Explained: Why were crypto intermediaries brought under PMLA

The Indian government introduced a significant notification on March 7, 2023 bringing into coverage various crypto intermediaries within the purview of the Prevention of Money Laundering Act, 2002 (PMLA). The move comes at a time when many crypto intermediaries are already facing investigations from the Enforcement Directive (ED), the enforcing agency of the PMLA. News reports suggest that over Rs 9 billion has already been attached as proceeds of crime in connection with crypto frauds.

With the notification, the government has specified that a reporting entity (RE) under the PMLA would now include persons carrying out “for or on behalf of another natural or legal person in the course of business” the below-mentioned activities:

(i)   exchange between virtual digital assets (VDA) and fiat currencies

(ii) exchange between one or more forms of VDAs

(iii) transfer of VDAs

(iv) safekeeping or administration of VDAs or instruments enabling control over VDAs and

(v) participation in and provision of financial services related to an issuer’s offer and sale of a VDA

Entities covered

The coverage under the PMLA is borrowed from the definition of Virtual Asset Service Provider (VASP) in the Report of the Financial Action Task Force (FATF) on ‘Updated Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers’ released in October 2021. Since the government has not given a detailed explanation about the entities that will be covered under the PMLA due to the notification, one can usefully refer to the guidance provided in the FATF report in relation to the definition of VASP. From this guidance, it may be gleaned that the following services would now be covered under the PMLA:

– Services provided by cryptocurrency exchanges such as order-book exchange services, which bring together orders from buyers and sellers, typically by enabling users to find counterparties, discover prices, and trade.

– Brokerage services that facilitate the issuance and trading of VDAs on behalf of a natural or legal person’s users.

– VDA escrow services including services involving smart contract technology that VDA buyers use to send, receive or transfer fiat currency in exchange for VDAs when the entity providing the service has custody over the funds.

– Advanced trading services which may allow users to access more sophisticated trading techniques, such as trading on margin or algorithm-based trading.

Further, per the guidance given in the FATF report, the coverage would not extend to:

-An internal transfer of virtual assets by a single legal person within that legal person – i.e., within units of a particular company.

– Persons providing ancillary services or products to a VDA network like hardware wallet manufacturers or providers of unhosted wallets to the extent that they do not also engage in or actively facilitate as a business any of the aforementioned covered VDA activities or operations for or on behalf of another person.

– Persons solely engaged in the operation of a VDA network, such as providers of internet network services and infrastructure, computing resources such as cloud services and creating, validating, and broadcasting blocks of transactions.

Impact of the amendment under PMLA

With this notification, money laundering issues associated with cryptocurrencies/ VDAs are now sought to be addressed. VDAs allow a great extent of anonymity due to the inherent nature of the technology itself, making it difficult for the government to track the trail of transactions in VDAs, both within and outside the country. This had led to a risk of VDAs facilitating money laundering and other nefarious activities/ economic offences.

The amendment clears the position on the KYC and reporting requirements for crypto exchanges and intermediaries in the country and has been welcomed by many in the industry as it will help enhance the confidence of retail investors in cryptocurrency/ VDAs. Crypto exchanges/ intermediaries would now qualify as “reporting entity” and be required to follow KYC requirements and maintenance of records in terms of the PMLA as well as the PML (Maintenance of Records) Rules, 2005. Once such KYC and record-keeping requirements are in place, the government will be able to track any instances of money laundering. Persons found to be engaged in money laundering or terrorism financing by transferring cryptocurrency/ VDAs would then be subjected to rigorous penal consequences including imprisonment.

Where India stands on crypto regulations

The present notification is only one piece of the overall regulatory framework of VDAs/cryptocurrency in India and globally. Other aspects such as setting up an overseeing regulatory body, stipulating corporate governance requirements, securing consumer/investor protection, etc. should also be considered while bringing in an overall crypto regulatory regime. The absence of licensing/registration regimes for crypto intermediaries may make it difficult for the government to monitor and administer the present regulation under PMLA also.

Globally, major jurisdictions are transitioning from a light-touch approach, i.e., regulating from an anti-money laundering (AML) or payment perspective, to a more comprehensive approach, i.e., regulating from an investor protection perspective.

Under India’s G20 presidency this year, there is a clear push to arrive at a global consensus – and rightly so considering the nature of the underlying technology – on the suitable regulatory framework for cryptocurrency. In the interim, India has been prudent to take measures to safeguard its revenue interest by bringing VDAs under the Income-tax Act, 1961 last year as well as countering risks of money laundering and other economic offences through the present inclusion under PMLA.