Virtual Digital Assets: Parliament panel seeks a regulatory framework

Why in News?

The Standing Committee on Finance, in its 36th Report on the Securities Markets Code, 2025, asked the Union government to examine a statutory and regulatory framework for Virtual Digital Assets. The report was presented to the Lok Sabha and laid in the Rajya Sabha on 23 July 2026.

The panel said VDAs that do not meet the legal tests of a security or derivative can remain outside the proposed Code. Until Parliament enacts a comprehensive framework, it suggested recognised Self-Regulatory Organisations working under a designated regulator’s oversight.

• The proposed Securities Markets Code, 2025 uses a technology-neutral definition of securities, but a crypto-asset is not brought within securities law merely because it is recorded as a digital token.
• The Committee identified an existing regulatory vacuum involving fraud, market manipulation, misrepresentation, weak grievance redressal and regulatory arbitrage.
• An interim SRO framework should set minimum standards for governance, transparency, disclosure, investor protection, conduct and grievance redressal.
• The Indian Express reported that nearly 12 crore Indians, based on a Chainalysis estimate, participate in the VDA ecosystem. This is an industry estimate, not an official count of regulated investors.
• The Ministry of Finance told the Committee that VDAs are regulated only for limited purposes such as taxation, anti-money laundering and reporting, not through a complete market-regulation statute.

The development matters in the context of:

• The issue tests how India can protect retail participants without treating every blockchain token as a security or suppressing useful distributed-ledger innovation.
• Because VDAs can move through offshore exchanges, private wallets and decentralised protocols, an effective regime needs domestic coordination and cross-border regulatory cooperation.
• Tax collection and suspicious-transaction reporting address specific state interests; they do not create licensing, prudential, custody or market-conduct rules for the whole sector.

UPSC Relevance

Prelims Relevance

• A Virtual Digital Asset is a statutory tax category covering specified digital representations of value, crypto-assets and notified non-fungible tokens; it is not the same as legal tender.
• India’s Central Bank Digital Currency, the digital rupee, is sovereign money issued by the RBI and is distinct from privately issued crypto-assets. See Central Bank Digital Currency.
• Under the current income-tax framework, income from transfer of a VDA attracts a 30% special rate, apart from applicable surcharge and cess.
• Only the cost of acquisition is deductible while computing such VDA income; a VDA transfer loss cannot be set off against other income or carried forward.
• A 1% tax deduction at source applies to consideration for VDA transfers above statutory thresholds, helping create a transaction trail.
• The PMLA notification of 7 March 2023 brought five classes of VDA-related services within the reporting-entity framework.
• VDA service providers covered by the notification must register with FIU-IND and follow customer due diligence, record-keeping and suspicious-transaction reporting duties.
• A Self-Regulatory Organisation is an industry body recognised and supervised by a public regulator; it cannot by itself confer legal-tender status or replace parliamentary legislation.
• The FATF Travel Rule seeks originator and beneficiary information for qualifying virtual-asset transfers as part of global AML/CFT standards.
• A tokenised share, bond or investment-scheme unit can remain a security because its legal substance, not its digital form, determines classification.

Mains Relevance

GS Paper 3

• Regulation of digital financial innovation, investor protection, cybersecurity and systemic-risk transmission.
• Effects of borderless and pseudonymous assets on tax administration, capital flows, monetary sovereignty and financial stability.
• Policy distinction among private VDAs, tokenised securities and the digital rupee.

GS Paper 2

• Role of department-related standing committees in legislative scrutiny and evidence-based regulation.
• Institutional design for a designated regulator, inter-agency coordination, consumer redress and accountable delegated rule-making.

Essay

• Innovation grows sustainably when trust, accountability and legal certainty develop alongside technology.
• In a borderless digital market, national regulation remains necessary but cannot work in isolation.

Background and Context

What counts as a Virtual Digital Asset?

The tax definition is broad enough to track new digital forms, but it should not be confused with approval as money or as an investment product.

• A VDA may be information, code, a number or a token generated through cryptographic or similar means and representing value that can be transferred, stored or traded electronically.
• The category covers specified crypto-assets and NFTs, while notified exclusions include gift cards, loyalty points and subscriptions that serve limited consumer purposes.
• Indian currency, foreign currency and the RBI-issued digital rupee do not become private VDAs merely because they can exist electronically.
• The classification is purpose-specific: tax law can call an asset a VDA, PMLA can regulate its service provider, and securities law can separately test whether the instrument is a security or derivative.
• A sound answer should separate three questions: what the asset legally represents, which activity a platform performs, and which public interest is at risk. The same token may trigger tax reporting, AML checks and securities regulation for different reasons without becoming sovereign money.
• For a conceptual foundation, see Cryptocurrency and blockchain regulation in India.

