On Monday the Reserve Bank of India issued a notification to virtual currencies or cryptocurrencies and repeating what she has been saying for over 8 years. It instructed banks to comply with the existing rules on money laundering, terrorist financing, foreign exchange management and know-your-customer norms when dealing with crypto companies.

This was triggered by emails sent to their clients by India’s leading banks last week warning them of the risks of investing in cryptocurrencies. While HDFC Bank asked customers for information about the nature of certain transactions, SBI Cards and Payments warned its users not to buy cryptocurrencies using their credit cards. Both banks said they would take action if customers fail to comply.

Quoting a circular that was rejected by the Supreme Court last year on grounds of “proportionality” is obviously not legally tenable at first. The RBI said in its statement on Monday. It stated: “The circular is no longer valid as of the date of the Supreme Court judgment and therefore cannot be quoted or cited.”

But over the past three months, some of the leading banks have blocked access to deposit and payment channels on crypto exchanges. Nobody knows exactly what was said or communicated to the banks by the supervisory authority. But sources at banks and crypto exchanges have told MediaNama that it all started with the IPL – the Indian Premier League, the cricket tournament.


A complete overview of the regulation of cryptocurrencies in India.


The burden of euphoria

Average time of day last year Trading volume on the leading Indian crypto exchanges fluctuated between $ 250,000 and $ 6 million, or 18 lakh-Rs 43 crore. As of January this year, the average daily trading volume shot up to $ 1 to $ 400 million or Rs 7 billion to Rs 3,000 billion on some days.

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Given the immense wealth accumulation in a short period of time, the mania about Bitcoin prices and the higher trading volume, which means more exchange fees, advertisements were placed during the IPL earlier this year, especially with the clear message “Buy Bitcoin”.

Sources said this clearly triggered the RBI, which informally communicated that it was uncomfortable with the extent of banking activity in the crypto-verse. Bankers also said that with higher trading volumes, questions came up from the RBI.

Since the Supreme Court rejected the RBI in April 2018 circularbanning banks from dealing with crypto companies and individuals, banks opened their channels to these companies. This included checking account services and working with payment service providers. It became relatively easy to buy cryptos for as little as Rs 10 to Rs 500 per month through UPI and cards, e-wallets and other digital payment methods. Some of the big payment service providers stayed away, but the leading banks saw this as a tremendous opportunity to potentially earn fees, perhaps to support the future of currencies, assets, and finances.

In fact, last year the top court asked the RBI to work on new regulations. But the RBI has not issued any new guidelines for banks and payment companies since the ruling.

What banks don’t know

When money flows from Person X to Crypto-Exchange ABC, the banks will know this information because ABC is on their network and uses its software to accept deposits from investors. The exchanges themselves have adopted a code of conduct and standard operating procedures to ensure they comply with RBI’s existing rules on money laundering, KYC and other issues.

When X takes 50,000 rupees, she dumps them in cryptos and a few months later earns 100,000 rupees and then decides to withdraw 50,000 rupees; the bank knows again that ABC gave X the rupee currency.

But the bank and crypto exchange may never figure out what X really did with the cryptos. Because Bitcoin works on the principle exchange, it can act as currency. That means as a medium of exchange, which in the case of Ethereum, for example, is also a tradable asset and a commodity.

If X bought 20,000 rupees in Bitcoin to fund illegal activities, the banks need to know about it. If X made Rs 10,000 on his initial nefarious investment in Rs 20,000 and then pulled that illegal money off the exchange back into the formal banking system, the banks need to know.

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In 2020, deals worth $ 42 million in cryptocurrencies on Indian blockchain accounts were conducted on the dark web. And Ponzi schemes continue to run amok.

When it comes to illegal crypto activity and traceability, it depends on which crypto enthusiast you are talking to. People in the crypto industry would say there are “tools and software,” tech experts say that “anonymity is fundamental to technology,” while bankers would tell you, “if X is smart enough, they can get away with it.”

Imagine even if 1% of the average trading volume is withdrawn from the crypto exchanges daily, that’s around 7 lakh rupees on some days and 30 billion rupees on others. This is an immense flow of money that flows indiscriminately through the banks, which of course burdens the legal and compliance departments of the banks with questions and filings.

Understandably, the RBI considers all of this to be too risky. Especially without a law that gives it the legal authority it needs to intervene and legislate.

