Context

• Rulemaking is an arduous task sometimes diverging from the intent. This can be particularly challenging in the case of emerging technologies, where change is rapid and constant.
• Today, there are calls to regulate artificial intelligence (AI) and blockchain technology. Amidst all this, India's measured approach to regulating Virtual Digital assets is commendable.

 What are VDAs (Virtual Digital Assets)?

• According to the Income Tax Act, 'virtual digital asset' refers to any information, code, number, or token (not being Indian currency or foreign currency) generated through cryptographic means and blockchain technologies.
• It can be transferred, stored, or traded electronically and its definition specifically includes a non-fungible token (NFT) or any other token of similar nature, by whatever name is called.

India's recent attempt to regulate VDAs

• India has recently extended the anti-money laundering provisions to virtual digital assets businesses and service providers.
• The Union Finance Ministry, in a gazette notification, extended the following activities under the Prevention of Money Laundering Act (PMLA) Act 2002:
  • Exchange between virtual digital assets and fiat currencies.
  • Exchange between one or more forms of virtual digital assets, transfer of virtual digital assets.
  • Safekeeping or administration of virtual digital assets or instruments enabling control over virtual digital assets.
  • And participation in and provision of financial services related to an issuer’s offer and sale of a virtual digital asset.

Key-features of the above extension

• Such rules are already applicable to banks, financial institutions and certain intermediaries in the securities and real estate markets.
• The extension provides virtual digital assets platforms with a framework to diligently monitor and take actions against malpractices.
• A standardisation of such norms will go a long way in making the Indian virtual digital assets sector transparent.
• It will also build confidence and assurance in the ecosystem, and give the government more oversight on virtual digital asset transactions.
• Such risk-mitigation measures are in line with global guidelines put forward by the International Monetary Fund (IMF) and the Financial Action Task Force (FATF).
• Such guidelines acknowledge the role Virtual Asset Service Providers (VASPs) play in regulating and monitoring the virtual digital assets ecosystem.
  • VASPs are the most efficient bridges and eyes for regulators to effectively implement Anti-Money Laundering/Countering/Combating the Financing of Terror principles.

What it means for VASPs?

Compulsory Registration as a reporting entity

• Virtual digital assets platforms carrying out the said activities will now have to register as a reporting entity with the Financial Intelligence Unit-India.
• The unit is the national agency to strengthen India’s efforts against money laundering and terror financing.

Implementation of KYC Provision

Reporting entity platforms such as CoinSwitch are now mandated to implement know your customer, record, and monitor all transactions, and report to the Financial Intelligence Unit-India as and when any suspicious activity is detected.

Way forward - Reconsideration of Tax regime for VDAs:

• There is an opportunity to bring virtual digital assets taxes on a par with other asset classes.
• Building on the regulations, India should reconsider its tax treatment of virtual digital assets, which is an outlier, both domestically and internationally.
• With the PMLA notification now, mitigating the most critical money laundering and terror financing risks, there is little reason for the tax rates to be as prohibitively high as they are (30% tax on income from VDAs).
• Reducing the tax arbitrage vis-à-visother economies will also help stem the flight of capital, consumers, investments, and talent, as well as dent the grey economy for virtual digital assets.

How can India use the G20 presidency to its advantage?

• India’s leadership and experience could help the finance track of the G-20 which is spearheading critical discussions on establishing a global regulatory framework for virtual digital assets.
• There is also an opportunity to consider the steps taken by other G-20 nations. In Asia, Japan and South Korea have established a framework to licence VASPs while in Europe, the Markets in Crypto-Assets (MiCA) regulation has been passed by the European Parliament.

Conclusion

• Spearheading the global coordination and focusing greater oversight on domestic virtual digital assets ecosystem simultaneously could provide India with much needed assurance to everyday users and regulators.
• Going forward, a progressive regulatory framework will instil the animal spirit in India’s innovation economy and establish India’s virtual digital assets leadership.