Regulatory minefield: ED enters the crypt, waking up the ghosts for Crypto Inc

Mumbai: The seven-year itch has come a year late for India's turbulent crypto trade. After 2018, when the Reserve Bank of India (RBI) had cut off crypto exchanges from banks, another existential crisis now stares at them in the face. It stems from Enforcement Directorate's indictment of four crypto firms last week.

By going after these entities which used digital coins for unauthorised money transfers from abroad, the agency has woken up a sleeping dog. According to ED, cryptocurrencies freely crossing borders can fall foul of foreign exchange laws even if the funds used in buying or selling cryptos are kosher.

The message is simple: When money moves in and out of India in the garb of cryptos and banks are bypassed, there's serious breach of the Foreign Exchange Management Act (FEMA) even though there's no violation of the anti-money laundering law (PMLA) and funds (paid or received) aren't 'proceeds of crime'.


As trade surged and many used virtual digital assets (VDAs) to move funds overseas, it was a matter of time someone someday would have raked it up. Crypto players knew it was a lurking threat. With ED raising it, maybe unwittingly, it's now a looming one.

LIQUIDITY CRUNCH

ED's position strikes at the heart of crypto platforms which regularly deals with offshore exchanges and companies, either directly or indirectly, to generate 'liquidity'-the lifeblood of crypto houses. Indian exchanges source crypto from overseas in the absence of sellers here.

"What's significant is the legal premise underpinning the enforcement action, and not merely specific allegations. Read broadly, that premise may not stay confined to remittance-style fact patterns, but extend to other cross-border VDA transactions, including over-the-counter (OTC) purchases. Given that most VDAs are issued by overseas entities, and the difficulty Indian players face in securing banking support to remit funds for acquiring VDAs from abroad, this reasoning could pose a serious challenge for crypto businesses in sourcing liquidity," said Purushottam Anand, founder of Crypto Legal. RBI, he thinks, should settle how VDAs are characterised under FEMA, without which accessing offshore liquidity will remain a regulatory minefield.

How do Indian exchanges pay foreign suppliers? Either transmit USDT or stablecoins which are linked to the US dollar, or transfer funds through banks. The first violates FEMA as banks and forex haven't been used. To a crypto geek, it's a wonder called blockchain; to ED, it's a variant of 'hawala'. The second option may require false declaration as no bank would handle funds for 'crypto import'.

Often exchanges don't directly deal with overseas players but transacts with 'liquidity providers'. Still, questions would crop up on the dealings of liquidity providers.

IN & OUT OF WALLETS

ED's action could bring to the fore how cryptos from abroad are 'deposited' in (and 'withdrawn' from) local exchange wallets as they flow in and out.

A legal minefield has suddenly surfaced, feel experts. Some firms named by ED are registered with Financial Intelligence Unit (FIU) that combats money-laundering and receives data from crypto platforms. But the issues raised by ED are beyond FIU.

"Given their border-less nature cryptos can no longer be seen through the PMLA lens alone. Most platforms permit withdrawals, and once assets leave the platform, effective oversight is difficult. This has implications under RBI's Liberalised Remittance Scheme (LRS) which forbids a resident individual from remitting beyond $250,000 a year. I feel directions about deposits, withdrawals, payments, LRS applicability, and FEMA compliance should come from RBI," said Sudhakar Lakshmanaraja, founder of Digital South, a blockchain education trust.

ED's treatment of cross-border crypto transfers as money transfers has economic logic, but clashes with the positions of RBI before Supreme Court and that of Madras HC, said Harshal Bhuta, a FEMA specialist. "Both declined to treat crypto as currency. If crypto isn't currency, equating its movement with money transfer is debatable. More so, because very little crypto is mined here, yet are freely available with trading volumes growing. This inevitably raises questions on how cryptos enter India, who pays for them, and how," said Bhuta.