Why the Securities Markets Code leaves a gap

The proposed Code follows economic substance, so tokenisation does not automatically move every digital asset inside or outside securities regulation.

• The Securities Markets Code, 2025 seeks to consolidate the SEBI Act, 1992, the Securities Contracts (Regulation) Act, 1956 and the Depositories Act, 1996.
• A tokenised representation of an existing share, bond or investment-scheme unit can still be a security because distributed-ledger record-keeping does not change the underlying legal rights.
• A cryptocurrency lacking the defining characteristics of a security or derivative may remain outside the Code even if it is traded for speculative returns.
• The Committee noted that some VDAs display securities-like traits such as organised trading, price discovery, leverage and exposure to an underlying asset, yet may still escape a clear supervisory perimeter.
• A pooled arrangement can qualify as an investment scheme when investors contribute funds, expect returns and lack day-to-day control, even if the arrangement uses tokens. The legal test attaches to the arrangement’s substance rather than to the underlying asset alone.
• This perimeter problem can encourage regulatory arbitrage, where functionally similar products face different rules because of legal form or technology.

India's existing tax layer

The tax regime records and taxes VDA transactions, but payment of tax neither legalises a product nor guarantees its safety.

• The regime introduced through the Finance Act, 2022 taxes income from VDA transfers at 30%, with applicable surcharge and cess.
• No expenditure deduction is permitted except the cost of acquisition; losses cannot be set off against other income or carried to later tax years.
• The 1% TDS mechanism applies above prescribed annual thresholds and can also cover consideration paid wholly or partly in kind.
• A Finance Ministry reply to the Rajya Sabha in February 2026 highlighted offshore exchanges, private wallets and decentralised platforms as obstacles to identifying taxable income and beneficial ownership.
• The Income-tax Act, 2025, effective from 1 April 2026, retains the 30% special-rate treatment and the transaction-level deduction architecture in a reorganised statute. This continuity strengthens revenue collection but still leaves prudential and conduct questions to a separate policy process.
• User-level transaction reporting strengthens visibility for tax administration, but it does not supply product approval, exchange licensing, reserve standards or investor compensation.

India's anti-money-laundering layer

The PMLA framework regulates specified service-provider conduct to detect illicit finance, not the economic merits of every VDA.

• The 7 March 2023 notification covers VDA-fiat exchange, VDA-VDA exchange, transfer, safekeeping or administration, and financial services linked to an issuer’s offer and sale.
• Covered providers must register as reporting entities with FIU-IND, even when an offshore business serves Indian users.
• Core duties include KYC and customer due diligence, beneficial-owner identification, risk-based monitoring, record retention and suspicious-transaction reports.
• FIU-IND’s VDA AML/CFT guidelines, updated on 8 January 2026, support implementation of PMLA, counter-terror financing and proliferation-financing controls.
• The reporting perimeter is activity-based: it follows a provider conducting notified services for or on behalf of another person in the course of business. A person’s self-hosted wallet may create enforcement difficulty, but the wallet itself is not automatically a licensed financial intermediary.
• This layer helps trace criminal proceeds, but it does not fully govern custody failures, misleading promotions, conflicts of interest, wash trading or orderly resolution. See India’s money-laundering framework.

What the interim SRO proposal means

The Committee views supervised self-regulation as a bridge, not as the final constitutional or statutory settlement.

• A recognised SRO could frame common codes on disclosures, advertising, token listing, custody, governance, complaints and member audits.
• Recognition by a designated regulator would be essential to reduce capture by dominant exchanges and to make standards enforceable within a public-law framework.
• The Committee asked for minimum standards of governance, transparency, disclosure, investor protection, grievance redressal and regulatory oversight.
• An SRO can respond faster to technical change and pool industry expertise, but it faces conflicts when the same members write rules, earn fees and investigate one another.
• A credible bridge would separate standard-setting, supervision and adjudication, publish enforcement outcomes, protect whistle-blowers and require independent directors. The public regulator should be able to inspect the SRO, reject weak rules, hear appeals and act directly when market integrity is threatened.
• Statute must still define the regulator’s mandate, licensing perimeter, inspection powers, sanctions, appeal routes, data access and accountability to Parliament.

Risks that a full framework must address

The regulatory case rests on identifiable market, technology and governance failures rather than on price volatility alone.

