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Action against offshore crypto exchanges operating in India under money laundering laws may deprive local exchanges of much-needed liquidity and complicate their plans to move abroad, three industry executives said.

The finance ministrys Financial Intelligence Unit (FIU) on 28 December wrote to Binance, KuCoin and seven others that any exchange offering services to Indian users must register as a reporting entity, and file statements with the income tax department. The FIU also recommended blocking the web addresses of these exchanges in India.

Exchanges like Binance remain the key source of liquidity for most Indian exchanges, who also use an arbitrage margin of nearly 10% in any crypto token trade through them, since they do not really hold crypto reserves. This makes them reliant on major global exchanges, who are also at a beneficial place when it comes to the overall taxation regime. India also does not have a dedicated crypto law, all of which points to an unfavourable, unsustainable situation that Indias crypto exchanges need to first solve," said

Sidharth Sogani, founder and chief executive of Crebaco, a cryptocurrency research firm.

Attracting liquidity has historically been one of the biggest challenges for crypto exchanges worldwide, including the defunct FTX. Exchanges, including many in India, accept orders in Indian rupees to hold crypto token orders, using larger exchanges such as Binance to get access to being able to buy or sell any crypto token.

Crypto trades and profits in India are subject to 30% income tax, while a further 1% tax deduction at source (TDS) is mandated on every transaction conducted through India-based crypto exchanges. Since the introduction of these taxes, in 2022, crypto trading volumes in India have plummeted.

Data sourced by Mint from Crebaco showed a drop of 93% and 60% in daily average trading volumes in WazirX and CoinDCXtwo of Indias top crypto firmsbetween March 2022 and now. Volumes could fall further with the action against the foreign exchanges.

One of the executives cited above also agreed that taxation and liquidity pose significant challenges in an already-ragged crypto market in India.

The 1% TDS on all crypto trades is a massive hit for exchanges in India, since it takes away heavily from the prospect of arbitrage trading. This leaves exchanges such as CoinSwitch and CoinDCX at a precarious spot in terms of liquiditywhich is primarily derived only when there is healthy trade in the industry," the executive said.

CoinDCX and CoinSwitch did not respond to queries till press time.

The FIU action has complicated exchanges plans to move offshore, a second person added.

For most of these crypto exchanges, the offshore moves were largely designed to ease compliance and taxation issues, which have been significantly complicated in India. The latest notice wouldnt make a big difference to the likes of Binance or KuCointhey are anyway not keen on setting up elaborate India operations or go out of their way to comply with regulations in India. What this will affect are Indian exchanges and startups, who will likely cancel their moves abroad since that will not make any difference to a large extentstrategically or financially," the executive said.

Both executives agreed that a move abroad would only make sense if Indias exchanges were able to proliferate the crypto-forward global markets, and build their own liquidity and reserves.

Most exchanges are projecting a bullish future amid a strong, sustained rally for Bitcointhe bellwether token for the global crypto industry. The price of one Bitcoin token has risen from around $27,000 in October last year, to $47,000 last weeka 74% increase.

The rally has largely been fuelled by talks of the introduction of an exchange-traded fund (ETF) for Bitcoin in the US. Even as Indian exchanges hope this brings some dormant users back into the fold, a smorgasbord of challenges including regulations, taxation and liquidity may not help them soar with the rising tide.

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FIU action bodes ill for local crypto exchanges | Mint - Mint