Into the unknown: Why the future of India's crypto ecosystem looks blurred

Trading activity is a function of market sentiment; in a bear market, investors will not buy bitcoin at depressed levels Illustration: Chaitanaya Dinesh Surpur

Is this current market phase a short, summery day in a still-bleak crypto winter? Equity markets across the globe have staged a bit of a recovery—after a depressing first half-year—on the hope that global inflation will start to ease off and that it may not completely derail growth across economies. Consumer spending in some countries is also starting to improve.

However, for a crypto retail investor, particularly in India—where a stifling tax structure makes investing and trading a financial hazard—a rise in bitcoin and ethereum prices from their June lows might not be good news yet. The risk averseness is real.
 

The WazirX parentage puzzle

For investors, jolts have continued uninterrupted in July and August. In mid-July the Internet and Mobile Association of India (IAMAI) said it was shutting down the Blockchain and Crypto Assets Council (BACC) due to a “still very uncertain” resolution of the regulatory environment for the industry. The IAMAI will now focus on promoting the proposed Central Bank issued Digital Currency (CBDC).

In August, WazirX, India’s premier crypto exchange by trading volumes, got embroiled into a controversy over its ownership with global crypto exchange Binance. A regulatory spotlight was on WazirX, and this, possibly, led to a public spat between Binance’s CEO Changpeng Zhao (popularly called CZ) and WazirX’s co-founder Nischal Shetty on Twitter.  

The controversy erupted after the Enforcement Directorate (ED) had issued a show cause notice to WazirX on charges of violations of the Foreign Exchange Management Act (FEMA). On August 5, the agency announced that it had raided the properties of Sameer Mhatre, a WazirX director, and also frozen some of WazirX’s bank accounts for Rs64.7 crore. This was reportedly part of the ED’s investigation into several Chinese loan apps operating in India.

CZ claims Binance does not own or has not acquired Zanmai Labs, the legal entity which operates WazirX, and that the Indian entity was in charge of customer sign-ins and KYC. Binance only owns certain assets and the intellectual property for WazirX through the 2019 deal. This has been refuted by Shetty, who maintains that WazirX was “acquired by Binance” and that Zanmai Labs has a licence from Binance to run rupee-crypto pairs in WazirX.

The controversy has hurt WazirX’s trading volumes, which were falling after hefty tax norms the government had introduced, starting April 1. Spot trading volumes for WazirX have plummeted sharply—like for all other domestic crypto exchanges—to $1.65 million on August 16, from $52.7 million on April 1, when the 30 percent crypto tax was introduced in India. Trading volumes have also become volatile since July (see chart) due to weakening macroeconomic sentiment.



The fact that Binance chose to remain silent for nearly three years and did not clarify facts relating to ownership of WazirX until the ED investigation happened is intriguing. Retail investors obviously know the least. Binance officials were unavailable for comment at the time of writing.
 
Branding consultant and crypto investor Sidhant Sidana, who trades on the WazirX platform, decided to stop trading for some time when the controversy broke. “But I knew the tie-ups it has with brands such as Mobikwik, so I continued after sometime,” he says.

Sidana, 27, has been investing in crypto through WazirX for over two years, which now constitutes a fifth of his portfolio. He has remained a loyal investor with WazirX, deciding not to switch to another exchange simply because “of the convenience of all the processes”.  Like most other crypto investors, Sidana now has more “liquid and reliable” cryptos in his portfolio, staying away from “fad and illiquid” ones.

Despite the ownership controversy overhang, WazirX’s vice president Rajagopal Menon says business is “as normal” at the exchange, but declined to talk about the ownership debate. “Operations are humming… we are using this time to BUIDL,” he tells Forbes India, “improvements to our trading engine, APIs.” BUIDL is a call to crypto innovators to build and contribute to building the crypto ecosystem, instead of just trading or owning cryptocurrencies.

The Binance-WazirX ownership debate is yet to be resolved. WazirX has the option of moving court to resolve the matter, but an industry source says: “There is a possibility that the deal may yet get consummated; 95 percent of the deal is done… the teams are talking to each other, so anything is possible.”



Menon is not oblivious to some of the concerns which WazirX faces, particularly plummeting trading volumes, which for a crypto exchange means lower total income, depending on trading fees. Most of India’s large crypto exchanges have seen a boost to their total income and profitability from 2019 onwards (see chart)—led by a surge in interest and the adoption of crypto trading in India.

Also read: Crypto crash: A wake-up call

A bad year ahead

“Trading activity is a function of market sentiment; in a bear market, investors will not buy bitcoin at depressed levels. Once the macro sentiment improves, trading volumes will improve,” Menon says. But he admits that the coming year “will be very bad” till mid-2023. “We expect the sentiment to improve after that. We have a longish runway because we've been around for while… but I fear that smaller, financially-weaker exchanges will struggle. Larger crypto exchanges will pull through these tough times.”

Sidharth Sogani, founder and CEO of Crebaco Global, a crypto and blockchain market research and ratings firm, says: “Trading volumes at most of the crypto exchanges have been falling for months. The burn rate for them is equally high. The biggest concern it raises for crypto exchanges is their ability to raise fresh capital.”

