The banks were not comfortable servicing cryptocurrency businesses. The exchanges and payment gateways would have to make immediate changes in the way money flowed into their platforms.
Some exchanges were told that they should stop accepting money from customers transferring cash via online modes such as Immediate Payment Services (IMPS), National Electronic Funds Transfer (NEFT), and Real-Time Gross Settlement (RTGS). A few payment gateways were asked to stop processing money intended for cryptocurrency trading. Other payment gateways started levying a 2% service charge on such transactions, making it expensive for their cryptocurrency customers who typically trade in lakhs of rupees.
If this was not done, the tacit message from the banks was that the funds wouldn’t be settled. One company was even warned of account closure if it didn’t comply with the directions.
It’s been just two weeks since, but the impact of the banks’ communications is there for all to see: express transfer features have been disabled on some of the exchanges, additional charges have been applied for payment gateway transactions, and in several cases the only option available is direct bank transfer, which the exchanges have mentioned will take more time than usual to process. “We are working on highest priority to resume INR withdrawals followed by INR deposits very soon," read a pop-up notification on cryptocurrency exchange Koinex.
The target of the banks clearly was the velocity of barrelling cryptocurrency trades. At one stroke, the easy flow of money between investors and exchanges was stopped when the exchanges and payment gateways started implementing— around 27 December—what the banks were asking them to do.
Cryptocurrencies are virtual currencies which are created and held electronically. They are based on the so-called blockchain technology and are usually decentralized in nature. They are “mined"—a process that adds transaction records to a cryptocurrency public ledger—or bought/traded.
Bitcoin is not the only cryptocurrency with the 1,381 others created after it collectively called altcoins: like ether, litecoin, ripple, dogecoin, and such. The market cap of altcoins has grown 176 times in the last one year to $476 billion, shows data of Bitcoin tracker Coin Dance; the Bitcoin market cap topped $283 billion—a 17X expansion. Together, the market cap of both adds up to $759 billion: about one-third of India’s national income.
New York cryptocurrency analyst Chris Burniske had in June 2017 estimated that Indians account for 10.98% of the monthly global Bitcoin trade volume. The number is likely to have only gone up given how Indians have been thronging to cryptocurrency exchanges.
An orchestrated effort?
It is not clear what triggered the directives from banks. One person with knowledge of the development said on condition of anonymity that the Reserve Bank of India (RBI), which has had an uneasy relationship with cryptocurrencies like central banks the world over, was behind the coordinated moves. The central bank, the person said, had instructed the Indian Banks’ Association (IBA) to convey the changes to be made to the banks.
When asked for comment, an RBI spokesperson pointed FactorDaily to a webpage with all its notifications, announcements and reports relating to Bitcoin, with no additional comment. V.G. Kannan, chief executive officer (CEO) of IBA, said there was no meeting with RBI on the topic, adding he didn’t know of any verbal instructions from central bank officials either.
His colleague, Ramachandran Krishnamurthi, IBA’s senior advisor (banking tech), also denied any direction from RBI and outlined the context of the thinking among bankers: “Cryptocurrencies have not been recognized by the RBI. ...the only thing is to not encourage all these exchanges."
“The problem was earlier the Bitcoin was $200-$300. Today, one Bitcoin is over Rs10 lakh so it has become more of a gambling thing... Who will get hurt we don’t know. But, when people get hurt, at that time they will blame the government ‘Why did you not ban it?’, ‘Why is your bank supporting this?’," he said.
Cryptocurrency exchange managements were upset about the changes, but there was little they could do. In an email sent to customers, exchange ThroughBit’s CEO Abhishek G. blamed banks for choking the business. “A couple of weeks back, it was an I-T (income tax) survey that had stalled all operations for over 24 hours and this time it is banks asking our ‘payment gateway’ providers to stop services to cryptocurrency businesses," he wrote.
Abhishek did not name the banks, neither did cryptocurrency exchanges Koinex and Zebpay, which also had also notified customers of the changes. “As communicated to us by our payments partners, INR deposits will only be possible via Payment Gateway (which carries 2% charge, inclusive of goods and services tax). IMPS, NEFT, RTGS transactions will not be entertained," Koinex wrote on a Medium post. “...INR withdrawals will only be processed via NEFT channel. Thus, users need to expect a standard delay in receiving funds to their bank accounts."
