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Cryptocurrency: Unmasking the Risk

Are you wondering where the Bitcoin and cryptocurrency enthusiasts around you have suddenly vanished? They are not gone, only silent in the wake of all the crypto scandals and subsequent losses suffered by masses across the globe. Moreso, after the worldwide shift requiring digital-asset platforms to follow anti-money laundering standards similar to those followed by other regulated entities like banks or stock brokers. 

Crypto in India Through the Years

The Indian government and RBI have always been skeptical about the loose legality and loopholes surrounding cryptocurrency transactions and exchanges since the very beginning. Hence, the 2018 ban on crypto dealings in banks. Although, that did not discourage the general interest in crypto for long, as the Supreme Court overturned this ban in 2020. 

The struggle to accept and regulate crypto usage and promotion continued as it was banned again, this time from being advertised in both men's and women's cricket leagues. Even with the government's overt hostility towards crypto, the surge in the numebr of crypto users seen between 2017 and 2022 is an overwhelming 760%.  

Many crypto startups in India flourished during this time. However, not all of them could sustain till now due to a sharp 75% drop in investment during 2022. Currently, some of the most popular ones are:

  • Polygon
  • CoinSwitch
  • CoinDCX
  • Vauld
  • Chingari

By the end of 2022, the government had over 3,300 crypto accounts suspected of illegal activities like money laundering and drug trafficking. The Indian market has proved very volatile for both crypto startups and users. In 2023, companies like CoinSwitch want to diversify their business to stocks and mutual funds to stabilize revenues. While Unocoin, India’s oldest exchange, is confident in its existing business model and reluctant to diversify.

Understanding the Inner Working of Cryptocurrency 

Cryptocurrencies operate based on blockchain technology, a decentralized and secure system. Transactions are recorded in blocks, forming an unbreakable chain. To validate transactions and mint new coins, mining is employed. Miners use computational power to solve complex puzzles, ensuring transaction integrity. In Proof of Work (PoW) cryptocurrencies like Bitcoin, the first miner to succeed in adding a block is rewarded with newly minted coins. Proof of Stake (PoS) cryptocurrency uses validators based on staked coins for verification, reducing energy consumption. Cryptocurrencies facilitate secure and transparent digital transactions through these mechanisms, reshaping the financial landscape.

How Crypto Frauds Crept In?

India is currently one of the biggest cryptocurrency markets in the world, with the most extensive user base and the second-largest transaction value. This is even though between January to October of 2022, the monthly transaction volume of Indian crypto exchanges saw a 97% decline. This decline is in no way indicative of a drop in the less-than-legal uses of cryptocurrency. Many traders in the last couple of years have parked large sums of crypto assets overseas for tax evasion. 

Case In Point: Role of Former FTX CEO in $40 Billion Terra Luna Crash 

The FTX collapse caused ripples in the crypto market, and now further revelations have surfaced regarding the downfall of crypto 'Robinhood' Sam Bankman-Fried. Investigations are underway by US prosecutors into his possible role in orchestrating the death spiral of TerraUSD (UST) and its affiliated token Luna. The Terra algorithmic stablecoin ecosystem, which suffered a $40 billion market value wipeout earlier this year, is now being re-examined due to the FTX collapse. The investigation focuses on on-chain and centralized exchange activity, as traders can only see half the picture. At the same time, the other half remains obscured due to undisclosed user information. The instability of UST had become evident in early May, prompting liquidity withdrawals and panic swapping that disrupted the balance on the Curve pool. With poor liquidity on centralized exchanges and an aggressive shorting of Luna, the de-pegging of UST from the dollar became exacerbated, with suspicions pointing towards FTX's sister trading platform Alameda as a significant player in the massive sell-off.

Crypto: A Dangerous Balancing Act

Central banks worldwide maintain a profound sense of skepticism towards cryptocurrencies, mainly due to their unique product structure and regulatory complexities:

Decentralization Dilemma

Cryptocurrencies operate on a decentralized network, with each node acting as its ledger, making effective monitoring and regulation of every node's activities challenging.

Anonymity and Illicit Activities

Crypto transactions offer pseudonymity, raising concerns about potential illicit activities, such as terrorist funding and arms trade, facilitated by this anonymity.

Lack of Regulation

The crypto market currently lacks comprehensive regulatory frameworks to curb illicit activities leading to unmonitored and anonymous financial transactions.

Balancing Innovation and Security

While crypto presents opportunities for financial innovation, we have yet to strike a balance between fostering technological advancements and safeguarding against illicit activities.

Vigilant Monitoring

Central banks need to closely study the implications of cryptocurrencies on the broader financial landscape without failing to address any challenges and counter illicit activities.

Case in Point: Restraining Crypto's Hand in Terror Funding

The 'No Money for Terror' meeting held in Delhi in December 2022 by the Home Affairs Ministry had the use of cryptocurrency by terrorists as the primary agenda for discussion. Driven by its decentralized nature and the absence of effective policing, of particular focus was the exploitation of the dark web by terrorists seeking transfers or crowd-sourcing funds through cryptocurrencies. Having concerns similar to India, the UK shut down all its Bitcoin ATMS in early 2022. In the meeting, Australia also raised concerns about Russian paramilitary forces leveraging cryptocurrency donations to buy weaponry, armor, and drones to contribute to the ongoing Russia-Ukraine conflict. The key takeaway from the meeting was that cryptocurrency was no longer a niche option for criminal funding but rather a mainstream avenue that needs policing.

