Cryptocurrency and Digital Assets Regulation in India

Executive Summary

India’s journey in regulating cryptocurrencies and digital assets represents one of the most dynamic policy evolutions in the global financial landscape. From the initial stance of near-prohibition to the current framework of regulated tolerance, the nation’s approach reflects the complex balance between encouraging financial innovation and maintaining economic stability. This comprehensive analysis examines the multifaceted aspects of India’s cryptocurrency regulation, its economic implications, and the landmark legal cases that have shaped the current regulatory environment.

Historical Context and Evolution

The Early Years (2013-2018)

The Reserve Bank of India’s relationship with cryptocurrencies began in December 2013 with its first public notice cautioning users about the potential risks of virtual currencies. The concerns raised were threefold: financial stability risks, operational risks, and consumer protection issues. During this period, cryptocurrency trading in India operated in a regulatory grey area, with exchanges self-regulating through KYC/AML procedures while seeking legitimate banking relationships.

The situation reached a critical point in April 2018 when the RBI issued its controversial circular prohibiting all regulated financial institutions from dealing with cryptocurrency businesses. This effectively created a banking embargo on the entire crypto industry in India, forcing many exchanges to either shut down or move offshore. The circular’s impact was immediate and severe, leading to:

• A significant decrease in trading volumes on Indian exchanges
• Migration of Indian traders to foreign platforms
• Development of peer-to-peer trading systems to circumvent banking restrictions
• Exodus of blockchain talent from India to more crypto-friendly jurisdictions

The Supreme Court Intervention (2020)

The watershed moment in Indian cryptocurrency regulation came with the Supreme Court’s decision in Internet and Mobile Association of India v. RBI. This landmark judgment fundamentally reshaped the regulatory landscape through several key findings:

• Constitutional Rights Analysis: The Court recognized cryptocurrency trading as an occupation protected under Article 19(1)(g) of the Indian Constitution, subject to reasonable restrictions.
• Proportionality Doctrine: The judgment established that regulatory measures must be proportional to the risk they aim to address. The Court found the RBI’s blanket ban disproportionate to the perceived risks.
• RBI’s Jurisdiction: While affirming the RBI’s power to regulate virtual currencies, the Court emphasized the need for evidence-based regulation rather than pre-emptive prohibition.

Current Regulatory Framework

The Taxation Regime

The introduction of specific tax provisions for virtual digital assets (VDAs) in the Finance Act 2022 marked India’s first explicit recognition of cryptocurrency transactions in statutory law. The key provisions include:

1. Tax Rate and Structure:

• A flat 30% tax on income from VDA transfers
• No deduction allowed except the cost of acquisition
• Loss from one VDA cannot offset gains from another
• 1% TDS on transactions above specified thresholds

Impact Analysis:

The stringent tax regime has had several consequences:

• Reduced trading volumes on Indian exchanges (estimated 90% decline in some cases)
• Increased compliance burden on traders and exchanges
• Migration of traders to international platforms
• Creation of a clear audit trail for cryptocurrency transactions

Banking and Financial Services Regulations

The post-Supreme Court regulatory framework has evolved to include:

1. Know Your Customer (KYC) Requirements:

• Mandatory identity verification aligned with banking norms
• Risk-based customer due diligence
• Regular updating of customer information
• Transaction monitoring and reporting

2. Anti-Money Laundering (AML) Framework:

• Integration with FIU-IND reporting systems
• Suspicious transaction reporting requirements
• Record-keeping obligations
• Staff training and compliance programs

3. Enhanced Due Diligence:

• Multi-layer verification process
• Risk-based assessment of customers
• Regular updating of customer information
• Transaction monitoring systems

4. Reporting Requirements:

• Suspicious Transaction Reports (STRs)
• Cash Transaction Reports (CTRs)
• Cross-border Wire Transfer Reports
• Monthly compliance reports

5. Integration with Financial Intelligence Unit:

• Real-time reporting mechanisms
• Automated red flag systems
• Compliance officer appointments
• Regular audit requirements

Exchange and Trading Requirements

Operational Guidelines:

1. Registration and Licensing:

• Mandatory company incorporation in India
• Minimum capital requirements (₹15 crores proposed)
• Fit and proper criteria for directors
• Technology infrastructure standards

2. Trading Parameters:

• Order matching rules
• Price discovery mechanisms
• Settlement cycles
• Market making provisions

3. Risk Management:

• Cold wallet storage requirements
• Hot wallet limits
• Insurance requirements
• Cyber security protocols

Economic Implications

Impact on Financial Markets

Creation of Parallel Investment Ecosystem: The cryptocurrency market has created a significant parallel investment ecosystem in India, characterized by:

1. Market Size:
2. Daily trading volume: approximately ₹2,000 crores (2023 data)
3. Active retail investors: 15-20 million
4. Registered exchanges: 10+ major platforms
5. Banking Sector Impact:
6. Reduced remittance costs
7. Competition in payment services
8. Integration of blockchain technology
9. New revenue streams from crypto services
10. Innovation Ecosystem:
11. Growth in blockchain start-ups
12. Development of DeFi platforms
13. Creation of India-specific crypto solutions
14. Integration with traditional financial products

