Crypto investing guide: How to choose the right virtual digital asset exchange?

India has emerged as a global leader in the adoption of Virtual Digital Assets (VDAs), driven by the burgeoning acceptance of blockchain technology and its transformative potential. According to Chainalysis’ 2023 crypto adoption index, India stands at the forefront of grassroots crypto adoption worldwide. While investors have various options for exploring VDA investments, centralized exchanges remain the most popular choice.

The prevalence of centralized exchanges stems from their user-friendliness and simplified trading processes. However, investors must recognize the importance of selecting a compliant exchange to ensure a secure and protected investment environment.

Understanding Compliant Exchanges and Key Considerations

What constitutes a compliant exchange? What are the crucial factors to consider when selecting a VDA exchange?

Essential KYC Practices
Investors should choose exchanges that proactively implement robust measures to prevent money laundering, terror funding, and tax evasion. Diligent Know Your Customer (KYC) procedures are essential. Many exchanges employ secure and advanced KYC methods, requiring customers to submit identity verification documents such as Tax ID (PAN Card) and Identity Card (Aadhaar Card/Voter Id Card/Passport/Driving License). Exchanges can request re-verification or undertake enhanced due diligence in case of discrepancies.TDS Compliance and FIU Registration
In the Union Budget 2022-23, the Honourable Finance Minister announced a Tax Deducted at Source (TDS) deduction of 1% on all VDA sell transactions, effective from July 1, 2022. It is crucial for investors to be also aware that income from the transfer of VDA, such as cryptos and NFTs, is subject to a 30% tax at the end of each financial year.

In response to the introduction of TDS provisions, many exchanges have implemented processes to ensure full compliance with the tax mandate. These measures ensure timely deduction and submission of the applicable TDS to the government authorities. It is imperative for investors to select exchanges that seamlessly integrate these processes on their platform to ensure compliance on the part of their users.Additionally, investors should choose a platform which is registered as Reporting entities under Financial Intelligence Unit (FIU), ,which basically means it is complying with the Prevention of Money Laundering Act (PMLA) guidelines.

Consumer Protection and Proof of Reserves
Investors should prioritize exchanges that emphasize consumer protection. One crucial aspect is the regular release of Proof of Reserves (PoR) and Liabilities Reports, typically on a quarterly basis. A Proof of Reserve audit involves engaging a third-party crypto auditor to verify that an exchange holds the assets stated on its balance sheet, ensuring alignment with customer holdings. This verification process utilizes cryptographic techniques such as the ‘merkle tree’ method.

In a commitment to transparency and consumer safeguarding, exchanges make a comprehensive list of wallet addresses publicly available for viewing and verification. This proactive step enables customers to easily confirm that the reported balances are indeed backed by tangible assets.

It is noteworthy that several exchanges in India persist in publishing PoR reports every quarter. This ongoing practice reflects a dedication to maintaining transparency and instilling confidence among VDA users.

Select a platform with a robust consumer redressal mechanism to ensure swift resolution of issues and a secure trading experience.

Avoiding Offshore Exchanges and Embracing Domestic Compliance:

According to a recent study by Esya, approximately 5.2 million users have shifted to offshore platforms since the implementation of TDS. In a parallel trend, investors are gravitating towards Peer-to-Peer (P2P) platforms to sidestep TDS requirements. It is essential for Indian users to recognize the associated risks when opting for offshore or P2P platforms over domestic exchanges, which adhere to all government regulations. In contrast, many offshore exchanges operating in India neglect regulatory compliance, posing potential fraud risks beyond India’s jurisdiction.

While some P2P platforms conduct basic Know Your Customer (KYC) verifications, the overall lack of stringent oversight introduces risks. Addressing disputes and issues arising during transactions becomes challenging due to the absence of a regulatory authority. Scammers take advantage of the escrow system on P2P exchanges, deceiving users and undermining the secure transfer process, eroding the trust-based nature of these platforms.

Reputable Exchanges with Long-Term Vision
Investors should prioritize exchanges established by technology entrepreneurs with a proven track record and a long-term vision for VDA and their brands. These exchanges demonstrate a commitment to the Indian market and are more likely to adhere to regulatory requirements.

Exercise caution against fraudulent websites and individuals impersonating exchange representatives who entice victims with promises of high returns.

Conclusion

Choosing a compliant VDA exchange is paramount for Indian investors to safeguard their funds and navigate the evolving regulatory landscape. By prioritizing compliant exchanges, investors can mitigate risks, ensure responsible trading practices, and contribute to the sustainable growth of India’s VDA ecosystem.

(Rohan Bhandari is SVP, Head of Compliance, CoinDCX. Views are own)