FinTechDigital Assets – The Paradoxical Position in India

June 17, 20220

INTRODUCTION

India is evolving into a vibrant environment that provides finance start-ups with a platform to possibly become billion-dollar unicorns. Fintech start-ups in India are pursuing a variety of goals, from expanding new industries to investigating global markets.

The global players of Fintech are coming together, to orchestrate the revolution in the business, and India is at par with the Digital India Campaign and other initiatives promoting it powered by technology. FinTech companies are changing the interaction with digital assets. These companies spearheaded the advancements of digital assets for various financial services, by promoting blockchain technology and crypto-assets.

The value of the digital asset economy to India’s GDP will grow at a 43.1 % compounded annual growth rate from $5.1 billion in 2021 to $261.8 billion in 11 years, resulting in a $1.1 trillion contribution to the country’s economy.

In 2021, the global financial services sector is expected to be worth more than $22 trillion, and by 2025, it will be worth more than $28 trillion.

FinTech firms allow anyone with internet access to adapt to faster, cost-efficient, transparent, and more efficient financial banking services. The credit goes to the accessibility advancement in mobile phone technology, cloud computing, big data analytics, etc.

Digital Assets are the most recent technological advancements, such as assets created through blockchain and distributed ledger technology. They are causing revolutionary paradigm shifts in the financial services sector. This technology is changing the way we manage and create wealth and the manner of interaction between users and financial services/products.

For instance, the tokenization of assets is a fascinating method of raising capital. Given the right policies and regulatory framework, India can achieve its true potential in this sector.

Therefore, this article undertakes an analysis of the regulatory framework for Digital Assets in India.

THE CONCEPT OF DIGITAL ASSET

Digital Assets  can be possessed and transferred, used as a kind of currency in transactions or as a storage medium for intangible content such as computerised artworks, video, or contract documents. Cryptocurrencies like bitcoin, asset-backed stable coins like tether, and non-fungible tokens (hereinafter “NFTs”) -certificates of ownership of original digital media – are examples of digital assets.

Digital Asset ownership records are stored safely on a blockchain, which is a  decentralised database or electronic ledger that is distributed among its users. This framework allows digital assets to be transferred without the use of a centrally situated entity, like a bank, broker, or intermediary. This will make the transactions faster and easier.

NFTs for instance are revolutionising the engagement of people on a daily basis, from digital art to ticket sales, music, collectibles, luxury items, and gaming. Though it is an early age, NFTs are expected to grow into an industry worth more than $1 trillion.

The Indian Government, in their Memorandum for explaining the provisions in the Finance Bill, 2022, proposed to insert a new clause (47A) in Section 2 of the Finance Act to define the term “virtual digital asset”.

A virtual digital asset, according to the proposed new clause, is defined as-

any information, code, number, or token (not being Indian currency or any foreign currency), generated through cryptographic means or otherwise, by whatever name called, that provides a digital representation of value that is exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account, and includes it’s any financial transaction or investment and can be used electronically for trading, transferring or storing”.

The term includes NFTs as well as other similar tokens.

Moreover, according to this explanatory memorandum; “Virtual digital assets have gained tremendous popularity in recent times and the volumes of trading in such digital assets have increased substantially. Further, a market is emerging where payment for the transfer of a virtual digital asset can be made through another such asset. Accordingly, a new scheme to provide for taxation of such virtual digital assets has been proposed in the Bill.”

ADVANTAGES OF DIGITAL ASSETS

The major advantages of adopting digital assets for a company include low transfer fees, high security, quick transactions, and new market potential. Digital assets have practically entered mainstream banking and represent a significant technological achievement in their own segment.

Digital assets, as tricky as they seem given their decentralised nature, have proven to be a highly secure payment method. Transacting through digital asset, give cost-effective transactions. A number of transactions are done by the businesses on daily basis and thus, can use digital assets to conduct more cost-effective transactions.

It is crucial to remember that transaction fees can be cost-effective when using digital assets, but transaction prices may vary greatly depending on a variety of circumstances. For the same reason, it is important to undertake a critical analysis of the digital asset that has been put to use.

Transactions involving digital assets are recorded on decentralized public ledgers containing the information flow of all transactions, making it reasonably straightforward to track transactions and build audit trails.

Furthermore, once a digital asset transaction is started, it cannot be changed or reversed. The ownership is retained by the individual and the transactions are secured by blockchain technology, which prohibits hackers from stealing or altering your funds.

The encrypted transactions that cannot be in any manner decrypted without having the owner’s or receiver’s key. By using digital assets, one can transfer, trade and transact very swiftly. The initiation time and the receiving time is reduced substantially. Additionally, the time period between the two is also made almost negligible.

Now given these advantages it is important to see the regulatory framework in place.

INDIA’S PRESENT FRAMEWORK ON DIGITAL ASSETS AND THE SUGGESTED CHANGES IN THE PRESENT FRAMEWORK FOR DIGITAL ASSETS IN INDIA

The Reserve Bank of India (hereinafter abbreviated as “RBI”), for the first time, identified virtual currencies in the regulatory regime on December 24, 2013, when it issued a warning to holders, users, and traders of virtual currencies about the potential economic, financial, legal, operational, customer protection, and security risks associated with virtual currencies.