Zebpay, too, emailed its customers it was closing its express transfer bank accounts.
The banks had already started cracking down on Bitcoin and altcoin investments made by resident Indians on international exchanges that allow the use of credit cards. Such traders were told by their credit card issuers—the earliest instance of such a letter in FactorDaily’s reporting is from October—that such transactions are in violation of Foreign Exchange Management Act (FEMA), 1999.
One such advisory Citibank NA sent its credit card users read: “Indian residents are therefore prohibited from trading in foreign exchange in domestic and overseas market, including binary option trading with commodities, stocks, indices, bitcoin index and forex, etc."
This made little sense to individuals who, at least technically, are keeping to the rules. Until the government amends FEMA Act and the Negotiable Instruments Act, “using credit cards to purchase cryptocurrency can be challenged as (being no different from) buying any other product off the internet," said Yasaswy Sarma, partner at Chennai-based chartered accountancy firm GPRSK and Associates.
Biting the bullet, not yet
The move by banks to increase friction in the flow of capital into Indian and overseas cryptocurrency markets and is only the latest effort by the Indian government, its agencies, and the banking and markets regulators to crack down on the exploding volumes of virtual currency trades.
Disparate as they may seem (and, probably, are), warnings, the setting up of task forces, nationwide income tax surveys, tax notices to traders, and nudges to financial intermediaries (banks as also payment gateways) have all been part of the government’s efforts to rein in what it believes is a dangerous trend (see timeline).
The RBI was the first among Indian institutions to raise caution about virtual currencies. It began looking into it in June 2013, going by what was publicly disclosed and raised its first flag less than six months later. There’s little regulation of virtual currencies, it is prone to hacking and online fraud, there are no underlying assets…, the RBI circular read. It repeated the same concerns in February 2017 and December 2017. But all three were in the form of what-to-worry-about notices like mutual fund advisories seen on TV.
In response to a Supreme Court direction on a public interest litigation (PIL) in July last year, all that the central bank said was that it had put out multiple notices and that there was still no clarity yet on the legal status. Unhappy with the response, the litigants filed another PIL, which has been tagged with another PIL. The next hearing is scheduled this week.
The central government, too, cautioned Indians on 29 December—just after when the cryptocurrency exchanges had begun to comply with the latest bank directives. The finance ministry repeated what RBI said in December 2013: that virtual currencies were not backed by assets, how investors need to be worried about hacks, and that there were other risks like money laundering.
The big question—whether Bitcoin or other cryptocurrencies are legal—has still not been answered now. Last week, finance minister Arun Jaitley told the Rajya Sabha that the government was still studying the issue. “A committee under the chairmanship of secretary, department of economic affairs (DEA), is deliberating over all issues related to cryptocurrencies to propose specific actions to be taken," he said, reiterating the RBI’s earlier statement that cryptocurrencies are not legal tender (like paper currency).
A senior finance ministry official told FactorDaily there were three committees in the government to look into all aspects of cryptocurrencies: the DEA secretary-chaired committee, a tech sub-committee, and one at the government’s apex policy body NITI Aayog.
“All the three committees recommended that cryptocurrency should not be a legal tender in India. Because you cannot track the source, which makes it difficult to track the money," the official said. The enforcement directorate (ED) and banks were told to keep an eye on violations and cryptocurrency transactions, he added.
A finance ministry spokesperson said he was not aware of any directions from the ministry. But given the public statements of RBI and the government, ED and banks may be moving on their own.
The tax angle
“Whatever the intention of the regulator is, it is necessary to communicate it clearly and formally rather than through indirect means," said Anirudh Rastogi, founder and managing partner at Delhi-based law firm TRA, which counts cryptocurrency exchanges among its clientele. “What I am not hearing is that the question of bitcoins being not illegal is resolved once and for all or how they are to regulate it, if at all," he said, adding clarity is missing.
The I-T department doesn’t seem to be missing clarity. For it, cryptocurrency may not have been declared illegal but income gains are real and they need to be taxed. The first major move by the government that got public attention was the 13 December surveys led by the Bengaluru offices of the I-T department on cryptocurrency exchanges in India across various cities. According to a report by The Hindu, the data collected by the I-T department show trades worth Rs17,800 crore on these exchanges and it is sending notices to around 4,000 high networth traders.
