Crypto Crux: Regulatory Roller-Coaster

If you are older than millennials, you might recall the famous Ajit joke: “Liquid ise jeene nahi dega, aur oxygen ise marne nahi dega”. Well, such seems the condition for crypto assets in India, for while the consumer demand makes markets tick, legal uncertainty still looms large.

Globally, crypto markets are enmeshed in political flux and policy fluidity. The urgency for a definitive regulatory framework to protect users has never been greater. In India, this need is underscored by three developments: the Department of Economic Affairs' announcement of a discussion paper on crypto policy expected by September, the alarming $230 million hack of the WazirX exchange, and the growing volume of offshore crypto trading by Indians.

There is no absence of government intention to enhance user safety in crypto markets. In January, India blocked nine offshore exchanges, a move widely seen as positive. User activity from India plummeted after the URL blocking, and several of the offshore exchanges eventually approached the Financial Intelligence Unit to register locally. But, a closer look at trading patterns reveals that blocking measures are not enough to protect investors. According to a May 2024 Eaya Centre report, the volume of peer to peer trading—the primary method through which Indian users deposit and withdraw INR on offshore exchanges—skyrocketed by more than 400% in April 2024, compared to the previous year.

Moreover, not all URLs were blocked. For example, binance.com was blocked, but p2p.binance.com and accounts.binance.com were not. Additionally, many offshore exchanges offer the option to download their app files from mirror sources, and users could also use Virtual Private Networks. And new platforms emerge daily, such as NoOnes, an exclusive P2P exchange founded in 2023, which has already processed over $100 million in monthly transactions, with India playing a leading role. Crypto investors remain at the mercy of several unregulated offshore players.

Regulatory attitudes towards crypto are still evolving in India. The RBI sought to supress crypto and deny service providers access to the traditional financial systems, by cutting them off from traditional banking channels and financial institutions, in 2018. This prohibition was set aside by the Supreme Court on grounds of proportionality. The RBI, as the custodian of financial resilience, doesn’t want to legitimise crypto markets, in part because it will make supervision harder.

These factors also inhibit global policymaking, but political winds might blow towards more mainstreaming of the crypto ecosystem, given its steady appeal with the all-important and politically fickle youth demographic. This is clear in the US Presidential candidates’ positions on crypto, with Trump taking the lead in declaring his support for light-touch regulations. RBI’s latest Financial Stability Report suggests it is closely watching the actions of regulators in developed countries like the US.

There seems to be a growing international consensus around the principle of ‘same activity, same rules,’ applying regulations to crypto intermediaries similar to those for traditional financial intermediaries. Licencing will significantly increase crypto market transparency as more transactions are processed through compliant entities, creating a virtuous circle of blockchain transactions. What can be formalised and regulated would allow for such activities to be tracked, instead of pushing them under the radar or outside the Indian boundaries.

The Securities Exchange Board of India could consider regulating parts of the crypto ecosystem using its own rigorous standards for Market Infrastructure Institutions. Traditional stock exchanges, depositories and clearing houses are all designated MIIs and constitute a key part of India’s economic infrastructure.

Centralised crypto exchanges and regulated stock exchanges are structurally and functionally similar. Focusing regulations around these actors will not only help administer the regulations, but also protect the most users, aligning with traditional financial regulation approaches centered on intermediaries. MIIs are required to implement mechanisms and designate personnel to address grievances within specific timelines. They are also subject to record-keeping and reporting requirements. Stock exchanges must resolve complaints within granular timelines, after which unresolved matters are referred to a specialised appellate committee. These processes could be adapted to create a standardised grievance redressal framework across the crypto asset ecosystem.

The recent hack of the WazirX exchange and the subsequent backlash over its proposed "socialised loss" strategy only show how consumers are left to their market “destiny” without regulatory framework of an MII. This ad hoc anti-consumer decision of a platform highlights the arbitrariness of financial asset related decisions in the absence of clear regulations. If only a regulatory framework were in place, there would also be fit and proper process for the key management personnel, to bring experienced talent in MII operations. Regulating MIIs will also increase investor confidence, ensuring that more crypto activity is localised rather than flowing offshore.

The government must expedite the drafting and implementation of comprehensive crypto regulations to bring balance to a globally emerging financial asset class. Sufficient safeguards can be built with agile regulations and wider supervisory apertures to ensure investor protection and financial resilience, and mitigate the actions of bad actors who attempt to evade Indian laws.

Dr. Srinath Sridharan is a policy researcher and corporate advisor.

Vivan Sharan is founder of Koan Advisory Group.

The views expressed here are those of the author, and do not necessarily represent the views of NDTV Profit or its editorial team.