High taxes on crypto will disincentivise compliance

The Indian crypto and blockchain industry has been a standout sunrise sector of 2021, attracting venture capital investments worth $638 million. The path India takes can have a profound impact on the world as well. With a high talent-density, robust public digital infrastructure, and growing internet adoption, we are uniquely positioned to shape the global crypto landscape, and internet’s future.

But there is competition. From the Asian financial hubs of Dubai and Singapore to the United States, regulators realise the crypto ecosystem can be harnessed to strengthen and deepen the reach of legacy financial systems.

With the Finance Bill (2022), we took a step forward by defining virtual digital assets, but took two steps back by imposing onerous tax provisions. Virtual digital assets are defined as digital representations of value exchanged with the promise or representation of having inherent value, or a store of value or a unit of account. While the Bill recognised the growing interest among Indians in this emerging asset class, it imposed tax structures that curtail its growth and potential to positively impact our economy and competitive landscape.
 

Taxes are best-placed to meet their objective if they incentivise compliance. Prohibitively high taxes or onerous provisions disincentivise compliance and could push investors out of the regulatory framework.

This will have two fallouts. Indian crypto platforms will lose their users, weakening the domestic industry. And investors who have a lot at stake, or are determined, will be incentivised to move their holdings outside of the Indian jurisdiction.
 

The government’s ability to effectively monitor and implement the tax provision would be impaired if crypto holdings are on platforms outside the country. Tax disputes could become the order of the day. Further, the migration of users will benefit foreign platforms at the expense of the domestic industry. Or worse, investors could move their crypto assets into decentralised and high-risk exchanges with little Know-Your-Customer (KYC) requirements.

Decentralised exchanges are marketplaces that enable direct crypto transactions between users, without an intermediary to manage the funds. According to Elliptic, a blockchain analytics firm, global trading volume on decentralised exchanges has crossed $30 billion per month.

Many of these decentralised exchanges function outside the scope of anti-money laundering and terrorist financing measures. The Financial Action Task Force (FATF) has said that decentralised exchanges and peer-to-peer marketplaces are at high risk of misuse.

Decentralised exchanges also heighten exposure to scams. Rug-pulls are most common on decentralised exchanges, the blockchain analytics firm Chainalysis notes in its latest crypto crime report. Rug-pulls refer to crypto scams where deceitful developers syphon out investor funds after the tokens they made turn a neat profit. Chainalysis notes that such scams are on the rise on decentralised exchanges, as tokens are often listed on the platform without a code audit or due diligence.

Driving users and their investments to such platforms will create a problem that India may find hard to mitigate. This is not the case today. India’s crypto investors purchase and sell crypto-assets through centralised exchanges and platforms. These platforms follow KYC requirements that are on a par with the banking industry, and more stringent than even the Travel Rule that FATF recently recommended for virtual asset service providers.

Users willingly abide by these requirements, because the platforms are trustworthy and convenient to use. Strict cybersecurity measures followed by these platforms also reassure them. Further, responsible platforms list crypto tokens only after due diligence. Globally, there are over 13,000 crypto tokens available, according to CoinGecko’s tracker. But in India, platforms list only a fraction of these tokens — after due diligence.

Regulations should encourage users to stay within this framework.

The writer is the co-founder and Chief Executive Officer of CoinSwitch