“The data collected from I-T survey has been segregated and shared with different jurisdictional director generals and the investigation is going on across the country now," a senior IT department official told FactorDaily on condition of anonymity. “A lot of the trades take place on exchanges outside India and even the servers for some of the Indian exchanges are located outside India and this makes tracking difficult."
The department knows that many traders have invested accounted-for money and would have paid the taxes. “What we are looking for is investments that are not disclosed to the department and the income gained by the users through these investments that are not accounted," the official added.
It is also important how the investor or trader has treated the cryptocurrency and paid the corresponding tax. In the case of cryptocurrency mining, for instance, what an investor makes is to be treated as income from business, said the official. “If you are carrying out cryptocurrency mining as a business, then the value of the mined cryptocurrency will be your business income, whatever expenditure you will incur will be your cost, and net profit will be taxable as a business income based on the respective tax bracket," he said. Trading earnings can be business income or capital gains depending on the holding period, he added.
Despite the I-T department’s swift moves —it has asked 28 questions in notices to individuals—and banks squeezing the cash flowing to and from cryptocurrency exchanges, the frenzy on Indian cryptocurrency exchanges continues: in part, driven by the global rally. But, the heightened demand for cryptocurrencies in India, more now than ever, has them trading at much higher prices on Indian exchanges compared to globally.
Chandan Choudhury, a cryptocurrency analyst and trader from Bengaluru, spots a strong upward trend. “Cryptocurrency exchanges have been having issues with INR withdrawal and deposits. In spite of that, the market is moving up. The market is having what we can call the mother of all bull runs right now," he said.
Exchange officials say cryptocurrency trading volumes have doubled in the last three weeks. This couldn’t be independently verified because exchanges do not publish volumes except some that display daily live volumes but a look at the trend in prices of two popular cryptocurrencies shows the rise in demand in India (see chart 1 and 2).
Normally, except on a few occasions, the prices of cryptocurrencies traded in India closely track international prices. Data sourced from one of the exchanges, however, shows the price differential between prices in India of Bitcoin and Ether is in divergence with international prices in the last three months. One reason for this, experts say, is because international prices tend to be depressed a little towards the end of the calendar year over taxation deadlines.
Still, strong Indian prices bucking the international trend is unprecedented and reflects surging demand that supply can’t keep up with. The last time prices of cryptocurrencies in India were distinctly higher than international prices was in the November 2016 period of demonetization—nearly 10% then versus about 17% now.
Some exchanges are witnessing a steady rise in the number of people signing up for their service. “We used to have around 1,000 registrations a day in December 2016 but last month we averaged 10,000 registrations daily," said Sathvik Vishwanath, co-founder of Bitcoin exchange Unocoin. Other exchanges have also posted notifications on the delay in opening new accounts due to the backlog in processing applications from new users.
Choudhury said that he has also observed heightened activity on peer-to-peer (P2P) platforms and also a surge of HNIs on the market.
“People who have made money in the market are cashing out but alongside there are a large number of HNIs trying to enter the markets," he said. “One way the prices are going up so it is not scaring people and if you want to exit, there is a vibrant P2P market."
Users can place buy or sell requests on P2P platforms such as LocalBitcoins in India. WhatsApp, Telegram and other social media groups also help connect sellers and buyers. They can then transact on the platform or do so via their cryptocurrency wallets.
This shift is something flagged by Sunil Aggarwal, author of Bitcoin Magnet. “The government does not have a mechanism to stop the spread of cryptocurrency because if they ban exchanges, the transactions will move elsewhere," he said, predicting “this confused state of the government will continue for another year or so".
Another reason that demand for cryptocurrencies continues to be strong is the profile of the smart trader: young, tech-savvy, and lustful of the returns virtual currencies offer. Paying taxes is the last thing that will stop him or her from the hottest asset class of the day.
Durgesh Pandey, a young cryptocurrency trader from Mumbai, is one such trader. “I have paid my advance taxes for my cryptocurrency trade. I don’t have any issue paying taxes or giving details," he said. Still, he said he found it odd that in spite of receiving taxes on his cryptocurrency trades, the government has not yet clarified the legality of Bitcoin or has no any security for cryptocurrency investors. FactorDaily
Sunny Sen and Josey Puliyenthuruthel contributed to this story.