or more types of digital assets, and any transfer of these assets, among others. In addition, records of all series of cash transactions individually valued below INR 10 lakh that are integrally connected with each other need to be maintained if they take place within the same month and the aggregate exceeds the 10 lakh threshold. International transactions of value over INR 5 lakh with either origin or destination being India must also be maintained for the 5-year period.
Principal Officers must now be appointed by these service providers who will be responsible for furnishing information to the authorised officer of the government. An internal mechanism for detecting suspicious transactions has to be developed. These transactions then need to be reported within 7 days of being satisfied as dubious. Failure to comply with the requirements of PMLA can result in a monetary penalty on a director of the board or an employee to the tune of INR 1 lakh for each failure.
With shady transactions being constantly reported, bad actors will be quickly identified and eliminated. Consequently, the restored credibility of VASPs will increase consumer confidence and aid in luring institutional investment. Taking the long-term future of the VDA sector into consideration, these steps are certainly in the right direction. Reinforcing the compliance infrastructure will reduce instances of fraud and other financial harm. It also ensures that VDAs are not used in illicit manners that are inconsistent with the broader economic policies. It prevents tax evasion, money laundering, and terrorist financing and integrates cryptocurrencies within the existing financial framework. The herders will need to keep a tight rein on these wild colts to modulate the digital frontier and safeguard innocent investors from the stampede.