Investment Landscape

Retail Participation:

1. Demographic Analysis:

• 70% investors aged 18-35 years
• Tier 2 and 3 cities showing rapid growth
• Average investment size: ₹10,000-50,000
• Growing female investor participation

2. Investment Patterns:

• Preference for top cryptocurrencies (Bitcoin, Ethereum)
• Increasing interest in DeFi protocols
• Rising adoption of crypto SIPs
• Growth in NFT investments

Institutional Framework:

1. Current Status:

• Limited institutional participation
• Growing corporate treasury investments
• Emerging crypto fund structures
• International collaboration initiatives

2. Risk Management:

• Portfolio diversification strategies
• Hedging mechanisms
• Compliance frameworks
• Insurance coverage

Case Studies Analysis

In Internet and Mobile Association of India v. RBI (2020) : The case dealt with the legality of an RBI circular issued in April 2018, which restricted regulated entities like banks from dealing with or providing services to businesses dealing in cryptocurrencies. This effectively imposed a banking ban on cryptocurrency trading, severely affecting the industry in India.

Background: Cryptocurrencies like Bitcoin had grown popular in India, but concerns arose over their speculative nature, use in illegal activities, and potential risks to financial stability. In response, the RBI issued a circular prohibiting banks from supporting cryptocurrency transactions. The Internet and Mobile Association of India (IAMAI), representing crypto stakeholders, challenged this move, arguing that it was unconstitutional and crippled their legitimate business operations.

Key Legal Issues: The case revolved around three main issues:

1. Freedom of Trade and Business (Article 19(1)(g)): IAMAI contended that the circular violated their fundamental right to practice any trade or profession.
2. Proportionality of the Restriction: The principle of proportionality requires state action to be rational, necessary, and the least intrusive option available to achieve its objective.
3. Legislative Competence: IAMAI argued that RBI lacked legislative authority to issue a complete ban on cryptocurrencies since no law expressly prohibited their use.

Supreme Court’s Observations: The Supreme Court acknowledged RBI’s authority to regulate entities under its domain, especially concerning risks to the financial system. However, it found that:

• There was insufficient empirical evidence presented by RBI to demonstrate actual harm caused by cryptocurrencies to the economy.
• The banking ban was disproportionately harsh and failed to strike a balance between preventing risks and allowing innovation in financial technology.
• The circular infringed upon the rights of individuals and businesses under Article 19(1)(g) of the Constitution.

Judgment and Rationale : In its ruling, the court struck down the RBI circular, stating it was unconstitutional. The decision was based on the principle of proportionality, as RBI’s measures imposed excessive restrictions without exploring less intrusive alternatives. The court also held that cryptocurrency exchanges were engaging in legitimate business activities, and the circular failed to adequately consider the adverse impact on their operations.

Broader Implications: This ruling set a precedent for financial regulations in India and highlighted the court’s role in protecting businesses from arbitrary executive actions. It also emphasized the urgency for Parliament to establish a clear legislative framework for cryptocurrencies to provide legal certainty to the sector.

The WazirX Case (2021) involved allegations of financial irregularities and violations of the Foreign Exchange Management Act (FEMA) by WazirX, one of India’s leading cryptocurrency exchanges. The Enforcement Directorate (ED) accused the platform of facilitating unregulated cross-border cryptocurrency transactions worth ₹2,790 crores, raising concerns about money laundering and non-compliance with know-your-customer (KYC) and anti-money laundering (AML) norms. The ED claimed that WazirX allowed transfers to and from foreign wallets without adequate documentation, exposing gaps in oversight.

This case brought regulatory shortcomings in the Indian cryptocurrency ecosystem into sharp focus. It highlighted the urgent need for a robust legal framework to govern crypto exchanges, ensure compliance with financial regulations, and prevent misuse. For WazirX, the investigation resulted in asset freezes and reputational harm, while for the industry, it underscored the risks of operating without regulatory clarity, prompting calls for a balanced regulatory approach to foster innovation while ensuring financial integrity.

International Best Practices Integration

Global Alignment:

• FATF recommendations adoption
• G20 framework implementation
• Cross-border regulatory cooperation
• Technology standards harmonization

Conclusion

The Indian cryptocurrency and digital assets landscape continues to evolve, shaped by:

• Judicial interventions
• Regulatory developments
• Market dynamics
• International trends

The path forward requires:

• Balanced regulation
• Innovation support
• Consumer protection
• Market stability measures

Future Considerations – Technology Evolution:

• DeFi integration
• NFT market development
• Cross-chain solutions
• Layer 2 scaling

Regulatory Development:

• International coordination
• Standard setting
• Market surveillance
• Consumer education

Created By : Advocate Rani Gupta