Preventing Money Laundering In The Digital Age: India’s Approach To Virtual Digital Assets – Navodaya Singh Rajpurohit And Prakhar Singh – Money Laundering

A. Introduction

Blockchain technology stands as one of the most transformative
innovation of this era, redefining traditional financial systems
and ushering in new economic paradigms. With the advent of
blockchain technology, user ecosystem faced
numerous challenges, as they rightly say, “everything has its
pros and cons”. The rapid adoption of blockchain technology
have had profound effects on various industries, business models,
governments, and jurisdictions across the globe. ¹

Blockchain technology has offered multitude of advantages like
decentralization, inflation protection, diversity, speedy and
cost-effective transactions, safe and secure environment,
accessibility, and transparency. ² However, money laundering,
ransomware scams, illicit trade using darknet, thefts, hacking,
terror funding etc. are some of the challenges associated with
blockchain technology. ³

Rise in criminal activities:

While blockchain technology has introduced a wave of disruptive
innovation, it has also raised significant concerns regarding
illicit activities. The pseudonymized nature of the transactions
makes it difficult for the authorities to trace and investigate.
This makes them susceptible to money laundering activities, which
presents a significant threat to market integrity. ⁴

While answering the questions in Parliament, the Government of
India informed that the Directorate of Enforcement is investigating
several cases related to Crypto frauds wherein a few crypto
exchanges have also been found involved in money laundering.
Necessary action as per provisions of Prevention of Money
Laundering Act, 2002 (PMLA) has been taken by the Directorate of
Enforcement. As on 14.12.2022, proceeds of crime amounting to Rs.
907.48 crores have been attached/seized, 03 persons have been
arrested and 04 Prosecution Complaints have been filed before the
Special Court, PMLA, in these cases. Further, under Foreign
Exchange management Act, 1999 (FEMA), assets amounting to Rs.
289.68 crores have been seized under section 37A of FEMA and 01
Show Cause Notice to crypto exchange Zanmai Labs Pvt Ltd, known as
WazirX, and its Director under FEMA for transactions involving
crypto assets worth Rs. 2,790.74 crore has also been issued. ⁵

Recently, a probe by Economic Offences Wing (EOW), Odisha has
disclosed about a Rs 1,000 crore pan-India cryptocurrency Ponzi
scam. It has been reported that crime syndicate had received
deposits from Non-Resident Indians in Hungary, Dubai, Canada, and
Nepal. Due to these type of growing incidents analysts is debating
if the Cryptocurrency transactions is the new form of
“Hawala”⁶ .
The concerns with respect to the security and national interest of
India are also arising.

B. Status quo

Currently, there is no uniform or specific law
that governs the aspects related to Blockchain or cryptocurrency
industry. Despite being in its nascent stages of reforms, The
Indian government, and the Reserve Bank of India (RBI) have taken
steps to regulate and monitor cryptocurrency transactions to curb
money laundering, tax evasion and other illegal activities e.g.,
Government of India vide Finance Act, 2022 has defined the
cryptocurrencies as “Virtual Digital Assets” (VDAs)⁷
for the purpose of taxation.

However, to have a better understanding about the current legal
framework, it is important to understand the events that took place
between the period of 2013 – 2023 that has shaped the backbone of
today’s regulations.

Evolving Legal Framework

‘Days of initial caution’: 2013-2017
– RBI issued notification dated, Dec 24, 2013,
cautioning users, holders, and traders of virtual currencies to be
aware of the potential risks associated with cryptocurrencies ⁸ but it
did not impose an outright ban. This cautionary note from the RBI
indicates that while cryptocurrencies, such as Bitcoin, were
gaining popularity in India during this time, there were concerns
about their legality and potential risks.

Similarly, vide its notification dated Feb 01, 2017, RBI advised
that it had not given any licence or authorisation to any entity or
company to operate schemes or deal with bitcoin or any virtual
currency. As such, any user, holder, investor, trader, etc. dealing
with Virtual Currencies will be doing so at their own risk. ⁹

These notifications denotes the initial cautionary approach
taken by RBI which were directed not to deter legitimate players
but to provide a word of caution to people who could get effected
by gullible crypto scams.

