WazirX controversy bares crypto's vault of trade secrets in India

A few days back, Finance Minister Nirmala Sitharaman urged the start-up community and public to deal in cryptocurrency with caution because everything that was floating around was not currency.

In the first week of August, the country’s top nine crypto exchange platforms were summoned by the Directorate of Enforcement (ED) in Hyderabad. The exchanges were questioned for money laundering, especially over a number of Indian non-banking financial companies and their fintech partners for predatory lending practices in violation of the Reserve Bank of India (RBI) guidelines and by using tele-callers who misuse personal data and use abusive language to extort high interest rates from the loan takers.

The ED found that large amounts of funds were diverted by the fintech companies to buy crypto assets and then launder them abroad. These companies and the virtual assets are untraceable at the moment, hence the summons to the crypto exchanges.

In a span of two weeks or so a lot has happened, the latest being the ED freezing crypto exchange Vauld’s assets worth Rs 370 crore.

Before Vauld, WazirX, which is owned by Binance, was pulled up by the ED and its bank assets worth Rs 64.67 crore were frozen. With the ED heat on, Binance disowned the company. And the spat between the founders Changpeng Zhao (CZ) of Binance and Nischal Shetty of WazirX on the ownership of the company will be forever chronicled on Twitter.

On August 9, WazirX came out with a detailed response on the ED issue and stated that it has a no-tolerance policy towards illegal activities.

While the ED investigation is still going on, the fact that WazirX is paying the price for its association with Binance is clear.

As for Binance, getting embroiled with the ED is much more worrisome than washing its hands off WazirX. A little background here: Binance, the world’s largest crypto exchange, is undergoing a restructuring that started last year. The restructuring was being done due to regulatory concerns over the firm’s lack of systemic transparency.

According to a Finextra report, CZ in an interview to the South China Morning Post had said that the company will rebuild itself into a centralised business. The Finextra report said that according to a notice published by the Financial Conduct Authority (FCA) in August 2021, Binance has previously refused to declare where certain operations are held, who its key stakeholders are, and the legal and regulatory status of its products. As it stands, Binance operates through a sprawling network of offices around the world and has no “official” headquarters.

Along with regulators in Japan, Hong Kong and Italy, the FCA has prohibited Binance’s UK entity from operating in the country.

As a part of the restructuring, Binance had appointed Greg Monahan, a former US treasury criminal investigator, as global money laundering reporting officer.

Sources within the company believe that they will come out of the situation unscathed because they have not done anything wrong. But the question is who will lose out. WazirX’s brand will certainly take a beating. The platform has already seen its volume drop drastically. Now, with Binance pulling out, users are moving away from the platform.

Last week, the company held a town hall for its employees to address any issue that they were concerned about. Employees are getting anxious with the company trying to prove that it is owned by Binance, but they also want to know how the ED investigations will impact operations.

Several people in the industry that Business Standard spoke to said that users from WazirX are either going to Binance or other international exchanges. Industry players also said that this incident will just move people away from WazirX, not from crypto trading.

That’s where the finance minister’s comments become significant. Checks with other crypto investors as well as exchanges show that despite the ED crackdown investment sentiments among the investors have not been impacted.

“Crypto adoption is on track, these news have no impact. I would rather tell investors to keep their assets in non-custodian wallets than in exchanges or platforms,” said a founder of a crypto platform.

Others also feel that moving away to international exchanges will only complicate the traders. In an email to users, WazirX said: “We have noticed that users are opting to withdraw their funds to international exchanges. However, in the process, they may unknowingly be non-compliant. International exchanges do not have TDS (tax deduction at source) frameworks in place. Most of them have no visibility over the user’s real identity or the scale of transactions. Thus, putting the onus of deducting TDS on the individual, which is nearly impossible.”

The email goes on to explain the issue. Individual users may move away to international exchanges, but when it comes to exchanging crypto to Indian rupees they will face issues. It is mandatory for the buyer (whether a resident of India or not) to deduct 1 per cent (5 per cent in some cases) of the amount paid to the Indian seller for transactions more than Rs 10,000.

In a notice dated June 22, the Central Board of Direct Taxes mandates a person who is responsible for paying any resident any sum by way of consideration for transfer of crypto to deduct an amount equal to 1 per cent of such sum as income tax thereon. The tax deduction is required to be made at the time the sum is credited to the account of the resident or at the time of payment, whichever is earlier.

“WazirX has a framework for complying with the TDS as per the government notification. We request the users not to panic and take the right decision,” the management’s email said.

Industry players are also saying that users are moving to decentralised wallets so that they have control of their investments. “Users can do that, but will they pay the 1 per cent TDS to the government? For that they will have to go through the exchanges,” said a founder of the start-up Web3.

It is perhaps time for the government to come out with clear rules on crypto. Though the RBI has always stated that crypto is not a legal currency to transact, the fact is that there are thousands of people who want to trade in them.

The Indian start-up ecosystem has seen a good amount of investments in the sector. According to the Tracxn database, since 2021 there has been an investment of $640 million. For 2021, the figure was $441 million across 15 rounds. Last year, two crypto exchanges in India became unicorns.

On the radar

• In August 1st week, ED summoned India’s top nine crypto exchange platforms; they were questioned for money laundering, especially over a number of Indian NBFCs and their fintech partners for predatory lending
• The ED found funds were diverted by fintech companies to buy crypto assets and then launder them abroad
• The ED froze crypto exchange Vauld’s assets worth Rs 370 cr, and WazirX’s bank assets worth Rs 64.67 cr
• With the ED heat on, WazirX was disowned by Binance, the world’s largest crypto exchange and users are moving away from the platform
• Checks with crypto investors as well as exchanges show that despite the ED crackdown investment sentiments among investors have not been impacted
• Industry players are also saying that users are moving to decentralised wallets so that they have control of their investments