Regulating Virtual Digital Asset Service Providers In India Could Take From Model Law

The Virtual Digital Asset Service Providers in India are coming up with creative business models. VDASPs are operating as on-ramp/off-ramp platforms for currency transactions, facilitating seamless transition between traditional fiat currencies and digital assets. Some VDASPs are developing stablecoins tailored for the Indian consumer base, which reflects a growing demand for stablecoins in India. In addition, services such as atomic swap protocols are being developed to enable direct asset trading across different blockchain networks. This evolution highlights the necessity for regulatory measures to ensure stability within India's rapidly advancing digital asset landscape.

The Commonwealth Model Law (“Model Law”), proposed in the March 2024 meeting of Commonwealth law ministers, lays down a proposed framework for member countries to regulate digital assets in line with international standards, aiming to enhance consumer protection. The Model Law aligns with the FATF recommendations, requiring VDASPs to be regulated for AML/CFT purposes. It serves as a template for member countries, including India, to develop their own tailored regulatory framework.

It is pertinent to note that India ranks amongst the top Commonwealth countries in the adoption of digital assets. The current regulatory framework provides for registration of a VDASP with the Financial Intelligence Unit – India (“FIU-IND”) and certain compliances envisaged under the Prevention of Money Laundering Act, as well as the PML (Maintenance of Records) Rules, 2005.

The Virtual Digital Asset Service Providers in India are coming up with creative business models. VDASPs are operating as on-ramp/off-ramp platforms for currency transactions, facilitating seamless transition between traditional fiat currencies and digital assets. Some VDASPs are developing stablecoins tailored for the Indian consumer base, which reflects a growing demand for stablecoins in India. In addition, services such as atomic swap protocols are being developed to enable direct asset trading across different blockchain networks. This evolution highlights the necessity for regulatory measures to ensure stability within India's rapidly advancing digital asset landscape.

The Commonwealth Model Law (“Model Law”), proposed in the March 2024 meeting of Commonwealth law ministers, lays down a proposed framework for member countries to regulate digital assets in line with international standards, aiming to enhance consumer protection. The Model Law aligns with the FATF recommendations, requiring VDASPs to be regulated for AML/CFT purposes. It serves as a template for member countries, including India, to develop their own tailored regulatory framework.

It is pertinent to note that India ranks amongst the top Commonwealth countries in the adoption of digital assets. The current regulatory framework provides for registration of a VDASP with the Financial Intelligence Unit – India (“FIU-IND”) and certain compliances envisaged under the Prevention of Money Laundering Act, as well as the PML (Maintenance of Records) Rules, 2005.

While these provisions provide foundation for a legislation, there remains an opportunity to develop a more comprehensive legislative standard that addresses compliance requirements across various corporate structures. For example, a potential concern is that certain VDASPs are exchange platforms which operate as private limited companies while performing functions akin to a stock exchange. This dual role allows them to maintain user funds in escrow arrangements, yet they often lack the rigorous regulatory standards required of a stock exchange. As a result, fresh digital asset offerings on these platforms can occur with minimal regulatory scrutiny, posing potential risks for investors.

Therefore, it is imperative, basis the Model Law, that a framework is put into place which may, amongst other aspects, address the following:

Legal Framework for VDASPs and Issuers: The establishment of a legal framework for VDASPs and Issuers of Initial Virtual Asset Offerings, which has been defined under the Model Law, as to when an Issuer makes a virtual asset publicly available for purchase, seems critical at this juncture.  

Comprehensive Regulatory Authority: To consider creating an apex regulatory authority empowered with supervisory functions over the sector. It can be authorised to implement a future legislation and roll out regulation(s) that cover pricing, trading practices, and market integrity to deter manipulative behaviours, such as pump and dump schemes, insider trading, and wash trading.

Accountability and Transparency: It may be made mandatory for all parties associated with the Issuer or platform operator to disclose their affiliations within stipulated timeframes. Furthermore, a publicly accessible register of licensed entities may be established to enhance transparency and allow users to make informed decisions.

Emergence of a Regulatory Sandbox: The apex regulatory authority may consider creating a regulatory sandbox, which would provide a structured environment for entities that do not fit existing classifications, promoting innovation while still safeguarding consumer and market integrity. This may include DeFi, DAOs or stablecoins, amongst others.

Imposition of Penal Measures: Strong punitive measures may be considered against natural persons involved in non-compliance, not merely limiting corrective actions to blocking access to a platform.

The advent and rapid growth of VDASPs as discussed above, have placed the responsibility squarely in the hands of regulators to establish a robust regulatory framework to protect the interests of users. The Model Law is a good starting point, for initiating the creation of a holistic legislative framework, to encompass provisions for governance of digital assets. This will not only enhance market stability but also instill confidence amongst consumers.

Pallavi Singh Rao is partner at Cyril Amarchand Mangaldas.

Shrish Gautam and Siddharth Kothari are associate at Cyril Amarchand Mangaldas.

Disclaimer: The views expressed here are those of the author, and do not necessarily represent the views of NDTV Profit or its editorial team.