Executive Summary 

The Indian crypto asset industry has witnessed exponential growth over the last five years and today, the country reportedly has 15 million crypto asset holders that have put in INR 6.6 billion in these crypto asset holdings. India now has two crypto unicorns and over 350 crypto startups in what is clearly a flourishing industry.

This report seeks to bring clarity around crypto assets as a technology and make recommendations for the regulation of the Indian crypto asset market. Like all financial assets, crypto assets pose certain policy risks that must be addressed through a coherent framework that balances the public interest with the need to encourage innovation. Towards this end, the report recommends the induction of a safe harbour for crypto assets, similar to the one inducted for internet intermediaries in the Information Technology Act, 2000 and the Copyright Act, 1957. The size of first-generation internet technology companies today is testament to the enabling power of safe harbours as a tool to promote innovation. If the crypto asset space presents the future of the internet, as many experts propound, it is imperative that the crypto industry be afforded the same legal succour that allowed big technology companies to reach where they are today.

In an effort to establish regulatory recommendations for India, the authors have carried out an exhaustive study of international regulatory approaches and bucketed them into four categories. The first approach involves accommodating crypto assets into existing frameworks as they stand. The problem with this approach is that several crypto assets do not fall neatly into the definition of existing financial instruments and therefore fall outside the regulatory ambit. The second approach is innovation-friendly steps taken by some regulators to encourage startups to set up base within their jurisdictions and help the local crypto industry grow. The third is crypto-specific legislation or amendments that address the concerns around licensing and registration, definition, tax, money laundering and terror financing, and investor protection. This approach is comprehensive and seems the most practical route and is being adopted by most advanced financial jurisdictions.

The analysis of possible regulatory pathways under existing regulation in India reveals a similar problem. It is likely that most prominent crypto assets such as Bitcoin would not be suitably accommodated as securities, or commodities. While crypto assets may be recognised as capital assets, the frameworks that currently regulate these assets in India would necessarily leave gaps in investor protection and service provider registration.

The analysis of the way crypto markets work, reveals that the industry should be regulated through exchanges. These entities account for the bulk of the volume of activity in most major crypto networks and provide point of entry for most retail and institutional investors into the crypto market. As such, they should serve as the designates for regulation around the various policy risks presented by crypto assets.

Recommendations

• • Define crypto assets broadly to bring all assets under one framework which will help avoid jurisdictional clashes between different regulators. For this purpose, we recommend the following definition – A crypto asset means an asset that is created and conveyed using any distributed ledger technology and is not legal tender and may not be used for payments within the Union and may be used as a representation and/or of value, means of exchange, or a unit of account or be representative of financial interest and rights. 
  • Adopt a co-regulatory approach where SEBI, the RBI, and the Ministry of Finance, and a crypto asset service providers industry association work together to oversee and regulate the Indian crypto market. Industry experts can devise codes for oversight which are affirmed and backed by the SEBI, the RBI, and the Ministry of Finance, and implemented and enforced by an industry body.
  • Make crypto asset custody services and exchange interoperable to enhance consumer safety and convenience.
  • Introduce investor protection norms that are similar to SEBI’s disclosure-based frameworks.
  • Notify crypto asset service providers as “Reporting Entities” under the Prevention of Money Laundering Act, 2002.
  • Introduce a safe harbour such as the one provided under Section 79 of the Information Technology Act, 2000 for all crypto asset service providers. Safe harbours have proven very effective safeguards for innovation (many large technology companies have gotten to where they are because of them) over the years and are a lot easier to implement than regulatory sandboxes. Many of the world’s big technology companies have scaled up on the back of safe harbours. If crypto asset markets form the basis for a better, safer, more valuable internet, it stands to reason that they should be afforded the same accommodations granted to existing internet intermediaries.
  • Tax income from crypto assets as capital gains. Avoid placing a transaction tax on exchanges.
  • Regulate crypto asset ads through a framework similar to money market mutual funds as provided under the sixth schedule of the Mutual Fund Regulation. Advertisements are an important source of education and awareness for consumers. Moreover, in the crypto asset space, the opportunity to advertise incentivises crypto assets to invest in events hosted by educational institutions such as hackathons. Barring the ability of crypto asset service providers to advertise completely will not only harm consumers but also make it difficult for university cohorts interested in developing competencies around crypto assets to raise funds.
  • To address FEMA concerns around stable coins, have exchanges and other crypto asset service providers comply with reporting requirements under the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019.
  • Follow the lead of entities such as Coinbase and work with industry to develop technological tools for compliance with regulatory norms.
  •   Establish minimum security standards for crypto asset service providers.
  • The state may consider introducing tax incentives for entities that give relevant and verified information on any other crypto asset service provider  acting in contravention of the law.
  • Prohibit the listing of crypto assets that have no public address and consequently afford complete anonymity to holders.

Read the full report here.

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The authors would like to thank Dr. Vikash Gautam for his inputs on this report.

• Economics and Finance
• Cyber Security
• Internet Governance
• India
• CYBERSECURITY AND INTERNET GOVERNANCE
• ECONOMICS AND FINANCE

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