‘Arising Legal
Challenges‘: 2018- 2020
– In 2018, RBI banned regulated entities from dealing in
virtual currencies. This was essentially done to cut off banking
support for cryptocurrency exchanges in India. RBI’s April 06,
2018 ¹⁰ circular directed the regulated
entities to:

(i) Not to deal in virtual currencies nor to provide services
for facilitating any person or entity in dealing with or settling
virtual currencies; and

(ii) To exit the relationship with such persons or entities if
they were already providing such services to them.

However, RBI’s April 06, 2018 circular was challenged before
the Supreme Court of India in Internet and Mobile Association
of India v Reserve Bank of India ¹¹ (IMAI vs
RBI) and was struck down failing the test of proportionality.
The Supreme Court also noted that Government of India is unable to
take a call despite several committees coming up with several
proposals including two draft bills, both of which advocated
exactly opposite positions. The Supreme Court, however, upheld the
RBI’s power and authority to regulate virtual currencies.

‘Moving towards regulation’: 2021
– Amidst the regulatory uncertainties the Indian
government considered various measures to regulate cryptocurrencies
which led to the introduction of “Cryptocurrency and
Regulation of Official Digital Currency Bill, 2021“. The
purpose of which was to promote the underlying technology of
cryptocurrency and provide a legal framework. However, no further
action was taken by the legislature to move it for discussions and
most likely will need a re-introduction in the parliament if it
must take its future course.

An RBI notification dated 31 March 2021 clarified that its
earlier notification dated 6 April 2018 prohibiting regulated
entities from dealing with virtual currencies was struck down by
the Supreme Court of India on 4 March 2020 in IMAI vs RBI, and can
no longer be quoted when cautioning clients. The notification
further provided that regulated entities may carry out customer due
diligence processes in line with the regulations governing
standards for KYC, AML, counter-terrorist financing (CTF) and
obligations of regulated entities under the PMLA, in addition to
ensuring compliance with the relevant provisions of the FEMA for
overseas remittances.

‘Income Tax’ on VDA transactions: 2022-2023
– The Finance Act 2022 ¹² introduced
amendments to the Income Tax Act 1961 by defining ‘virtual
digital assets’ (VDAs). The amendments also imposed a flat 30%
tax on income generated from the transfer of VDAs and a 1% tax
deductible at source (TDS) on the transfer of VDAs from one person
to another. Through its Circular 13/2022 ¹³ , the Central
Board of Direct Taxes has issued guidelines to address difficulties
in implementing the revisions to the Income Tax Act, 1961 in
relation to cryptocurrencies/VDA exchanges and peer-to-peer
transactions. Apart from the taxation on VDAs, Indian Computer
Emergency Response Team (CERT-in) on April 28, 2022 issued
directions under Section 70B(6) of the Information Technology Act,
2000 relating to information security practices, procedures,
prevention, response and reporting of cyber incidents. ¹⁴

C. Tackling ‘Money laundering’ menace

Enacted in 2002, PMLA forms the backbone of AML regulations in
India. Although, it was not originally designed to address
cryptocurrencies, authorities have made attempts to extend its
provisions to govern any suspicious crypto-related activities. The
objective of PMLA is to prevent and control money-laundering
activities. It also allows authorities to confiscate and seize any
property obtained from the proceeds derived from laundered
money. ¹⁵

Section 3 of the PMLA defines ‘money laundering’ as
follows:

“whosoever directly or indirectly attempts to indulge
or knowingly assists or knowingly is a party or is actually
involved in any process or activity connected with the proceeds of
crime including its concealment, possession, acquisition or use and
projecting or claiming it as untainted property shall be guilty of
the offence of money-laundering.”

Further, through an amendment dated August 1, 2019, an
explanation was added to the above clause to clarify that a person
involved in one or more of the following processes or activities
connected with the ‘proceeds of crime’ is also guilty of
money laundering:

• concealment;




• possession;




• acquisition;




• use;




• projection as untainted property; or




• claiming as untainted property.

The ‘proceeds of crime’ are defined in Section 2(u)
as:

“any property derived or obtained, directly or
indirectly, by any person as a result of criminal activity relating
to a scheduled offence or the value of any such property or where
such property is taken or held outside the country, then the
property equivalent in value held within the country or
abroad.”