The regulatory state

The RBI said in its statement that banks, credit unions, payment banks, small financial banks, non-bank financial companies and payment system providers “can still carry out customer due diligence processes” and comply with existing regulations.

Presumably, the banks followed these standards for ABC as a company and X as private customers.

In recent years, the RBI has intensified its enforcement measures against banks, financial institutions and payment companies. The fines are increasing and last year they used economic sanctions as a further regulatory instrument for the first time. It’s not that banks didn’t follow existing KYC, money laundering and foreign exchange guidelines. Can today’s bank look the other way and fail to comply with any type of activity?

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The problem is that there is no legal definition of cryptocurrencies. Nor has the government given RBI or any other financial regulator regulatory powers to look after the space.

Banks and payment companies cannot track and monitor complex transactions across the crypto-verse through their existing technology and compliance software.

While banks can monitor what goes in and out of X and ABC’s account when X is on Bank A and ABC’s account on Bank B’s network, the mix becomes more complex. This requires industry-wide coordination and regulation. The tax authorities would also have to see this data.

Perhaps some of the larger and wealthier banks and payment companies have bought expensive software to track blockchain transactions. But most of them would not have the opportunity to do so.

First, the government said it would ban cryptocurrency activity in India, then made it clear that it would take a “calibrated approach”. After that, the government changed corporate financial disclosure rules to recognize virtual currencies as digital assets. Through this change, it also indirectly recognized the role of crypto exchanges as companies performing a fiduciary function. The government also notified parliament that crypto exchange transactions and investments are taxable.

It is reportedly now forming a new committee to review the prospect of regulating the crypto-verse. According to sources, this committee will consist of parliamentarians and cabinet ministers, unlike the previous committee of government officials who recommended a total ban and criminal law provisions against crypto firms, investors, traders and miners.

In recent months, influential stakeholders such as Infosys non-executive chairman Nandan Nilekani, former Treasury Secretary Subash Chandra Garg who headed the previous crypto committee Shashi Tharoor have said that regulating cryptocurrencies is the way to go. A month after its launch, the India Covid-Crypto Relief Fund has raised nearly $ 1.6 billion that will be distributed to NGOs and other organizations working to fight the virus.

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The government and RBI should console themselves with the fact that a global consensus has been formed over the past 8 years that cryptocurrencies are not a threat and to protect themselves against risks: They need regulations. From market regulators, global card networks, banks, hedge funds, monetary authorities, corporate coffers, exchanges and local authorities opening their arms to cryptocurrencies and blockchain, but with regulations.

Politics and Chaos

Unfortunately, policy making is not just a relationship between government, regulators, businesses and citizens / consumers. It is also a political act, and cryptos can certainly be used as a political tool. The adoption of cryptos has been inevitable since its inception a decade ago in the wake of a financial disaster. This follows the same historicity when metal was made into coins or when the first parchment or paper notes were created to replace an older method of payment and exchange.

Given the political nature of cryptocurrencies and emerging technologies, the government is broadly adopting a centralized approach; be it artificial intelligence, blockchain, digital currencies / assets and even the use of vaccines.

If a CBDC is in the works because the government believes the underlying technology behind the blockchain is inevitable, it cannot take cryptography out of the equation. This is similar to the argument WhatsApp made in its lawsuit against the governments’ new rules. If the state accepts the right to privacy, it must accept its right to encrypted messages. If CBDC or a digital rupee can be bought and used by citizens, banks and companies, the government cannot avoid the decision to buy, sell, trade, mine and generate exorbitant returns on cryptocurrencies.

Just last week, HDFC Bank’s treasury department released a note examining the returns on leading cryptocurrencies and comparing them with the returns on investments in the S&P and NASDAQ indexes and gold since January. While the returns on Bitcoin were 36%, the return on the S&P Index, for example, was 17%. Because of these high returns, young people and ordinary investors are ready to invest some money in the world of cryptocurrencies and are ready to take the risk.

The banks’ note ended with the words: With CBDCs in the pipeline, it is “only a matter of time before Indian investors have legal access to crypto games”..

Due to unnecessary uncertainty, some of the top banks lost decent business with large inflows and outflows. The founders of the crypto exchange and their teams had to react to these changes overnight, make calls and code them away. Some of them turned to new payment partners and new banks, others lost. Meanwhile, Indian crypto activity remains resilient and most investors remain unwavering in their engagement.

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Why the Cryptic Messaging? Why the mess?