Virtual digital assets, or VDAs, have emerged as a global phenomenon in recent years, with investors enticed by their potential, tech companies are looking at the use cases of blockchain technology with VDAs as equity, And governments are apprehensive about their perceived risks to monetary and fiscal policy. , VDA has already gone through three ups and downs cycles. Some time ago, around the beginning of 2021, hopes began to fade, as the potential of this technology seemed endless, with tech-savvy experts eagerly speculating how crypto would transform every aspect of society. Investors in crypto are making profits that traditional investment competition cannot expect. Even today, despite the fall in crypto prices and collapse of crypto exchanges like FTX, India’s tax-deducted-at-source (TDS) records show transactions of approx. 6,000 crore, a huge year-on-year decline, but significant nonetheless.
In this nascent ecosystem, India was fast emerging as a global front runner with its deep pool of tech talent, a dynamic startup ecosystem and a government that was pursuing a digital revolution on a war footing. According to Nasscom’s 2022 report, India accounts for 11% of the world’s Web3 workforce, a remarkable 138% increase in blockchain and crypto-related jobs since 2018. World class crypto-products were being developed here. Those exciting days have since come to an early end, partly because crypto enthusiasm was punctured by a series of scandals, but also because our regulatory responses made it untenable. This was exacerbated by friendlier policies in other countries, leading to brain-drain and cross-border diversion of investment.
In early 2022, the Indian government was looking to take a cautious approach towards the crypto ecosystem. Instead of creating a regulatory framework for investment in VDAs with suitable guard-rails to protect investors, it chose to impose a heavy tax burden on crypto transactions.
On 1 February 2022, the government announced two new taxes: the first was a flat 30% tax on any gains from crypto transactions that could not be set off against losses in other crypto transactions; The second was 1% TDS, effective July 1, 2022, on any transaction 10,000. These measures were not commensurate with the tax regime for other asset classes such as mutual funds and shares, for which the equivalent tax is 15% and set-off against losses is allowed. These moves were meant to deter people from speculating on crypto assets, while giving the government a mechanism to monitor transactions. But they also dealt a significant blow to the Indian crypto ecosystem, with domestic crypto exchanges facing collapse as their Indian users shifted to foreign exchanges to avoid scrutiny.
While there was a need to protect investors from poorly-managed products and sometimes outright frauds, the government’s tax policy instead of regulation and investor education had an adverse effect on the entire VDA ecosystem in India. While Indian VDA exchanges are strengthening systems and processes by introducing KYC norms, educating investors and even resorting to audits to publish proof of reserves, with such a regressive tax structure, it There is no way of knowing how effective these self-imposed regulatory measures will be. Happen.
How did Indian investors react to the new policy? Evidence suggests that instead of being more careful in trades, many moved to offshore VDA exchanges that were shielded from the scanner of revenue officials. As a result, they are now at the mercy of foreign regulatory systems. An estimated half a million Indian investors were affected by the FTX crash. Regulators such as Japan’s Financial Services Agency are working to shield Japanese investors from the FTX decline. However, India has lost room for maneuver by starving local VDA exchanges.
Recent experiences highlight the fact that by not bringing regulation to consider crypto as an asset class for investment and instead imposing a heavy tax regime, Indian VDA exchanges have lost out, potentially new opportunities for blockchain. Use cases are being developed, and most have been discouraged. Importantly, India faces the risk of being shut out of the booming Web 3.0 market as investment shifts to other destinations.
Indian policy makers and the Reserve Bank of India have taken the stance that VDAs do not provide any inherent value. While this can be an endless debate, yet the demand for such properties is on the rise. The purpose of regulation is to protect investors and not just punish bad investment products.
Despite 2022 being a year of crypto disasters and cleanups, it is unlikely that investment in this space will completely stop. Therefore, it is the responsibility of Indian financial regulation to ensure that future investments are guided responsibly and to manage bad outcomes.
While India tries to build a global consensus around VDA regulation, investments should be brought back to Indian exchanges, where they can be effectively monitored. To do this, our hostile taxation regime for cryptocurrencies must be rationalized and brought on par with other asset classes. Regulation should also streamline how crypto exchanges comply with KYC and anti-money laundering principles, and require them to publish proof of reserves. This ecosystem needs rational taxation and sensible regulations.
Aruna Sharma is a practicing development economist and a former secretary to the Government of India.
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