Crypto’s compliance conundrum: Are Indian cryptocurrency exchanges going through withdrawal

In recent years, India has witnessed a surge in crypto trading, ranking among the top 5 nations globally when it comes to adoption rate of virtual digital assets. Centralised exchanges have experienced major success in the country given the ease of buying virtual digital assets with a few simple steps without additional custody challenges, an ideal scenario for Indian investors. However, amidst this burgeoning market, a great success rate for exchanges, a critical issue looms large: navigating the compliance landscape that is presented by regulators for platforms operating in this space. This leads to hindrance in smooth crypto withdrawals/fund access and other challenges that loyal user bases face from their trusted exchanges. This leads to crypto exchanges in the nation finding themselves grappling with a dilemma, caught between facilitating seamless transactions and adhering to regulatory requirements.

The KYC and AML protocols which exchanges have to abide by is a necessary step to prevent any illicit transactions. Crypto exchanges coming under the ambit of the PMLA was also a much needed move to address the concerns of domestic regulators and international governing bodies about the flow of funds and their potential use. In addition to these, India is also expected to roll out a domestic regulatory framework by next year. Which brings into question the literal and figurative ‘cost’ of compliance which is also set to evolve. Exchanges would be more than happy to meet all compliance requirements but also expect a midpoint where they are able to meet the needs of their customers who put their faith in them. The dialogues between regulators and industry bodies which represent the ecosystem needs more fruition based action items which ensures that companies aren’t leaving their users high and dry, as a result making them question the intrusion of centralised authorities in the decentralised space.

Recently, the government offered Indian exchanges a much needed level playing field by getting foreign exchanges operating in the country to comply with the laws of the land, especially the 1% TDS rule whose non abidance was giving them a leeway with investors. This was necessary to ensure that all regulations are equally applicable on players no matter how big or small their presence is in the industry. 

Now, in addition to this, there are some areas of compliance which are difficult for investors to comprehend because it is not clearly defined on a case to case basis but rather generic. In an effort to abide by these, crypto exchanges have to choose to act against the best interest of their users. Consider the following scenario, which exemplifies the intricate nature of compliance risks faced by crypto exchanges:

KYC and AML Checks: A customer undergoes rigorous KYC and AML checks as mandated by the regulatory framework. The verification process validates their identity, ensuring compliance with regulatory standards.

Successful Verification: Customer successfully clears the KYC and AML process, providing genuine credentials to the exchange.

Deposit and Transaction: Subsequently, Customer deposits INR 1 lakh into their exchange account and engages in cryptocurrency trading.

Withdrawal Request: Upon buying crypto, the customer submits a withdrawal request to transfer their assets to an external wallet.

Complaint and Investigation: Now in some cases there have been complaints lodged against such transactions.

Financial Trail: Law enforcement agencies commence an investigation and trace the INR 1 lakh deposit made by this to the exchange’s bank account. Law enforcement freezes the equivalent amount in the exchange’s bank account, aiming to safeguard the interests of the aggrieved party.

Empty Crypto Account: However, upon scrutinising the customer’s crypto account, authorities discover that all the cryptocurrencies have been withdrawn, leaving the account devoid of assets or in some cases come face to face with impersonation scams orchestrated by others through a certain account.

While this is a grave predicament, not all situations are similar. Majority of investors are lawfully trading on the platform and might choose to move funds to other places such as hardware wallets or a different account. But because of a blanket response to such incidents, customers find themselves in a limbo, unable to withdraw their crypto holdings. To mitigate such risks, industry stakeholders must collaborate closely with regulatory authorities to devise robust frameworks that strike a delicate balance between innovation and compliance. 

Enhanced due diligence protocols, advanced cybersecurity measures, and proactive risk mitigation strategies are imperative to safeguard the integrity of the crypto ecosystem while fostering trust among stakeholders. Now these are also cost intensive exercises. Besides manpower, they require technological upgrade, various third party integrations, and an infrastructure overhaul. In the fintech sector, there have been concerns of smaller players anticipating consolidation and an unequal playing field. In addition to this, the government’s focus on real time compliance and evolution while there lies certain ambiguities in existing systems is an operational concern like no other. 

Non compliance can ‘cost’ a business many things such as severe penalties of insurmountable value, loss of licences for operating causing a disruption and restlessness among users. Impact on financial revenues are also major because they affect operations, new product/business strategy implementation and unfulfilled customer needs. These might often be overlooked as regulations continue to evolve but the slightest straying from the norm and you’ll face consequences. This can be easily addressed by ensuring a symbiotic relationship with regulators to ensure you are ahead of the curve. At the same time if you were to automate all operations, it would be a wise (albeit time consuming) exercise to apprise the law enforcement of how individual cases are differentiated and a one size fits all approach will not work for all transactions. This can go a long way in ensuring that at one point of time, customer concerns are addressed and looked into while crypto companies ensure their role in abiding by laws of the land and avoid any defaults. 

Views are personal. The author is the founder of WazirX