Context

In the Union Budget speech, Finance Minister Nirmala Sitharaman announced a 30% flat tax rate levied on any gains made from the transfer of virtual assets including cryptocurrencies and Non-Fungible Tokens (NFTs).

What is cryptocurrency?

• Cryptocurrency (crypto) consists of a digital denomination designed to work as a medium of exchange through a distributed computer network (a blockchain) that is not reliant on any central authority such as a government or a bank for its upholding and maintenance.
• Legal status: The announcement of the tax by the Finance Minister now leads to the assumption that crypto is legal in India.
• Foreseeable are changes that would, down the road, legitimize and formally legalize the activities of crypto start-ups and enable them to access the necessary support system which might not have been available previously.

What are the implications of taxing cryptocurrencies in India?

• While critics are right in observing that the 30% flat tax rate is a harsh rate, this is a premium and price well-worth paying in exchange for what is effectively a ruling-out of prospects for a total ban on crypto by the central government.
• Scope for innovation: The high tax rate would inevitably hamper the willingness of investors to convert cryptocurrencies into national fiat, this may, in turn, open up more doors for technologically savvy and innovation-minded investors.
•  The extremely high tax rate and the fact that the losses cannot be offset would invariably propel investors to turn to alternative means of storing and undertaking transactions in cryptocurrencies, without foregoing the significant losses involved as they “switch” back into the rupee.
• An inadvertent upside of this, then, is the prospective conversion and reallocation of crypto-funds from one form to another.
• Such transformations would involve DeFi (Decentralised Finance) activities such as staking, lending, and providing liquidity, among others.

Scope for DeFi in India

• DeFi (or “decentralized finance”) is “an umbrella term for financial services on public blockchains.
• With DeFi, one can do most of the things that banks support — earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and more — but it is faster and does not require paperwork or a third party. 
• DeFi is global, peer-to-peer (meaning directly between two people, and not routed through a centralised system), pseudonymous, and open to all.
•  The processes highlighted above would drive innovation in the field of Indian DeFi.

Concerns

• Low participation due to high rate: The community of small and medium-sized enterprises (SMEs) and lower-end high net-worth individuals are going to find it most difficult to access the ecosystem given the substantial barriers posed by the tax rates.
• Lack of clarity: Additionally, when it comes to India’s crypto policy at large, there is a fundamental lack of clarity in aspects other than taxation.
• There appears to be a push to treat crypto as purely an asset class than a currency.
• The consolation offered by the Government in the form of the Reserve Bank of India’s CBDC, or Central Bank Digital Currency, will definitely help in pushing for the adoption of digital currencies, but, equally, defeats the fundamental purpose of cryptocurrency, which is decentralization.

Suggestion

• Reduce the tax rate:  There is a need to reduce tax rates in the future, though this must be weighed against considerations concerning government revenue and the need to curb speculative bubbles surfacing in relation to the currency.
• Incorporation of insights: The second reform constitutes the incorporation of insights from seasoned partners from international communities, the key should rest with engaging these individuals for their insights and advice on the best practices associated with cryptocurrency policymaking.

Consider the question “What is DeFi (decentralised finance)? What are the implications levying high tax on the cryptocurrencies?”

Conclusion

Systemic reforms are by no means easy, but they are critical as an amplifier of the successes that India has already accrued in the field and as an accelerator of India’s advancement in the sphere of crypto finance and blockchain social policymaking.

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