Virtual Digital Assets

Context: With the increasing popularity and adoption of virtual digital assets (VDAs) in India, there is a need for a progressive regulatory framework that can establish India’s leadership in the virtual digital assets space.

What are Virtual Digital Assets (VDAs)?

• A virtual digital asset, to put it simply, is a digital holding that has been encrypted on the blockchain, enabling anyone to confirm its authenticity and determine who owns it.
• This becomes a unique asset that may be purchased, sold, or transferred to a new owner since it is non-fungible, which means that it cannot be replicated, copied, or hacked.
• Cryptocurrencies, non-fungible tokens (NFTs), and decentralised finance are some examples of virtual digital assets.
  • Cryptocurrencies: They are digital currencies that use encryption techniques to secure transactions and control the creation of new units.
  • Non-Fungible Tokens (NFTs): They are unique digital assets that use blockchain technology to verify ownership and authenticity of digital content such as artwork, music, and videos.
  • Decentralized Finance (DeFi): DeFi refers to a range of financial applications built on blockchain technology that aim to provide decentralized and permissionless access to financial services such as borrowing, lending, and trading.

Advantages of Virtual Digital Assets (VDAs)

Growing Popularity of Virtual Digital Assets (VDAs) across the world

• VDAs have grown and diversified substantially since Bitcoin was first launched in 2009 and have evolved to serve different purposes and economic functions.
• The global cryptocurrency market size was valued at USD 910.3 million in 2021 and is projected to grow at a CAGR of 11.1% during the 2021-2028 period.
• The NFT segment worldwide is projected to grow by 18.55% (2023-2027) resulting in a market volume of US$3162.00m in 2027.
• VDAs and India:
  • The popularity of digital currency and virtual digital assets are on the rise in India.
  • As per the United Nations Conference on Trade and Development’s report in 2022, India ranked 7th on the list of countries ranked as per digital currency adoption with 7.3% of India’s population owning digital currency in 2021.
  • India ranked second in a list of 20 countries with the highest cryptocurrency adoption rate, according to the Chainalysis’s 2021 Global Crypto Adoption Index, with a growth rate of 641% over the past year.

Why is it Necessary to regulate VDAs?

• Protection of investors: The digital assets market can be highly volatile and subject to significant price fluctuations. By setting standards, regulation can help to protect investors by ensuring that they are provided with accurate and transparent information.
  • The year 2022 saw some of the biggest failures and wipeouts in the crypto industry involving bankruptcies and fraud scandals, be it the collapse of the crypto exchange FTX or the failure of Terra LUNA cryptocurrency, hurting investors across the world.
• Prevention of illegal activities: Crypto assets have been associated with illegal activities such as money laundering, terrorism financing, and tax evasion.
  • In 2021, illicit transactions using cryptocurrencies were estimated to be $14 billion, 79% increase from $7.8 billion the previous year, according to blockchain analysis firm Chainalysis.
• Financial stability: The growth of the digital assets market has raised concerns about its potential impact on financial stability. Regulation can help to mitigate these risks by setting standards for the conduct of market participants.

Regulation of Virtual Digital Assets (VDAs) in India

• Definition: Under Section 2 (47A) of the Income Tax Act (1961), VDAs are defined as
  • any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;
  • a non-fungible token or any other token of similar nature, by whatever name called;
  • any other digital asset, as the Central Government may, by notification in the Official Gazette specify.
• Unregulated: While there is no law explicitly prohibiting the use and trade of VDAs in India, currently, all forms of VDAs, including cryptocurrencies are unregulated in India and hence, currently, trading in the same is at the asset holder’s own risk.
• Taxation: The Union Budget announcement of 2022-2023 specifies that income from VDAs is proposed to be taxed at 30% and loss from transfer of VDAs cannot be set off against any other income.
• Guidelines for the advertising of Virtual Digital Assets and linked services: Issued by the Advertising Standards Council of India, guideline set out standards for advertising of VDAs such as the type of disclaimers to include, information that may be advertised/relied on and details to be shared, among other things.
• VDAs under the ambit of PMLA: On March 7, 2023, the union government issued a landmark notification under the Prevention of Money Laundering Act, 2002 (PMLA) bringing VDAs within the purview of the Act.
  • It means that entities dealing with VDAs must follow similar reporting standards and KYC norms as the other regulated entities like banks, securities intermediaries, payment system operators, etc.
  • The definition of “virtual assets” would include cryptocurrencies and non-fungible tokens.
  • Broadly, this means that any financial wrongdoing involving these assets can now be investigated by the Enforcement Directorate (ED).
  • Significance of the move: It will help in making the Indian virtual digital assets sector more transparent and also build confidence and assurance in the ecosystem. Also, the move is in line with the global guidelines put forward by the International Monetary Fund and the Financial Action Task Force (FATF).

Way forward for the VDA regulatory framework in India

• Reconsidering the tax regime: There is a need to bring VDA taxes on a par with other asset classes. Reducing the tax arbitrage vis-à-vis other economies will also help stem the flight of capital, consumers, investments, and talent, as well as dent the grey economy for virtual digital assets.
• Using the G-20 platform: India, as the current President of the G-20, could use its leadership position to spearhead critical discussions on establishing a global regulatory framework for virtual digital assets, while also instilling confidence in everyday users and regulators.

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