Mint Explainer: Reining in the wild crypto exchanges

In India, such concerns have bubbled up in recent days amid reports from the Enforcement Directorate (ED) investigating some 10 cryptocurrency platforms for suspected money laundering of more than ₹NOK 1,000 million.

This latest controversy once again brings into focus the lack of strong operational, governance and risk management practices at crypto exchanges, something the International Monetary Fund has highlighted in the past. But the lack of global consensus is a major stumbling block in the regulation of crypto and crypto exchanges.

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Have policy makers in India found the right approach to regulate cyrpto products and exchanges?

Why are the stock exchanges examined?

Some 10-odd crypto exchanges are under the ED lens for alleged money laundering of approx ₹1,000 crore – this sum is suspected to be the business revenue of some dubious instant loan apps, allegedly funded by Chinese entities.

The crypto exchanges are under the lens due to lack of due diligence in the financial transactions under scrutiny, because they do not raise Suspicious Transaction Reports (STR) and do not maintain proper KYC (Know Your Customer) records.

A notice has been issued to crypto exchange WazirX under the Foreign Exchange Management Act (FEMA) for outbound transfers of crypto assets of over ₹2,700 crore to unknown wallets.

Meanwhile, the public spat between WazirX and its operational partner Binance, a global cryptocurrency platform, over ownership and operational issues is also being monitored by the ED.

How is the crypto industry regulated in India?

In India, the crypto industry is largely unregulated at the moment. The Reserve Bank of India (RBI) has been wary of the inherently speculative nature of crypto products and banned virtual currencies in April 2018, but the Supreme Court overturned the central bank’s order in March 2020.

However, the RBI continues to staunchly oppose crypto products and platforms. This is what RBI Deputy Governor T. Rabi Sankar recently said: “Cryptocurrencies cannot be defined as a currency, asset or commodity. They have no underlying cash flows. They have no intrinsic value. They are akin to Ponzi schemes, and may even be worse.”

Sankar, in fact, went much further: “They (crypto) can (and if allowed most likely will) destroy the currency system, the monetary authority, the banking system, and generally the government’s ability to control the economy.”

The government’s proposed Cryptocurrency and Regulation of Official Digital Currency Act of 2021 seeks to ban all private cryptocurrencies in India and instead create an official digital currency to be issued by the RBI. Lawmakers will decide the future in parliament.

In the budget, Finance Minister Nirmala Sitharaman introduced a 30% tax on the transfer of digital assets such as cryptocurrencies and a TDS of 1% on each transaction. In a sense, at the moment, it is not illegal to own crypto assets.

But it is not uncommon for cybercriminals to target crypto exchanges.

What has been the global experience?

Money laundering through crypto exchanges has emerged as a global concern in recent years.

Criminals laundered $8.6 billion in cryptocurrency in 2021, a 30% jump from 2020, according to a report by blockchain data firm Chainalysis.

By tracking crypto wallets run by criminals, Chainalysis was able to estimate the money laundered in recent years. Europol, the EU’s law enforcement agency, has also issued a warning. According to Europol, “Illicit use of cryptocurrencies is mainly associated with money laundering purposes, trade in illegal goods and services and fraud.” It also points out that criminal networks have adopted crypto for large-scale money laundering.

The Financial Action Task Force (FATF), an intergovernmental organization, has sought global cooperation among countries to check the scourge of money laundering through crypto.

“It is important for countries … to understand the money laundering and terrorist financing risks associated with virtual asset activities and to implement appropriate mitigation measures to address these risks,” the FATF said in 2021.

Crypto exchanges are also frequently hacked by cybercriminals, scooping up billions of dollars in crypto assets. There were more than 20 hacks in 2021 where at least $10 million in digital assets were stolen from a crypto exchange or crypto project, NBC reports. A bitcoin scam by hacker Sriki sent shockwaves through Karnataka last year. Sriki is said to have hacked into the Bitifinex crypto exchange, which has a presence in over 50 countries.

Like we said, would you invest in stocks if exchanges like the NYSE or our NSE and BSE were vulnerable to hacking? Therein lies the need to regulate the crypto industry.

How do countries regulate crypto?

At the moment, a coordinated and unified approach to regulating crypto and crypto exchanges appears a distant possibility. The regulatory agencies have different approaches to crypto.

The US Securities and Exchange Commission appears to treat cryptocurrencies as securities, and securities laws apply to digital wallets and exchanges. The Commodities Futures Trading Commission treats Bitcoin as a commodity and allows cryptocurrencies to trade publicly.

In Canada, crypto is not legal tender, but can be used as payment for goods and services. Crypto exchanges must register with the Financial Transactions and Reports Analysis Center of Canada. Japan recognizes Bitcoin and other digital currencies as legal properties and crypto exchanges are legal and must be registered with the Financial Services Agency. China has banned all cryptocurrencies in September 2021 along with all exchanges.

Regulations will only be effective if there is a concerted global movement – ​​remember that cryptos are traded on global platforms and are outside the jurisdiction of a single country. To prevent cybercriminals from hacking into crypto exchanges and turning them into a conduit for money laundering, a global movement is again needed.

But currently, each country has its own crypto policy, which makes the task of regulating these virtual assets tougher. This may also have prompted the RBI to seek a crypto ban and convinced the Indian government that it is wise to ban private cryptocurrencies.

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