By Rameesh Kailasam and Madhabi Sarkar

In the recent past, there has been significant progress on regulating the Virtual Digital Assets (VDA) ecosystem in India. For example, the Prevention of Money Laundering Act 2002 (‘PMLA’) recognises VDA service providers as “reporting entities” under Section 2(1)(sa), and they are hence governed by the Financial Intelligence Unit India (FIU-IND). Almost all major domestic VDA exchanges have now registered as reporting entitites’ with FIU.

The Income Tax Act requires VDA exchanges to deduct TDS to maintain oversight over this space. The Indian Computer Emergency Response Team (CERT-IN) within the ministry of electronics and information technology has issued guidelines under the Information Technology Act 2000 that govern and introduce compliances for VDA service providers. In addition, the National Cyber Crime Reporting Portal-1034 has included VDAs in the reporting framework to create a channel for consumers to flag cyber fraud cases. The reporting platform has been made operational by the Indian Cyber Crime Coordination Centre (I4C) under the home ministry, with support and cooperation from the RBI, all major banks, payment banks, wallets, and online merchants.

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However, VDA service-providers in India are currently not allowed to access banking rails. Given the emergence and revolution of the Web3 space worldwide, protecting Indian VDA users is of paramount importance. It is also imperative to maintain oversight over the ecosystem. Non-availability of banking services including UPI to Indian VDA exchanges proves to be counter-productive Indian VDA exchanges offer a regulated service with several guardrails designed to protect Indian users and ensure oversight. By conducting compliances such as KYC, sharing information with the FIU, and deducting tax at source, Indian VDA exchanges are fully compliant with the law of the land. Further, they are instrumental in enabling key public authorities to maintain oversight over this space. Such exchanges that comply with the norms should be entitled to use banking / UPI services. Given that strong guardrails exist, there shouldn’t be any ground for denial. Unfortunately, the denial of UPI services to Indian exchanges has encouraged Indians to engage with VDAs through other channels such as Peer to Peer (P2P). Such channels do not comply with the guardrails/ regulations but enjoy full access to the Indian banking system for transactions. Conducting VDA activities to alternate channels also leaves Indian users vulnerable to frauds that are prevalent.

Most P2P transactions are facilitated by exchanges which do not have a registered office in India nor comply with regulations / guardrails otherwise complied by Indian domestic exchanges. Estimates suggest that cumulative trade volume of around ~`32,000 crore moved from domestic centralised VDA exchanges to foreign ones during February-October 2022. Several platforms exist that connect Indian users to their peers, enabling them to transact in VDAs using UPI rails. Moreover, transactions conducted on these platforms are not reported to any public authorities and are hence not monitored. Users of such P2P transactions have also often fallen prey to frauds and scams. Most recently, innocent Indian users’ bank accounts were frozen when they received funds in exchange for VDA through P2P channels. It was alleged that the funds in question were proceeds from a separate fraud. The non-availability of UPI on Indian VDA exchanges causes Indians to transact through P2P channels, where UPI services are available. It not only adversely impacts the Indian authorities’ objective of monitoring this space but also leaves users vulnerable to scams.

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Web3, popularly referred to as the next iteration of the internet, is bound to be a critical aspect of our common digital future. It is an open and decentralised internet that leverages blockchain technology and VDAs. It empowers users to read-write-own on the internet. It is based on Web 1.0’s defining features of openness and community ownership, while addressing the challenge of lack of incentives. Like Web 2.0, it promises to deliver secure and sophisticated solutions, but it addresses the challenges associated with centralisation. As the next iteration of the internet, Web3 promises to serve as the basis for new forms of economic and social interactions allowing people to collaborate, create, exchange, and take ownership of their data. Web3 cannot exist without VDAs. VDAs play a fundamental role in incentivising participants of a public blockchain network to engage with the blockchain and perform validation tasks on the network. They constitute incentives and disincentives that encourage honest participation on the blockchain, and penalises malfeasance.

Given the nature of VDAs, it is ensured that the underlying technology is economical, transparent and decentralised. It is therefore not only to India’s benefit to constructively encourage citizens to engage with VDAs, but also to citizens’ benefit to undertake such engagements from a wealth creation perspective. Inability to access VDAs using UPI creates a substantial roadblock. Banking/ UPI services to compliant Indian exchanges must be positively considered helping evolution of India’s Web3 ecosystem and further enhancing India’s ability to emerge as a global tech superpower.

Writers are respectively, CEO and senior manager (public policy), Indiatech.org