A Legal Perspective on Cryptocurrency in India: Risks, Regulations, and Road Ahead

AUTHOR: ATHARV BHATKHANDE, SCHOOL OF LAW AND PUBLIC POLICY, AVANTIKA UNIVERSITY

Introduction

3.07 trillion dollars is the current value of the cryptocurrency market on the global level which is just shy of the "L' Hexagone" or France which stands at an economy of $3.21 trillion dollar while on the other hand the cryptocurrency market in India is expected to see, reach a staggering amount of US$6.4bn by 2025. By 2025 the Indian cryptocurrency market is expected to see 107.29m users which is a major chunk of the Indian population. Cryptocurrency plays a very crucial role as it is not governed by any government and is not able to be tracked easily. Which makes it a hotspot for illegal sectors. Which makes it a crucial point to discuss. The need to discuss it is because of the unknown potential of cryptocurrency which is still yet to be identified. There are chances that the unknown harm is only known to crypto geeks and the general population is unaware of them. In this evolving world where the major portion of products is filtered and unfiltered cryptocurrency which is not governed by anyone makes it a very vulnerable product for misuse whether it is organized crime or unorganized crime. As allowing cryptocurrency is deemed as not good should it be banned or can it even be banned? No government can curb it successfully or promote it. Cryptocurrency had an unparalleled burst during the COVID era. Billionaires were seen promoting cryptocurrency. Billionaires were made due to cryptocurrency and people went bankrupt due to cryptocurrency. The world has seen all but what was unchanged are the crimes associated with it. The chance of crime reduction seems impossible but there is a famous quote “Prevention is better than cure” Stringent laws need to be made or some attempts need to be made a change in the world or we should promote cryptocurrency and take it as a positive thing as it is not controlled by anyone hence can’t be manipulated which makes it a very ground-breaking innovation and can be revolutionary on the evolution of mankind.

Historical and Evolutionary Background

Cryptocurrency as a concept was first mentioned by David Chaum in the year 1989 and later in the year 1990. The digital currency was created by David Chaum who was an American Cryptographer. A pseudonym of a group of programmers referred to as Satoshi Nakamoto released a paper titled “Bitcoin: a peer-to-peer electronic cash system. The most expensive cryptocurrency of the century “Bitcoin” was created by Satoshi Nakamoto in 2008 the origin of cryptocurrency came into existence or rose up due to the financial crisis of 2007 -2009. The Financial crisis made the developers think of creating cryptocurrency as the faith in the fiat currency was in despair. Cryptocurrency emerged in India for the first time around 2009 in the form of Bitcoin. It was in the year 2010 that the first commercial transaction occurred followed by the first Cryptocurrency exchange in the year 2013. Bitcoin was not able to capture the market or get recognition until it was mentioned by Forbes in 2011 which laid a good foundation for it and made it rise to 9 dollars as compared to the 1 dollar it was earlier dealt with. Bitcoin was soon traded in triple digits but suffered a major blowback when Mt. Gox a major exchanger lost 850,000 BTC to hackers due to a security breach. Which harmed a lot the reputation of bitcoin. This led to the birth of the second most famous cryptocurrency Ethereum. Ethereum was the first organization which gave birth to NFTs or Non-Fungible Tokens and DeFi decentralized finance application. The rise in bitcoin made the rise of new things like the Altcoins in 2011 Litecoin was first who was first launched as altcoin. Ethereum came into existence as Altcoin. The idea of ICOs and tokenization came into existence where ICO or Initial Coin Offerings became a very trendy model where startups issue tokens to raise their funds for the startup.

Definitions and Legal Classifications

To understand cryptocurrency is essential to know about virtual currency as cryptocurrency is the species and virtual currency is its genus. Virtual currency under box 3.4 of RBI says “Virtual Currency as a type of unregulated digital money, issued and controlled by its developers and used and accepted by the members of a specific virtual community” while the FATF defines it as “As a digital representation of value that can be traded digitally and functioning as a medium of exchange, a unit of account and a store of value but not having a legal tender status”.

Virtual currency is altogether different from fiat currency. According to Britannica Money in simple terms is money that is made legal tender by a government decree or fiat. On the other hand, cryptocurrency doesn’t have any type of physical form.

Merriam–Webster defines cryptocurrency as any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions. Cambridge defines it as a “digital currency produced by a public network, rather than any government, that uses cryptography to make sure payments are sent and received safely”. The Indian organization defined FATF reported as potential AML/CFT Risks and “A math-based, decentralised convertible virtual currency that is protected by cryptography”.