The amendment dated August 1, 2019 also added an explanation to
the abovementioned clause, clarifying that the ‘proceeds of
crime’ include not only property derived or obtained from
the scheduled offence, but also any property which may directly or
indirectly be derived or obtained as a result of any criminal
activity relatable to the scheduled offence. The schedule includes
offences under various statutes, such as Indian Penal Code, 1860,
Information Technology Act, 2000, Trademarks Act, 1999, Copyright
Act, 1957 and Securities and Exchange Board of India Act, 1992
apart from others.

Ministry of Finance notification dated
07.03.2023

While the Directorate of Enforcement was already investigating
various crypto exchanges for possible money laundering and foreign
exchange violations, Ministry of Finance vide its notification
dated 07.03.2023 included various activities that will classify a
business as a person carrying on designated business or profession
which would, in turn, categorise such entity into a “reporting
entity” under Section 2(1)(wa) of the PMLA.

One of the most significant developments in India’s legal
framework for cryptocurrency is the inclusion of VDAs within the
scope of the PMLA. ¹⁶ Service providers involved in
any of the notified activities have now become ‘Reporting
Entities’ for the purpose of PMLA and have to adhere to same
norms as prescribed by the PMLA.

The amendment requires activities by a person carrying on
designated business or profession, when carried out for or on
behalf of another natural or legal person in the course of business
as an activity for the purposes of sub-clause (vi) of clause (sa)
of sub-section (1) of section 2 of the PMLA and such activities
shall include:

a. exchange between virtual digital assets and fiat
currencies.

b. exchange between one or more forms of virtual digital
assets.

c. transfer of virtual digital assets.

d. safekeeping or administration of virtual digital assets or
instruments enabling control over virtual digital assets; and

e. participation in and provision of financial services related
to an issuer’s offer and sale of a virtual digital asset. ¹⁷

However, it is to be understood that while this notification
specifically affects the virtual asset service providers (VASPs) in
the industry, it does not exclude individuals who are using
decentralized crypto wallets for such transactions as well. Any act
or omission punishable under the scheduled offences of PMLA or used
for any money laundering purposes will continue to fall under the
scope and ambit of PMLA even if it is undertaken by an individual
unaffected by the notification.

Compliances under PMLA

Under the new amendment, cryptocurrency exchanges or entities
dealing with VDAs in India are now required to follow strict KYC
norms, which include verifying the identity of users through
documents such as Aadhaar cards, PAN cards, Passports and address
proof. This helps in tracking and identifying users, making it more
challenging for money launderers to operate anonymously. Further,
Rule 9(1) of the Prevention of Money Laundering (Maintenance of
Records) Rules, 2005 (PML Rules) requires reporting entities to do
Client Due Diligence to determine if a client is acting on behalf
of a beneficial owner, if so, identify the beneficial owner.

In furtherance to the notification to include VDA transactions
under PMLA, the Financial Intelligence Unit – India (FIU-IND)
under Ministry of Finance also issued guidelines under Rule 7 (3)
of PML Rules on 10.03.2023 to various virtual digital asset service
providers titled “AML & CFT Guidelines For Reporting
Entities Providing Services Related To Virtual Digital
Assets” (FIU Guidelines). ¹⁸

Registration – FIU Guidelines in terms
of Rule 2 (wa) read with Rule 2 (sa) of PMLA requires all VASPs to
register as Reporting Entities with FIU-IND. ¹⁹ As part of
reporting entity registration, VASPs must disclose their account
details with Banks/FIs where they hold accounts for transactions as
well as for holding of client money. ²⁰ FIU-IND vide its
letter dated July 4, 2023 to all virtual digital asset service
providers has also clarified and provided registration process for
the VASPs. ²¹

Enhanced Monitoring – Sanctions
screening’ is a critical step in the KYC process that
helps reduce financial crime. The FIU Guidelines requires VASPs to
conduct sanctions screening both at the time of on boarding as well
as when any VDA transfer is initiated. Since VDA transfers can
currently be completed even without verification of sanctions
screening, VASPs may put in place the following safeguards.

• Putting a wallet on hold until screening is completed and
  confirmed that no concern is raised.