Common Crypto Scams In India

People's fascination with crypto remains strong despite the legal hurdles and market fluctuations. New and different illegal ways to make money always crop up; here are a few of the more popular types of crypto scams:

  1. Fake Initial Coin Offerings (ICOs): Scammers create fraudulent ICOs to raise funds for non-existent or worthless projects. They often use misleading marketing and false promises to attract investors
  1. Fake Exchanges and Wallets: Fraudulent cryptocurrency exchanges and wallets may imitate legitimate platforms to deceive users into depositing their funds. However, these fake platforms do not allow withdrawals, and users lose their funds.
  1. Pump and Dump: Cryptocurrencies offer a modern twist to the conventional pump and dump scheme. During ICOs or beyond, false claims can artificially inflate demand, enabling originators or dominant holders to profit significantly before a subsequent sell-off.
  1. Mining Scams: Some scams promise high returns on cryptocurrency mining investments or sell fake mining hardware. In reality, victims may never receive any profits or the promised equipment

Case In Point: India’s Biggest Cryptocurrency Scam Till Date

The GainBitcoin Ponzi scheme has devastated approximately one lakh victims, with an estimated loss of over Rs 1 lakh crore (Trillion). The fraud involved a multi-tiered pyramid led by Amit Bhardwaj and his 'Seven Stars,' operating in India and overseas. Promising a 10% monthly return in Bitcoin-on-Bitcoin deposits for 18 months through marketing programs, investors were enticed to lend their Bitcoins with hopes of substantial growth. However, relying on a finite number of Bitcoins, the flawed scheme resulted in significant losses for many investors who realized their mistake only after investing. 

On the Road from Regulation to Recognition

Before we delve into how the latest money-laundering laws came into effect against crypto, let us look at the past laws regarding crypto. In 2021, the Cryptocurrency and Regulation of Official Digital Currency Bill was introduced in parliament, seeking the creation of digital currency issued by the RBI. The legislation was held back due to crypto being borderless and requiring input from international regulatory bodies. Hence, without a concrete bill, cryptocurrency in India is still unregulated as a payment medium and is to be done at the investor's risk. However, a tax on digital assets has been recognized and put in place by the government dictating:

  • 30% tax on earnings from the transfer of VDAs
  • Investors to report the calculated profits and losses as part of income
  • 1% TDS on buyer's payment if the threshold crossed
  • Gifted cryptocurrency to be taxed on the giftee's end
  • Loss from crypto cannot be balanced against other income

The need for exclusive regulatory laws regarding crypto became even more apparent after seeing the steady rise in the usage and subsequent unchecked abuse of crypto for illegal activities.

Prevention of Money Laundering Act (PMLA) India

In March 2023, the central government introduced the PMLA Amendments that put many new areas under the purview of what falls under the category of money laundering in India. A significant addition here is Cryptocurrency and Virtual Digital Assets (VDA). Any institution or body dealing in the trading, safety, and other related financial services of VDAs will be counted as a 'reporting entity' under the PMLA. These may include crypto exchanges, wallets, and other service providers or intermediaries in the cryptocurrency ecosystem. 

Reason for Stringent Laws

This move aims to curb the misuse of cryptocurrency for money laundering while protecting the interest of the general investor and the country. The need to have sensible and systemic regulations for cryptocurrency has gradually become apparent to countries across the globe, and now India too.

Case in Point: Crypto Exchange WazirX and 10 More Under Probe

During 2022 alone, the ED and the Income Tax Department have witnessed and put at least ten different crypto exchanges on suspicion of aiding foreign companies to launder money through cryptocurrency. These exchanges allegedly allowed companies to buy crypto coins worth INR 100 crores and transfer foreign wallets, often with sketchy or missing KYC details.

Upto INR 289.28 crores were seized from crypto exchange Zanmai Labs Pvt Ltd, aka WazirX, under the Foreign Exchange Management Act (FEMA). The firm and its directors have also been issued a show-cause notice for suspicious crypto transactions worth INR 2790 crores.

Transaction Types Falling Under Amended Law

  • Conversions between VDAs and fiat currencies
  • The exchange of diverse VDA types
  • Any transfer of VDAs
  • Secure storage and management of VDAs
  • Financial services like issuance and sale of VDAs

India and G20's Approach to Crypto

Determined to avoid another FTX 2022-like blow-up in the crypto ecosystem, the Financial Security Board of G20 has decided to lay out a global framework for the transaction of crypto assets. The Finance Minister emphasized that India plans to tackle macroeconomic and financial stability risks and prioritize investor protection and education, all the while ensuring that no actions impede technological advancement. According to FSB, the past year revealed the crypto-asset's inherent volatility, structural weaknesses, and the risk of a service provider's failure impacting the entire ecosystem. If ties to traditional finance expand, spillovers to the broader financial system may heighten.

Proposed Areas for Regulation:

  • Ensuring adequate safeguarding of client assets 
  • Addressing risks associated with conflicts of interest
  • Strengthening cross-border cooperation

Closing Thoughts

While the RBI stands firmly against crypto in India, the new regulations are a welcome change to the average crypto investor. With better safeguarding of their assets, crypto onc again looks like a lucrative investment. According to a recent Statista study, India is set to have 156 million crypto users by the end of 2023. For the young crypto traders in India, the most significant cause of concern today is whether or not to file their overseas crypto assets in their ITR forms. Whether every single transaction from an Indian crypto exchange to an overseas wallet is considered money laundering is still under question. However, many traders consider FEMA a lesser evil than the Black Money Act or PMLA for VDA disclosure in the absence of a better answer to their dilemma.

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Cryptocurrency: Unmasking the Risk

  • January 23, 2024
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