To better understand cryptocurrency:

By mining, they are created i.e. solve complex cryptographic algorithms through computer power with the maximum number of coins that exist.
No organization or entity controls it but its value can be defined in various fiat countries of the world.
Supply and demand are the only determinants of its value.
Just like fiat currency, their purpose is to use in exchange for goods or services. \

Current Regulatory Landscape

Various governments or countries have tried to create a successful framework to deal with cryptocurrency. Cryptocurrency has existed since 2009 and is still working out how to govern it successfully. Countries like the UK, Japan, and Australia deem that they are legal tender while countries like Canada and China don’t consider them as legal tender. The stance of India regarding cryptocurrency is neither dormant nor active. India is still in dilemma whether to take it as full fletched currency or as a fake currency or not legal tender.

The Rbi deemed cryptocurrency as a VDA is unregulated, which could lead to potential financial instability. The RBI's take on that was that since it can be monitored it will be used for money laundering and other illegal activities and in April 2018 barred institutions (banks) from providing services to businesses involved with virtual currencies through a circular. This cut the lifeline of cryptocurrency as it prevented cryptocurrency from being exchanged for fiat currency. The ban was lifted by the honourable Supreme Court in the landmark judgement of IMAI v. RBI after that the Indian government decided to formalize this and introduced a bill that proposed to ban private cryptocurrencies while simultaneously laying the groundwork for Central Bank Digital Currency (CBDC) in the year 2021.

SEBI or Securities and Exchange Board of India primarily encompasses securities and always says that cryptocurrency does not come under the ambit of “securities” defined under section 2(h) of the Securities Contracts (Regulation) Act of 1956. SEBI considers cryptocurrency as a kind of Ponzi scheme and does not consider it as a reliable source. As of now SEBI specializes in managing centralised securities markets, and the decentralisation of DLT transactions presents a significant hurdle.

Due to cryptocurrency’s dynamic nature, it will come under the ambit of both RBI and SEBI and both will be required to work together to create a strong regulatory landscape. To achieve this the government introduced a bill in 2023 which could streamline their roles and cover legal status, compliance requirements for exchanges, tax implications, and AML/CFT measures. Since cryptocurrency operates across borders, it complicates enforcement and monitoring. The future regulatory landscape will make sure that Stricter AML and KYC Norms are enforced. A proper education of investors by SEBI to make sure that there are no fraudulent activities. The regulation must be of a global standard that aligns with the standard of the International Organization of Securities Commissions (IOSCO). The regulation of cryptocurrency is still in progress. RBI and SEBI will need to put their best game and use the best technology as the cryptocurrency is based totally on technology. India's approach towards cryptocurrency needs to take sides and RBI and SEBI need to help make decisions and create a strong and adaptable regulatory landscape.

Taxation and Compliance Framework

Tax is an important component of every nation. With certain nations dependent wholly solely on taxes only. In India, Virtual digital assets like cryptocurrency, and NFT are subject to taxation where capital gain at 30% additional 4%cess. Airdrops are also subjected to 30%taxation and forging Tax on Crypto Staking/Forging will also result in 30%. While TDS at 1% is deducted at a sale under section 194S if the transactions exceed ₹50,000 (or even ₹10,000 in some cases) it is crucial to understand that it is applicable to Indian residents only which is quite challenging as the transactions are generally done on a global level. No Deduction is done except in the case of cost of acquisition on the transfer of digital assets on reporting income.

While gifting digital assets attracts tax on the side of the receiver. The tax is applied to everyone whether it is private or commercial and it is the same for short-term and long-term gains. An important thing regarding it as a digital asset cannot be set off against any other income. Crypto is reported under schedule VDA in the ITR. It is important to note that except for tax, GST or Goods and service taxes may also apply to crypto-like transactions. Companies that facilitate transactions are considered as offering services and can be taxable and come under 18% payable tax. If the crypto mining is taken as business and crosses the threshold, they are also subject to 18% GST. Using cryptocurrency to buy products will make it compelling under taxation as suitable upon the transaction and is fair.