• Arranging to receive a VDA transfer with a provider’s
  wallet that links to a customer’s wallet and moving the
  transferred VDA to their customer’s wallet only after the
  screening is completed and has confirmed that no concern is raised.
  ²²

Reporting obligations – The FIU
Guideline also mandates the VASPs to report under rule 8(2) read
with rule 3(1)(D) of the PML Rules which provides for prompt
reporting of a suspicious transaction, which includes an attempted
suspicious transaction, large or suspicious transactions to the
authorities, such as the FIU-IND. Upon receiving complaints FIU-IND
can begin its inquiry by collecting all the data relevant for the
investigation. This is also in line with the CERT-in directions
dated April 28, 2022 to VASPs to collect and provide prompt
reporting of suspicious transactions.

The requirements under PML Rules read with FIU Guideline also
resonates with the Recommendation 18 of FATF i.e.,
“to implement group-wide programmes against money
laundering and terrorist financing apply to Designated
Non-Financial Businesses and Professions (DNFBPs)” …
“with its overall objective of improving the effectiveness of
AML measures”. ²³

Specific obligations – The FIU
guidelines outline some specific obligations for VASPs beyond the
general AML/CFT requirements. These include due diligence
obligations for Initial Coin Offerings/Initial Token Offerings
(ICOs/ITOs) where VASPs are involved in issuance, offer, sale etc.
of VDAs. For virtual digital asset transfers, the guidelines
mandate compliance with the ‘Travel Rule’ for obtaining and
transmitting originator and beneficiary information. Additional due
diligence is specified for transfers involving unhosted wallets.
The guidelines also cover requirements for correspondent
relationships between VASPs and other financial institutions.
Overall, the specific obligations aim to address the unique risks
and complexities involved in virtual digital asset activities like
anonymity, cross-border transfers, unhosted wallets etc. VASPs are
required to have policies and procedures tailored to fulfill these
specific obligations related to VDA transactions and services.

D. Conclusion and challenges ahead

Over the past decade, cryptocurrency regulations have evolved
significantly, with an increased focus on combating criminal
activities. While progress has been made, challenges persist due to
the global nature of cryptocurrencies and the rapidly changing
landscape. As we move forward, a balance between innovation and
regulation is essential to harness the potential benefits of
cryptocurrencies while minimizing their criminal misuse. While the
decentralized and pseudonymous nature of blockchain can make it an
attractive tool for illegal activities, it also presents
opportunities for detection and prevention.

The recent amendment to PMLA to include virtual digital assets
is a major step towards regulating cryptocurrencies in India. It
demonstrates the intent to monitor crypto transactions, bring
transparency and boost accountability. While there are challenges
in implementing these regulations, this move is a positive step
towards combatting money laundering in cryptocurrencies. It is
interesting to see that even before the recent notification,
enforcement agencies had initiated actions against bad actors
including VASPs. This inclusion of VDA transactions and VASPs under
PMLA will further empower the government and enforcement agencies
to curb money laundering in cryptocurrencies.

However, effective implementation requires overcoming several
key challenges. As decentralized, borderless assets, imposing
territorial regulations on cryptocurrencies has practical
difficulties. The government understands the global nature of
cryptocurrency and has taken steps towards global collaboration for
regulating cryptocurrencies. However, achieving international
consensus on cryptocurrency regulation is a complex and
time-consuming process. Evidently, there is a lack of clarity
regarding the timeframe and extent of the PMLA rules that will be
applicable on the VASPs. Stakeholders in the industry require clear
guidance on the implementation of these regulations to facilitate
compliance and avoid confusion. Though, the FIU-IND has provided
some clarifications with respect to the registration process, we
are yet to see a guidance on timeframe for implementation of
compliance by VASPs.

While framing regulations for emerging technologies like
cryptocurrencies poses complex challenges, effective enforcement
and oversight raises even greater difficulties. Robust
implementation of the PMLA regulations for virtual digital assets
would necessitate significant investments in enforcement mechanisms
and capabilities. Deploying advanced forensic systems, providing
specialized training, building tech-savvy enforcement manpower, and
developing sophisticated transaction monitoring tools are crucial
to detect potential abuse amidst the complexity of blockchain-based
systems. The decentralized and pseudonymous nature of
cryptocurrencies presents particular challenges for enforcement
authorities to unravel the audit trails of illicit financial flows.
Adequate budgetary allocation and inter-agency coordination is
vital to enforce the amended PMLA provisions on cryptocurrency
service providers in letter and spirit.

