Most of these platforms, known as virtual digital assets (cryptocurrency) service providers, have their official addresses in the Seychelles, British Virgin Islands or Cayman Islands, all tax havens. Some have Singapore or Hong Kong addresses.

The government said all VDA service providers operating in India and engaged in activities such as exchange between virtual digital assets and fiat currencies or the transfer of VDAs were required to be registered with the financial intelligence unit.

While 31 VDA service providers were registered, several offshore entities catering to Indian users had not, and were likely operating outside India’s anti-money laundering and counter financing of terrorism framework under the Prevention of Money Laundering Act, 2002. Kraken, KuCoin, Gate.io and Bitfinex were among those served notice for failure to comply with the requirements under the law.

Mint digs deeper into the issue.

Why are crypto exchanges under PMLA?

Virtual digital assets or cryptocurrencies are based on blockchain technologies, exist on decentralised networks, and are anonymous at the point of creation. This allows them to be outside the control of governments and centralised authorities.

Given the nature of cryptos, their use in laundering money has risen worldwide. Cryptocurrencies are used to facilitate payments for various forms of illicit activity including trade in drugs and other illegal goods.

The Financial Action Task Force, the global anti-money laundering watchdog, issued the first global standards to address the money laundering and terrorist financing risks of virtual assets in June 2019.

India brought cryptocurrencies into the ambit of the anti money laundering/counter financing of terrorism framework of the PMLA through a notification issued on 7 March, 2023.

The notification covered the exchange of VDAs for fiat currencies, exchange between one or more forms of VDAs, transfer of VDAs, involvement in and the delivery of financial services associated with an issuer’s offer and sale of VDAs, safekeeping, and administration of VDAs and instruments that enabled control over them.

This was done to ensure that the Indian government could regulate and monitor crypto transactions.

On 4 July, India’s financial intelligence unit directed all crypto exchanges to register as reporting entities with it. As a reporting entity under the PMLA, the crypto exchanges have to ensure they adhere to the KYC norms, maintain records, report suspicious transactions, and have internal control procedures.

As the government noted in its statement last week, the obligation is activity-based and not contingent on physical presence in India.

What is India’s stance on cryptocurrencies?

Before crypto exchanges were brought into the ambit of the PMLA, the government subjected crypto transactions to income tax.

Effective 1 April, 2022, any income from the transfer of VDAs became taxable at the rate of 30%, plus surcharge and cess. From 1 July, 2022, every transaction worth more than ₹10,000 was subject to a 1% tax deducted at source.

Earlier this December, the government cautioned offshore crypto exchanges that it would take action under the PMLA in cases of non-compliance.

A study by Esya Centre, a technology policy thinktank, in November stated that the 1% TDS led Indian users to trade on offshore VDA exchange platforms and other untraceable channels, resulting in revenue loss for the government. It estimated that 3-5 million users shifted to offshore entities since the TDS was announced in the Union Budget in February 2022.

The study further estimated that ₹3.5 lakh crore worth of VDAs were transacted on offshore platforms between July 2022 and July 2023, accounting for almost 90% of the total VDA trades by Indians.

India has not prohibited or regulated cryptos, although it has brought these under the Income Tax Act and the PMLA. Individuals and businesses are allowed to invest in, hold and transact in VDAs. India last year called for a global consensus for regulating crypto at the New Delhi Summit of the G20 Leaders.

What happens next?

The financial intelligence unit has written to the ministry of electronics and information technology to block the URLs of offshore crypto exchanges operating illegally without complying with the provisions of the PMLA in India. If the crypto exchanges that were served the show cause notice fail to comply with the requirements of the Act, Indian residents will not be able to continue transacting on them.

Users of these platforms could risk losing some money if they are unable to move crypto funds to an exchange that’s fully compliant with Indian laws. The offshore exchanges, however, are likely to give users enough time to move their funds should the platforms decide against registering with India’s financial intelligence unit.