Crypto Transactions are Liable to Tax in India on:

Spending cryptocurrencies to purchase goods or services.
Exchanging cryptocurrencies for other cryptocurrencies
Trading cryptocurrency using fiat currency such as ₹(INR)
Receive cryptocurrency as payment for a service
Receiving cryptocurrency as a gift
Mining cryptocurrency
Drawing a salary in crypto
Staking crypto and earning stake benefits
Receiving Airdrop

Calculating tax on cryptocurrency is very complex to manage crypto software. Which ultimately helps in generating Capital gain reports, Holding reports etc. Taking all the transactions from various sources like deposits, withdrawals, Trades etc. The software automatically recognises transactions like deposits, withdrawals, staking income, trades etc. The entries which are pending need to be classified and categorized. Closing balance verification is the last process which ensures that the closing balance, as per actual holdings, matches the books.

To make sure that the taxation and framework created are properly enforced and maintained cryptocurrency platforms in India have been brought under the purview of the Prevention of Money Laundering Act, 2002 (PMLA). Whereas investors who are involved in foreign cryptocurrency transactions would come under the Foreign Exchange Management Act, of 1999 (FEMA).

Challenges and Criticisms

Even though cryptocurrency has many advantages over fiat currency like any other technological product it faces its fair share of challenges and criticisms.

Cryptocurrency, even though a very secure way of transaction, is often targeted by hackers and is dependent fully on technology. Cryptocurrency transactions are often susceptible to security breaches, hacking, and cyber-attacks. Due to the absence of proper regulation, consumers are prone to face challenges regarding dispute resolution, fraud, and recourse in cases of loss or theft of cryptocurrencies. Crypto is not stable or highly volatile which makes it susceptible to extreme profit as well as loss of cryptocurrency. The major issue with cryptocurrency is its use in money laundering and illicit activities. Financing illegal activities has become one of its primary uses. Which ultimately increases the burden of law enforcement. Even though there are taxation laws, they present a proper framework which can be adaptable. In crypto, the knowledge of crypto is controlled by some individuals which makes the information very controlled increasing the scope of fake information circulating and misleading traders. The absence of a unified regulatory approach to cryptocurrencies globally creates the possibility of regulatory arbitrage, where businesses and investors may seek jurisdictions with favourable regulations, potentially leading to a lack of oversight. Cryptocurrency is generally an international transaction and the transactions are varied making compliance tougher as the rules vary from country to country making unified laws is a colossal job which is agreed upon by all countries and follows all the international standards such as anti-money laundering (AML) and counter-terrorism financing (CTF) regulations are a tough task.

Comparative Analysis and Future Trends

Cryptocurrency is a forever-growing phenomenon where the technology and the importance of cryptocurrency will continue to grow. Various Countries will play a very vital role in it and can play a vital role in its development. Countries like the USA take cryptocurrency as securities as commodities. The USA has passed a bank secrecy act where the transaction of such a commodity must be registered to FinCEN. In the UK there are no specific regulations for crypto asset Anti-Money Laundering and Counter Terrorist Finance (AML/CTF) rules. Is one applied to the crypto market? The Financial Services Markets Act 2000 is applied to a crypto asset if it functions as a specified investment under the Regulated Activities Order (RAO). The EU has created several rules and is seen as more welcoming towards it and was seen as visionary in making the proper guidelines. The future prospectus about cryptocurrency is still in progress but to understand it is important to see that the majority of work for which cryptocurrency is currently used is successfully curbed and it is used to increase the ease and not for spreading terrorism or other illicit activities. The non-influence of government in cryptocurrency is a key advantage it has but it is important for countries or governments to make sure that they are not overpowered by cryptocurrency as it will create havoc in the society.

Conclusion

Cryptocurrency has played a revolutionary role in humankind which is both innovative and controversial. In India, the crypto market is projected to grow exponentially, reaching $6.4 billion by 2025, with over 107 million users. The challenges on its ambiguity raises a major challenge since no country is able to understand fully and has created some kind of wall to safeguard itself.

India as a country is still in a dilemma on whether it wants to accept it or not. The SEBI and RBI will play a very important role in ensuring that whatever rules and regulations are created are properly created and properly enforced and that there are no loopholes present. Taxation policies, though stringent with a 30% levy on crypto gains and a 1% TDS, aim to bring transparency but may stifle innovation if not balanced with progressive regulations.

As the economy is growing the need for cryptocurrency will play a game-changing part in ensuring that it is successfully done and India can convert this momentum. This will require joining efforts from regulators, policymakers, and industry stakeholders to create a secure, transparent, and growth-oriented ecosystem for cryptocurrencies in India. The path would be hard but it is pertinent to understand that it would be needed for safeguarding India and making it the top economy.