Virtual digital assets(VDAs) and India’s stand on it– Explained, pointwise

Introduction

India’s approach to regulating virtual digital assets (VDAs) is measured and considers the challenges posed by emerging technologies. The government has extended anti-money laundering provisions to VDA businesses and service providers, requiring them to register with the Financial Intelligence Unit-India.

This move promotes transparency and aligns with global guidelines from organizations like the IMF and FATF. As India holds the G-20 presidency, it can plays a key role in shaping global regulatory frameworks for VDAs while learning from other nations’ experiences in regulating this emerging sector.  

What are Virtual digital assets?  

How are Virtual Digital Assets different from Digital Currency?

Virtual digital assets (VDAs) are a broad category of digital representations of value that can be traded, transferred, or stored electronically. They include various types of digital tokens, such as cryptocurrencies, utility tokens, and non-fungible tokens (NFTs).  

Digital currency, on the other hand, is a subset of VDAs and refers specifically to digital forms of money, like cryptocurrencies. These currencies can be used as a medium of exchange, a unit of account, and a store of value. A digital currency can be defined as a currency when it is issued by a central bank.  

In the case of India, the Reserve Bank of India (RBI) issued e-rupee. The government plans to tax profits made during transactions of these assets at 30 percent.  

Why India needs to regulate VDAs?

Growing VDA adoption: With an increasing number of Indian investors and businesses engaging in VDA transactions, it is essential to establish a regulatory framework to address potential risks and challenges.  

Market volatility: The highly volatile nature of VDAs can lead to significant financial losses for investors. Regulation is needed to minimize the impact of such volatility and protect investors.  

Lack of consumer awareness: Many Indian consumers may not fully understand the complexities of VDAs and could be vulnerable to misleading information. Regulation is needed to ensure transparency and accurate information dissemination.  

Fragmented regulatory landscape: Currently, VDAs are subject to a patchwork of rules and regulations. A unified regulatory framework is necessary to bring consistency and clarity to the market.  

Cross-border transactions: As VDAs facilitate cross-border transactions, it is important to have a regulatory framework in place to address potential issues related to foreign exchange management, taxation, and jurisdictional disputes.  

How does the government define and regulate virtual digital assets?

To regulate VDAs, the government typically: (a) Establishes a legal framework to classify and define VDAs, (b) Sets up licensing requirements for VDA service providers, (c) Implements anti-money laundering (AML) and combating the financing of terrorism (CFT) rules, (d) Enforces consumer protection and disclosure norms, (e) Mandates risk management and reporting standards, (f) Introduces taxation rules for VDA transactions, (g) Ensures transparent advertising and marketing practices.

These regulations help protect investors, maintain financial stability, and prevent illicit activities involving VDAs.  

In case of India:  

The Indian government defines virtual digital assets (VDAs) under section 2(47A) of the Finance Act, 2022. According to this definition, a VDA includes: (a) Any information or code or number or token (not being Indian currency or foreign currency) that meets specific conditions, (b) Non-fungible tokens (NFTs) or any other token of a similar nature, regardless of the name used, (c) Any other digital asset that the government may specify by notification.  

The government also may exclude any asset from the definition of virtual digital asset by notification. The CBDT issued two notifications for the purpose of defining virtual digital asset under section 2(47A) of the Act—one excluding certain assets from the definition, and a second defining NFT for purposes of the section.  

What are the advantages of Virtual Digital Assets (VDAs)?

Accessibility: VDAs are accessible to anyone with an internet connection, allowing more people to participate in the global economy. For example, people in developing countries can use VDAs to access financial services they may not have access to otherwise.  

Lower transaction costs: VDAs often have lower transaction costs compared to traditional banking services. For instance, crossborder payments can be faster and cheaper with VDAs like Bitcoin.  

Enhanced privacy and security: Using VDAs can provide a higher level of privacy and security compared to traditional financial systems. For example, blockchain-based VDAs can protect users from identity theft and fraud.  

Decentralization: VDAs are decentralized, meaning no central authority controls them. This can reduce the risk of manipulation and censorship. For instance, cryptocurrencies like Bitcoin operate on a decentralized network of computers.  

Financial innovation: VDAs can foster innovation in financial services, leading to the development of new products and platforms. For example, decentralized finance (DeFi) platforms built on Ethereum offer various financial services using smart contracts.  

Asset diversification: VDAs provide an alternative asset class for investors, allowing for portfolio diversification. For instance, investors can allocate a portion of their investments to VDAs like Bitcoin to potentially hedge against economic uncertainty.  

What are the challenges in controlling virtual digital assets?

Anonymity: VDAs can provide a high level of anonymity, making it difficult for authorities to trace transactions. For example, privacy focused cryptocurrencies like Monero can be used to hide transaction details.  

Decentralization: The decentralized nature of VDAs makes it challenging for governments to exert control over them. For instance, shutting down a single server won’t affect the Bitcoin network since it operates on numerous computers worldwide.  

Regulatory complexity: Creating and enforcing regulations for VDAs can be complex due to the rapidly evolving technology and varying legal frameworks across jurisdictions. For example, differing tax treatments for VDAs across countries can lead to confusion and compliance challenges.  

Volatility: VDAs often experience significant price fluctuations, making them a risky investment and complicating their use as a stable means of payment. For instance, Bitcoin’s value can change drastically within a short period, impacting investors and users.  

Cybersecurity risks: VDAs are susceptible to cyberattacks, which can lead to theft, fraud, and loss of assets. For example, cryptocurrency exchanges have experienced security breaches, resulting in the loss of millions of dollars worth of VDAs.  

Illicit activities: VDAs can be used for illegal activities, such as money laundering, terrorism financing, or purchasing illicit goods. For example, the anonymous nature of some VDAs can make it easier for criminals to conduct transactions without being traced.  

What should be done?

Establish clear regulations: The government should create comprehensive and transparent regulations to guide the VDA market. For example, implementing licensing requirements for VDA service providers can ensure responsible operation and consumer protection.  

Harmonize international standards: Global cooperation is essential to address VDA-related challenges. Countries can collaborate to establish standardized rules, such as in areas of anti-money laundering and taxation. For instance, the Financial Action Task Force (FATF) guidelines can serve as a starting point.  

Enhance cybersecurity measures: VDA stakeholders, including governments and service providers, must prioritize cybersecurity to protect user assets. For example, implementing strict security protocols for cryptocurrency exchanges can reduce the risk of hacks and thefts.  

Promote education and awareness: Public education campaigns can help users make informed decisions about VDAs and mitigate risks. For instance, providing resources on safe VDA practices, potential scams, and investment risks can empower individuals to navigate the digital asset landscape responsibly.  

Foster innovation: The government should encourage the development of new VDA technologies and applications, which can drive economic growth and benefits. For example, supporting research and development in areas like blockchain technology can lead to innovative solutions in finance, supply chain management, and more.  

Monitor and adapt: As the VDA market evolves, governments should continuously review and update regulations to stay current with emerging trends and challenges. For example, adjusting policies as needed to address new types of VDAs, such as stablecoins and decentralized finance platforms. 

Sources: Indian Express, The Hindu, Livemint, Economic Times and ORF

Syllabus: GS 3: Economic development – Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.