By Lavu Sri Krishna Devarayalu

Despite consistently housing some of the world’s top technology and engineering talent, India has historically only managed to extract a small portion of the total value created in the IT or internet industry – with the majority being captured by the companies availing Indian IT outsourcing. While Indian technology platforms – i.e., Zomato or CRED – have generated huge success by targeting the burgeoning Indian market, we have yet to see breakthrough Indian platforms at a global scale. Web3 offered a potential divergence to this trend; with VDA marketplace platforms like CoinDCX and CoinSwitch quickly achieving Unicorn status and technology platforms like Polygon cementing themselves as global Web3 leaders.

However, like the companies from the Web2 era, the current national policy direction threatens to snip the wings of this budding industry – once again relegating Indian companies to the role of back-offices. When India chose to levy a 1% Tax Deducted at Source (TDS) on all transactions involving VDAs, it sparked a ripple effect that created a drastically uneven playing field, reducing business on Indian platforms by over 95%  resulting in layoffs and the migration of users to foreign platforms. Ironically, while the purpose of the tax was to chill the Indian VDA market and create traceability; the primary outcome was a massive shift of 5 million plus Indian users, thousands of crores in assets, and several multiples more of trade volume – an estimated $30bn is currently being traded annually on foreign VDA exchanges by Indians — to foreign exchanges that do not report transactions to any Indian government entity. This outcome could have been avoided with a more holistic approach involving stakeholder consultations prior to implementing such a drastic policy.

The ramifications to the economy are not insignificant; money has velocity, and successful entrepreneurial endeavours have a ripple effect across the economy. In this case, the shift of users and assets has not only lead to substantial losses in terms of tax revenue by way of uncollected TDS and capital gains (A recent report by thinktank ESYA centre estimated the current uncollected TDS to be Rs.3500 crore), but also a waterfall effect in terms of revenues collected by platforms in India – which in turn reduces corporate income tax and employee income tax, as well as downstream consumption taxes for the government. The above only considers the tax loss from the migration of VDA trading, with the larger economic loss far more significant. It renders the millions of hours spent by Indian developers to hone their Web3 competency largely irrelevant, and will no doubt dry up the billions of dollars in FDI that would have otherwise (and already has – evidenced by the $1.5bn invested between 2021 and 2022) been injected into the economy.

Given India’s multifaceted competitive advantage in this space, Web3 represents a genuine opportunity that shouldn’t be passed up, even when weighed against the government’s very legitimate concerns – it’s an industry with a multi-trillion-dollar market capitalization boasting some serious volume, investment and activity. Public blockchains settled more in transaction volume last year than all major payment processors (Visa, Mastercard, Paypal) combined. The largest investment companies, including Blackrock and Fidelity, have entered the market, with both having Bitcoin ETF applications currently pending approval with the SEC, not to mention the multitude of ETP products already being traded across the world. For example, Brazil based crypto asset manager Hashdex recently reported that they have over $500 million in assets under management for their crypto index ETF.  

Indeed, if India can capture half as much of the Web3 market as it has of the global IteS export market, the industry justifiably generate more than $50bn in revenues by 2030.These predictions are based on India’s quantifiable competitive advantages not in wishful thinking — India has the second largest cohort of developers, the fastest growing cohort of Web3 developers, and is cementing itself as a world leader in terms of digital payments (albeit for domestically focused payments). Of course, applications of the technology are not exclusive to the VDA space; for example, regulated stablecoins can already significantly cut international remittance costs for senders and service providers. An INR backed stablecoin offering self-custody and complete programmability issued by a bank could be a crucial tinder in helping India achieve its aspirations for global rupee acceptance. The EU has already been adopting Web3 technologies for digital identity solutions through their European Union Digital Identity (EUDI) program and could be a game changer if correctly integrated with UIDAI services.  None of these aspirations have proven possible without proactive engagement with the global crypto ecosystem. VDAs and blockchain are synonymous in all the most important ways – meaning that to create an environment which can nurture groundbreaking innovation in blockchain or Web3 applications requires developers interacting with the crypto asset ecosystem; the two go hand in hand.

At this stage, it is also worth highlighting the key characteristics of Web3 – democratic access, transparency and fairness, as well as self-reliance, self-sovereignty, privacy and security; and have created a suite of technologies that allow real world implementations of these ideals via code. It’s a plain matter of fact that crypto has benefited people in dire straits. It may not be the perfect inflation hedge, but bitcoin has helped people protect their savings in war zones. It has changed the way we think about money – the concept of CBDCs is rooted in crypto assets – and economic organisation People have founded communities in Web3, and artists a new medium to express themselves with NFTs. Blockchain has added to the body of knowledge in cryptography, and may have a role to play addressing climate change and making governments more accountable. These trends are all the more relevant for entrepreneurs, online gig-workers and developers in countries like India – whose experience with the internet has been that of a great equaliser – who should be allowed to reap the benefits of an increasingly interconnected, sophisticated, digital world without barriers based on where they were born. 

Thus, deeper inspection of the current VDA policy regimen is urgently needed to capture the opportunity for high quality employment, genuine wealth creation, and the government’s larger vision of Atmanirbhar Bharat. A good place to start is the experience of other comparable countries – this type of prohibitive withholding tax for crypto transactions is unique amongst G20 nations, as is the singling out of the industry that has happened in India. Even China, which is often regarded as the model example for how to reign in the crypto market, has softened its stance, recognizing crypto assets legally as property, creating nationalised NFT markets, and aggressively pushing Hong Kong as the choice destination for global crypto companies.

While the immediate course of action may be to create a tax policy that maintains a level playing field, the deeper learning is that there is an urgent need to bridge the divide that exists between policy makers and the industry. Only through genuine engagement and dialogue can these concerns be appropriately addressed in such a way that local VASPs and regulators are partners in creating a safe environment for Indian investors. The suggestion is not without precedence; for example, the Japanese Virtual Currency Exchange Association (JVCEA), an SRO, has been a partner to the government for years and a key driver in making Japan a progressive yet well regulated Web3 leader. Other countries, like the UAE, have already created bespoke regulators and laws to oversee the industry independently. Regardless of the approach we do adopt, it is clear that ignoring the technology and adoption in India is no longer an option, and that the next steps must be active dialogue with the industry to correct the current situation and appropriately address the concerns that regulators have.

The author is member, Lok Sabha and Sakshi Naphade, LAMP Member

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