Service Denied: How A Covert Crypto Clampdown Is Playing Out In India

India's young cryptocurrency ecosystem is in a quandary.

After being shut out of the formal financial system, challenging it in court and winning against the most powerful of the country's regulators, the industry has once again seen business disrupted. This time, by a combination of overt and covert moves.

While there is no ban on cryptocurrencies in India, distrust of the segment is barely disguised. It comes through in the form of periodic warnings—official and unofficial—from the country’s banking regulator and central bank, but also in more covert ways, which ensure the ecosystem does not flourish.

At present, restricted access to the country's payment and settlement systems, alongside the recently introduced tax on cryptocurrencies, has meant that volumes across cryptocurrency exchanges are down 30-40%, according to industry executives, who spoke to BQ Prime on the condition of anonymity.

The Reserve Bank of India has already once tried to bar regulated entities from dealing with cryptocurrency-related transactions in 2018. After those strictures were challenged and defeated in the apex court, the RBI resorted to cautioning banks against it.

Still, in the absence of any official ban, a handful of banks had started to do business with crypto exchanges. Payment gateways like Billdesk were allowing users to make payments for crypto purchases via their platforms, including using the Unified Payments Interface. Mobile wallet providers like Mobikwik, too, had become facilitators by allowing buyers to route payments to crypto exchanges via their wallets.

Trouble restarted in the most unexpected of ways.

The U.S.-based crypto trading platform Coinbase was hoping to make a big splash of its entry into India. At a launch event on April 7, chief executive Brian Armstrong spoke about working with the National Payments Corp. of India so users are able to purchase cryptocurrencies through UPI, according to a Bloomberg report.

UPI is managed by NPCI, an initiative of RBI and the Indian Banks' Association.

Within hours, NPCI issued a denial.

“With reference to some recent media reports around the purchase of cryptocurrencies using UPI, National Payments Corporation of India would like to clarify that we are not aware of any crypto exchange using UPI,” the statement read.

The NPCI was not aware of the extent to which crypto-related payments were taking place via UPI, according to a payments industry official, who spoke on the condition of anonymity. Once it realised, the umbrella entity swung into action, the official said.

Not only was the UPI payment option disabled on Coinbase, payment gateways and banks, which until then were allowing payments to be routed for crypto transactions via UPI, started to block such dealings, according to the founder of a cryptocurrency exchange, who spoke on the condition of anonymity.

According to this person, UPI addresses going to crypto exchanges were blocked. The founder of a second crypto exchange confirmed that they too had faced blocks on payments coming to their platform via UPI.

Another executive from a second cryptocurrency exchange said that for some, the option of netbanking and immediate payment services or IMPS was still available. However, it was not clear how long the formal financial system would continue supporting these. Since UPI was a larger driver of trader traffic, losing it has caused disruptions.

Over the last two years, cryptocurrency exchanges have faced a variety of difficulties and delays in dealing with banks. These unreliable payments and frequent outages have been driving users away from exchanges, the founder of the second cryptocurrency exchange said.

The block on using UPI for payments has worsened the problem.

The NPCI has taken this decision in line with the RBI's stance on the cryptocurrency industry, said the payment industry official quoted above. The umbrella entity fears that even if a small proportion of crypto assets purchased through UPI payments could be used for money laundering or terrorist financing, it is better to not support it, the payments industry official said.

"It is the user's prerogative where they want to spend their money and how they want to spend it. A payments network, on its own, cannot stop them. Having said that, the NPCI is likely constrained due to some policy decision, due to which they have suspended such transactions," said Ketan Doshi, managing director, Pay Point India Network Ltd.

R Gandhi, former deputy governor, RBI feels that the NPCI could be empowered to do this. "Any payment system can decide to discourage or not accept risky transactions," Gandhi said.

While banks have asked the NPCI to issue formal directions regarding UPI for crypto assets, the umbrella payments company has not given any clear answers. This may be because any written instruction could be dragged to court, the payments industry official quoted above said.

Queries emailed to NPCI and RBI, on Thursday, were not responded to.

Alongside banks, mobile wallet provider Mobikwik, too, has withdrawn services.

Users on crypto exchanges could buy coins through Mobikwik's e-wallet. This was an attractive option for users since they did not need to link their bank accounts to exchanges. Last month though, Mobikwik disabled its services on exchanges without explanation.

According to the payments industry official quoted above, the RBI had questioned Mobikwik on the lack of adequate know-your-customer checks on such users. This prompted the company to disable its services.

Mobikwik declined to comment.

Payment gateway Razorpay, one of the more popular gateways, confirmed that it too is not allowing crypto-related payments to go through it.

"Razorpay does not support payments for crypto firms because it is a prohibited category for us internally. It is also not supported by our banking partners," a spokesperson at Razorpay told BQ Prime.

With banks, payment gateways and mobile wallets freezing out the crypto ecosystem once again, exchanges are looking for newer ways to process payments.

The first is to allow peer-to-peer payments for the trade, where the exchange is only responsible for holding the coins and the payment is made between the buyer and seller directly, said the first cryptocurrency executive quoted above.

It is not yet clear whether banks can block peer-to-peer payments if they are for crypto-related transactions, the second crypto exchange founder quoted above said.

A second option being used by some exchanges is to allow customer payments to be transferred to the exchange's current account to purchase coins, said the first founder quoted above.

While transferring funds to the current account is an option, it is not a long-term solution since banks tend to question large value deposits into current accounts, this person said.

The repeat of payment troubles being faced by crypto users and exchanges comes alongside an overhang of recently introduced taxes.

In February, the government introduced a 30% tax on earnings from transacting in crypto assets. The government also introduced a 1% tax deducted at source for any such transactions.

"...through that (taxation) we will be able to know who's buying and who's selling it," Finance Minister Nirmala Sitharaman said at a panel discussion organised by the International Monetary Fund. She had also called for a global framework for regulating cryptocurrencies to put a check on money laundering and terror financing.

The first crypto founder quoted above said that the industry is asking the government to lower the TDS levied on users. Monitoring of funds could also be done through a 0.01% tax, he said.

According to the second crypto exchange founder, the new tax rules have had an impact on flows. Users are holding back on trades and some have even left it altogether, owing to the onerous taxation norms. Eventually, it may even encourage some users to get into underhanded dealings to avoid taxes, this person said.

Meanwhile, the wait for an official legislation on cryptocurrencies continues. While the government has not said that it would ban all private cryptocurrencies in India, it has also not committed to a regulatory framework.

"Rather than having a system of ambiguity and confusion, India needs to look at bringing crypto regulations at the earliest. We could consider a custodian-based framework, where a dedicated body is in-charge of holding crypto assets and exchanges become intermediaries," said Sharat Chandra, vice president-research and strategy, EarthID. "This would allow for thorough supervision and monitoring without creating any hurdles," he said.