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Crowding Out the Crypto Crowd?

Sugata Ghosh

Last Friday, India’s chaotic world of cryptocurrencies had its first brush with one of the toughest laws. Officials of the Enforcement Directorate (ED), which investigates money-laundering and irregular foreign exchange deals, knocked on the doors of the leading crypto exchange WazirX, which is backed by Binance, the world’s largest crypto bourse founded by the Chinese-Canadian entrepreneur CZ.

Zanmai Labs, the Mumbai firm that owns WazirX, and two founder directors were served show-cause notices by ED in the course of a probe into a Chinese-owned betting app. WazirX has not been directly implicated in money-laundering — the notices are under Foreign Exchange Management Act (Fema) and not under the draconian Prevention of Money Laundering Act (PMLA). But launderers used the exchange to avoid banks in moving money in and out of the country.

No businessman would like his name in an ED note that talks about crypto (a digital currency which few fully understand), Chinese links (one would underplay, if not avoid) and money-laundering (governed by a widely worded statute).

Many in the new, disruptive, and often detached world of startups, with its joys of innovation and pangs of growth, may call this a ham-handed handling of a probe by an agency clueless about cryptos — like a traffic cop stopping a robocar. But it isn’t. This was waiting to happen. ED, perhaps unwittingly, has stirred up questions that need to be answered for cryptos to have a future in India.

Soon after a crypto is launched overseas, trading begins in India, even though there is little or no crypto mining here. What really happens? Newbie traders in India rush to place orders on local exchanges, driving up prices far beyond the international price in the absence of a ready, local supply; smarter traders cash in on the price gap: they buy the newly launched crypto cheaper from overseas and sell them on Indian exchanges.

For buying the new crypto, suave trader-arbitrageurs transfer funds abroad through official banking channels under RBI’s liberalised remittance scheme (LRS), or tap the unofficial hawala network, or use cryptos lying in wallets to pay for new ones.

Such trades are happening in the twilight zone of law. Many question the use of LRS for cryptos. It’s unclear whether cryptos purchased abroad and sold here violate Fema. Defenders of crypto argue it doesn’t, as RBI had clarified crypto is not a ‘currency’.

What if a transaction is outright suspicious? What if someone sends his accomplice in India with cryptos stored in a pen drive to raise funds here? Foreign currency surreptitiously enters the country, bypassing banks, on the back of cryptos. ED may be oblivious if a crypto moves from an offshore wallet to a local wallet, or viceversa. But it will step in if cryptos from abroad are converted into rupees by a person of interest.

Fixing this requires a change in anti-money laundering (AML) rules. The know-your-customer (KYC) regulations focus on the ‘source of money’, and not on the ‘source of cryptos’. Like banks, exchanges are satisfied as long as a client is not investing unaccounted funds. If cryptos have to be given legitimacy, the AML should find out the source of crypto. If there is large crypto inflow in a wallet, the trader should disclose how the crytos were acquired — as banks ask customers to explain large cash deposits or gifts from foreign friends.

Cryptos have to be weaved into anti money-laundering rules and the Financial Intelligence Unit (FIU) will have to check the veracity of self-declaration by crypto investors. WazirX may also have to explain why there are no separate wallets for Binance and WazirX. Can cryptos bought on Binance show up in WazirX wallet without a trail in the blockchain — the transparent, immutable digital ledger that the crypto community boasts of ? Can WazirX and Binance — separate entities in different jurisdictions — run the same wallet or an internal ledger to square off trades? Where is the server housed?

Some differences are irreconcilable. Crypto-backers guard their privacy, hold banks in contempt, and belittle central banks that cannot assess how new cryptos emerging from a woodwork of complex algorithms may influence money supply and macroeconomics.

The crypto fraternity argues that wallets are geography-neutral — there is no such thing as foreign or local wallet. It’s all part of a global network. Server location or data localisation is a payment regulation that doesn’t apply to cryptos.

Such nuances of modern fintech will inevitably clash with stern regulations on laundering, black money and benami. For the crypto crowd, the going is getting tougher.

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