While the amendment increases compliance for Indian VASPs,
managing cross-border transactions remains tricky. Ambiguities in
applying PMLA to complex crypto transactions and decentralized
platforms remains unclear. Another challenge is the lack of public
awareness about VDAs. The government will need to educate the
public on how cryptocurrencies work and associated risks and
benefits to protect consumers from frauds, scams, bad investments
and other industry specific issues, educating the consumers about
effective dispute resolution mechanism is also vital.

As the VDA space evolves rapidly, stakeholder consultations can
help frame balanced regulations without hindering innovation. India
has the opportunity for global leadership in progressive crypto
regulation. But long-term success will depend on proactively
addressing the challenges. The path to balancing innovation and
regulation will require sustained efforts.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

Footnotes

1 https://www.oecd.org/finance/2019-OECD-Global-Blockchain-Policy-Forum-Summary-Report.pdf
last visited on 28.10.2023

2
https://www.forbes.com/advisor/in/investing/cryptocurrency/advantages-of-cryptocurrency/

3
Akartuna EA, Johnson SD, Thornton AE. The money laundering and
terrorist financing risks of new and disruptive technologies: a
futures-oriented scoping review. Secur J. 2022 Sep 19:1–36.
doi: 10.1057/s41284-022-00356-z. Epub ahead of print. PMCID:
PMC9483896.

4
https://www.justice.gov/usao-sdny/pr/tornado-cash-founders-charged-money-laundering-and-sanctions-violations

5 https://pqals.nic.in/annex/1710/AU1938.pdf

6 https://economictimes.indiatimes.com/news/india/cryptocurrency-scam-economic-offences-wing-exposes-rs-1000-crore-fraud-spanning-across-india/articleshow/102517942.cms?from=mdr

7
(47A) “virtual digital asset”
means—

(a) any information or code or number or token
(not being Indian currency or foreign currency), generated through
cryptographic means or otherwise, by whatever name called,
providing a digital representation of value exchanged with or
without consideration, with the promise or representation of having
inherent value, or functions as a store of value or a unit of
account including its use in any financial transaction or
investment, but not limited to investment scheme; and can be
transferred, stored or traded electronically;

(b) a non-fungible token or any other token of
similar nature, by whatever name called;

(c) any other digital asset, as the Central
Government may, by notification in the Official Gazette
specify:

Provided that the Central Government
may, by notification in the Official Gazette, exclude any digital
asset from the definition of virtual digital asset subject to such
conditions as may be specified therein.

Explanation.—For the purposes of this
clause,—

(a) “non-fungible token” means such
digital asset as the Central Government may, by notification in the
Official Gazette, specify;

(b) the expressions “currency”,
“foreign currency” and “Indian currency” shall
have the same meanings as respectively assigned to them in clauses
(h), (m) and (q) of section 2 of the
Foreign Exchange Management Act, 1999 (42 of 1999);

8 Titled
“RBI cautions users of Virtual Currencies against Risks,”
Press Release: 2013-2014/1261.

9 Titled
“RBI cautions users of Virtual Currencies,” Press
Release: 2016-17/2054.

10
Titled “Prohibition on dealing in Virtual Currencies
(VCs),” RBI/2017-18/154.

11
MANU/SC/0264/2020

12
Supra at 7

13 https://incometaxindia.gov.in/communications/circular/circular-no-13-2022.pdf

14 https://www.cert-in.org.in/PDF/CERT-In_Directions_70B_28.04.2022.pdf

15
Prevention of Money Laundering Act, 2002

16
Notification No. S.O. 1072(E)., Dated 07.03.2023.

17
Supra at 7

18 https://fiuindia.gov.in/pdfs/AML_legislation/AMLCFTguidelines10032023.pdf

19
Financial Intelligence Unit – India (FIU-IND) is the central,
national agency responsible for receiving, processing, analysing
and disseminating information relating to suspect financial
transactions to enforcement agencies and foreign FIUs.

20
https://fiuindia.gov.in/pdfs/AML_legislation/AMLCFTguidelines10032023.pdf

21 https://fiuindia.gov.in/pdfs/downloads/VDASP04072023.pdf

22
ibid

23
https://www.fatf-gafi.org/content/dam/fatf-gafi/recommendations/Explanatory-Materials-R18-R23