While cryptocurrencies are not particularly regulated in India, they are not completely unrestricted either. There are enough sound bites from various arms of the government that imply that cryptocurrencies are frowned upon and may not be expressly permitted. A Reserve Bank of India circular in 2018 asked banks not to deal with or service entities involved with virtual currencies. However, the Supreme Court in 2019, in Internet and Mobile Association of India vs Reserve Bank of India, struck down this circular. Banks were asked to carry out due diligence for transactions in virtual currencies, under existing regulations related to anti-money laundering, foreign exchange and combating terrorism financing.

Furthermore, the government — via the Finance Act, 2022 — promulgated the definition of ‘virtual digital assets’, which covers cryptocurrencies, and imposed a 30 per cent tax on their transfer. In February 2022, the Advertising Standards Council of India issued guidelines for advertising and promoting virtual digital assets and services, directing advertisements to include a disclaimer on the risk of loss from such transactions with no regulatory redress. Due to these grey areas, the question remains over how best to regulate cryptocurrencies with transparency?

First, investors require increased transparency in terms of security and compliance. This will compel exchanges to practise more self-regulation and hold themselves to higher standards and purify the ecosystem, leaving only serious actors who understand the importance of developing trust to conduct business.

The Union Budget 2023 is expected to have a big impact on the future of cryptocurrencies in India. Finance Minister Nirmala Sitharaman has lobbied for a concerted international effort to regulate cryptocurrencies. If this goes through, India may be able to take a lead in this domain by 2023.

Second, since there are no independent prudential laws or robust consumer protection laws for crypto assets, India might seek guidance from the Financial Stability Board, a global standard-setting organisation.

The board had published a framework for the regulation, oversight, and management of crypto assets and markets for public feedback in October 2022.

Roadmap for regulation

The document had nine recommendations covering governance and risk management proportionate to risk and complexity, adequate disclosures, and a structure for data collecting, recording, and reporting. This should act as a roadmap for regulation of crypto assets.

Third, the RBI may use blockchain technology to regulate the cryptocurrency market. It may contemplate awarding cryptocurrency exchange licences after thorough record-keeping and compliance inspections. It may implement a structure mandating transmission of transaction records to the RBI, among other things. This should boost investor protection while also improving transaction security and reducing criminal activities.

Lastly, the Securities and Exchange Board of India (SEBI) may create a control mechanism for the trading features of cryptocurrency transactions. This would instil confidence in traders by minimising the chance of theft. Businesses may participate in initial coin offerings (akin to initial public offerings) to raise capital by issuing tokens in return for cryptocurrencies. SEBI can supervise and develop a return mechanism to protect investors in the event of a poor delivery.

Way forward

The RBI concept note on ‘central bank digital currency’ (CBDC) has proposed the digital rupee as an ‘alternative’ to cryptocurrencies. However, crypto businesses have criticised this stance, arguing that cryptocurrencies and CBDC can coexist because they are not equivalent. While the CBDC pilot was launched in November 2022 in the wholesale segment and in December 2022 in the retail segment, within a closed user group, it is still early days.

Besides cryptocurrency, investors and the government must embrace blockchain technology.

Scams like FTX may have less impact on Indian cryptocurrency investors due to the country’s strict tax legislation. However, such issues will likely continue to pop up in 2023, owing to weaknesses in both centralised and decentralised schemes. It is critical to fortify the cryptographic architecture. The cryptocurrency ecosystem is expected to see a surge in technology developments for improved security and transparency, and the regulations may consequently change. Further, the technological application of cryptocurrencies is expected to rise, culminating in the establishment of a new asset class for investment. Given the size and potential of India’s crypto markets, the government’s decision will have a significant impact on the direction, growth, rights, and reliefs associated with this technology, as well as on the cryptocurrency community as a whole.

(The writer is Partner, King, Stubb and Kasiva, a law firm)