India has two crypto unicorns—CoinDCX and Coinswitch Kuber. The ability to go back to raise more capital, even if later, will be a challenge.

Sogani does not believe that WazirX’s troubles would snowball to other exchanges. “The ecosystem is not majorly impacted by the 'WazirX effect'. It is the trident effect of the current stringent tax structure in India and absence of regulations which are continuing to impact the Web 3.0 ecosystem in the country,” he says. “The faster the government introduces regulations and guidelines along with relaxed taxation for cryptocurrencies and their intermediaries, the better it is for the ecosystem, future investment and innovations in this space.”  

Crypto exchange Unocoin’s CEO Sathvik Vishwanath says: “India housing 1.3 billion population along with digitisation and the online payments push have always been a hit cake for investments in a sector like crypto.”

Rameesh Kailasam, CEO of think tank IndiaTech, says global crypto exchanges continue to remain interested even at this stage. “The local sentiment has to improve, but currently the tax regime structure is hurting crypto intermediaries.” Kailasam has, in a 2021 white paper, suggested to the government to register Indian crypto exchanges and establish checks and balances. The paper recommends minimum ownership of 26 percent by Indian founders in crypto exchanges, similar to the practice followed in the banking sector in India (with FDI capped at 74 percent).

Nearly five months have passed since the imposition of a flat 30 percent tax on crypto profit. This was followed by 18 percent Goods & Services Tax (GST) which crypto exchanges have to pay for services. From July 1, investors have to pay one percent TDS (tax deducted at source) on virtual digital asset transactions carried out, to bring it under the radar of tax authorities.

Fast-growing crypto exchanges Bitbns’ and WeTrade’s trading applications last month introduced features for their customers to earn a cashback on the TDS paid by them. Bitbns has a feature of ‘zero TDS’ if an investor decides to open a crypto systematic investment plan (SIP) with Bitbns for 12 months. The exchange will bear the TDS burden.

WeTrade offers a TDS cashback to its customers. “The amount is like an additional reward and will be reflected in their WeTrade currency wallet,” says Prashant Kumar, founder of WeTrade. Over 4,000 users have availed of this feature, he adds.

Over the past 12 months, crypto exchanges have realised that trading fees alone will not be able to ensure financial security for the exchange. Most of them have started investment arms or introduced other products for their users to increase crypto adoption or strengthen their position in the crypto ecosystem.

Also read: Cryptocurrency: Is there hope beyond a dark winter?

Expanding business activity

In August, CoinSwitch launched a Web3 Discovery Fund “to narrow down and identify and enable early-stage startups leveraging the potential of crypto to solve real-world problems unique to India”, says CoinSwitch’s co-founder and CEO Ashish Singhal. He says the exchange is beta-testing its first non-crypto offering, which will be unveiled by the September-ending quarter.

Singhal believes India will be the “launch pad for population-scale Web3 projects” and that it will need the “collective effort of builders, early-stage startups, established industry players, venture capitalists, and policymakers. The Web3 Discovery Fund is a step toward that goal”. CoinSwitch has also partnered with Tiger Global, Ribbit Capital, Coinbase Ventures and Sequoia Capital India, among other funds to make investments.

Rival CoinDCX had in May launched a similar investment arm, through CoinDCX Ventures, to invest in early-stage crypto and blockchain startups. It has plans to invest Rs100 crore in the next 12 months.

WazirX’s Menon says there have been a few new initiatives they have been working on. “We have just done a soft launch for a gift card in the festive season. There have been several engineering updates for the platform and our mobile app User Interface has been completely re-modelled.”

Unocoin has plans to launch sub-broker and NFT platforms soon. “The bearish market for crypto is the time for a company like ours to focus on customer service and build products or services to eventually prepare for brighter times that cycle every alternate year,” says Vishwanath.

Kailasam says the move to invest in emerging innovative forms and variants in the blockchain universe is so that exchanges can “stay relevant”. These are offshoots to the existing crypto technology and will also help exchanges mitigate risks further.

The regulatory tax structure for cryptos will only make it more difficult for investors and exchanges to operate. Union Finance Minister Nirmala Sitharaman has masked the plans the government may have, but told the Lok Sabha in July that “any legislation for regulation or for banning can be effective only after significant international collaboration on evaluation of the risks and benefits and evolution of common taxonomy and standards”. This indicates that the government has an intent to regulate, but there is also helplessness on the regulator part.

With the country yet to regulate digital assets, much of the growth of the crypto ecosystem remains with the exchanges and venture funds. But with the Crypto Bill not in sight, the environment to innovate, grow the business and hire the best talent continues to prosper outside of India. For a crypto exchange where trading volumes continue to shrink, cash burns and cost effectiveness will become more relevant than attracting customers. The larger crypto exchanges will pull through, but smaller ones will find the going tough.

Since many have invested during their growth phase with subsequent funding that came in, it is likely that they may pull through now as they may have undertaken cost-effective measures. However, the much smaller ones may find it tough to survive for long under the current scenario.

 (Additional inputs by Naandika Tripathi)