The RBI has repeatedly emphasised the significant hazards involved with virtual currencies in order to protect the interests of virtual currency holders, users, and dealers.

The institute also prohibits the organisations regulated by it, from dealing in virtual currencies or providing services to facilitate any person or entity dealing in virtual currencies, according to the Notification dated April 6, 2018.

It also mandated the regulated businesses that already provided such services to terminate the agreement within 3 months from that Notification’s date. The Notification was challenged in Internet Mobile Association v. RBI 2020 SCC online SC 275, where the Supreme Court set aside the Notification while acknowledging the RBI’s prophylactic efforts.

Following that, the Ministry of Corporate Affairs of the Government of India issued a Notification on March 24, 2021, amending Schedule III of the Corporations Act, 2013, and requiring companies to submit declarations about virtual currency transactions done during a financial year.

The RBI also instructed all banks and regulated organisations to continue performing customer due diligence on their clients dealing in virtual currency in accordance with the various applicable regulations through a Notification dated May 31, 2021.

Given these ongoing deliberations and discourse, the legal status of virtual currencies in India appeared to be stabilising. The Central Government proposed to introduce the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 for creating a facilitative framework for the creation of the official digital currency to be issued by the RBI and to prohibit all private cryptocurrencies in India. This has led to market disruption and confusion about the legality of cryptocurrencies.

On the contrary, the government owing to the negative feedback on India’s stance on cryptocurrencies has recently begun to show a tolerant and more inclusive approach towards Digital Assets. Hence, the Financial Bill, 2022 has been introduced.

The Finance Bill’s definition of “virtual digital assets” is broad in scope and may encompass any other digital asset that the Central Government specifies by the announcement in the Official Gazette.

The current definition of “virtual digital assets” encompasses the numerous virtual currencies that are traded on Indian exchanges. It’s worth noting that the Finance Bill also states that the Central Government may remove any digital asset from the definition of “virtual digital asset” by notifying it in the Official Gazette, subject to the conditions provided therein.

In the Budget 2022 speech, Finance Minister Nirmala Sitharaman proposed a flat 30% tax on digital asset gains, regardless of whether the investor holds the asset for a long or short period of time.

Furthermore, any losses incurred by a virtual digital asset investor during the transaction cannot be offset against any other revenue. It has also been recommended that gifting of virtual digital assets be taxed in the recipient’s hands. Therefore, the present framework on Digital Assets in India, is inclusive yet restrictive in nature, and should be improved.

Since India is still at a very nascent stage of adopting digital assets and governing the same, it should consider and learn from how other countries, such as Singapore, have governed cryptocurrencies without stifling financial and technical innovation.

Singapore has embraced emerging technologies such as bitcoin and blockchain, establishing itself as a global leader in digital currency development.

The government has a favourable tax framework for cryptocurrencies, which has strengthened the industry and created a balanced regulatory and legal environment. It amended the Payment Services Act 2019 and inserted that any firm that supports the transmission, exchange, or storage of digital payments tokens, needs to obtain a licence and will be subjected to the Central Bank of Singapore’s laws and regulations.

India can also develop a specific regulation for the public offering, trade, transfer, and issue of digital tokens.  It can stipulate grounds for restriction and relaxation of usage of such digital tokens.

A similar recourse has been adopted by the Monetary Authority of Singapore.  A regulatory guideline can also include the manner of governance of entities dealing with such digital tokens both inside and outside India.

The legislation that is to be introduced over the use of cryptocurrency, can stipulate the pre-requisites that have to be satisfied for using and transacting through cryptocurrency without any or limited restriction. This can include obtaining a licence to operate.

A committee for analysing and preparing the statutory framework can be established which has members of leading banking and financial institutions and/or individuals who are an industry leaders in that, the statutory framework is to be accommodated according to the commercial sense required.

Lastly, the laws on anti-money laundering and countering the financing of terrorism can be amended in order to answer the transactions stemming from digital assets.

AMLEGALS REMARKS

It should be noted that the Indian government has recently undertaken a number of initiatives connected to the digitalization of the economy and has aided in the financing of financial technology.

In addition, numerous programmes for establishing the foundation for cashless payments and making India a cashless economy have been undertaken. Given the widespread use of digital assets in India, the country should consider how to capitalise  the ever-expanding crypto market to fuel its economy and strengthen its position as a digital superpower.

A well-thought-out framework for digital asset industry regulation will greatly strengthen the financial infrastructure as a whole, as well as protect the national security, deter financial crime, attract international capital, and create more jobs. This will propel the country toward its goal of becoming a worldwide superpower.

 

-Team AMLEGALS, assisted by Mr. Alay Raje (Intern)


For any query or feedback, please feel free to get in touch with prarthana@amlegals.com or tanmay.banthia@amlegals.com.

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