• Investor risk: opaque token economics, misleading returns, manipulation, insider dealing and weak complaint remedies can shift losses to retail users.
• Operational risk: hacked wallets, lost private keys, exchange outages and poor segregation of client assets can make recovery difficult.
• Illicit-finance risk: mixers, chain-hopping, private wallets and cross-border platforms can complicate sanctions screening and tracing.
• Macro-financial risk: leverage, stablecoin runs and deeper links with banks or payment systems could transmit shocks even if current regulated-system exposure is limited.
• Stablecoin risk: a token promising a fixed value can fail when reserves are opaque, redemption is restricted or custodians fail. Rules may need reserve quality, independent attestations, redemption rights and limits on using customer assets rather than a generic crypto disclosure alone.
• Sovereignty risk: widespread private settlement assets can complicate capital-flow management, monetary transmission and the state’s control over lawful money.
• Regulatory risk: rules that are too rigid can drive activity offshore, while weak rules can create a false signal of government endorsement.

Global approaches and coordination

Cross-border consistency matters because a wallet, exchange, issuer and customer can be located in different jurisdictions.

• The FATF applies its risk-based standards to virtual assets and service providers, with licensing or registration, AML/CFT controls and the Travel Rule.
• The Financial Stability Board issued high-level recommendations based on the principle of same activity, same risk and same regulation.
• During India’s G20 presidency, leaders endorsed the IMF-FSB synthesis paper roadmap for coordinated, risk-based crypto-asset policy rather than fragmented national responses.
• The Committee’s comparative review noted the European Union’s MiCA residual framework and Singapore’s use of payments and securities laws according to an asset’s function.
• International alignment does not require identical statutes. It needs shared minimum outcomes for licensing, governance, safeguarding client assets, disclosures, AML/CFT and information exchange, while allowing each jurisdiction to assign responsibilities according to its constitutional and financial-regulatory structure.
• India can require an offshore platform targeting Indian residents to meet local registration and compliance conditions, but investigation and asset recovery still depend on cooperation from the jurisdiction hosting the operator, servers, bank accounts or controlling persons.
• India needs mutual assistance, supervisory information-sharing and compatible data standards so offshore providers cannot gain an advantage by avoiding domestic safeguards.

Way Forward

Create a risk-based statutory perimeter

• Classify activities such as issuance, exchange, brokerage, custody, staking and stablecoin operation by economic function and risk, not by branding.
• Preserve technology neutrality while stating when a token is a security, payment instrument, commodity-like asset or separate VDA.

Use supervised self-regulation carefully

• Recognise an interim SRO only through transparent eligibility, independent governance, conflict controls, public rule consultation and regulator-approved enforcement.
• Give users a complaint route beyond the industry body through a statutory ombudsman or appellate mechanism.

Build investor and custody safeguards

• Mandate plain-language risk disclosures, fair advertising, suitability limits for complex products and warnings that taxation is not legal approval.
• Require segregation of client assets, proof of reserves and liabilities, cyber audits, recovery planning and controls over related-party transactions.

Coordinate regulators and enforcement

• Create a formal coordination mechanism linking the Finance Ministry, RBI, SEBI, FIU-IND, tax authorities and cybercrime agencies.
• Establish a lead regulator with clear powers while preserving each agency’s specialist role in monetary policy, securities, taxation and AML/CFT.

Align with global standards

• Apply proportionate FATF controls and interoperable transaction-data standards to Indian and offshore providers serving Indian customers.
• Use regulatory sandboxes and phased licensing to test rules, but attach sunset clauses and parliamentary review to any interim regime.

Conclusion

India does not face a choice between a total ban and unregulated growth. It needs a function-based framework that distinguishes private VDAs from tokenised securities and sovereign digital currency while closing clear investor-protection gaps.

The Committee’s SRO proposal can provide a temporary floor, but durable legitimacy requires parliamentary legislation, an accountable regulator and cross-border cooperation. Tax and AML compliance are necessary foundations, not substitutes for full market governance.

UPSC Practice Questions

Prelims MCQ 1

With reference to Virtual Digital Assets in India, consider the following statements:

1. Specified VDA service providers are reporting entities under the anti-money-laundering framework.
2. Taxation of income from a VDA makes that asset legal tender in India.
3. India currently has a comprehensive statute licensing all VDA exchanges and products.

How many of the above statements are correct?

(a) Only one (b) Only two (c) All three (d) None

Answer: (a) Only one

Explanation:

Statement 1 is correct. The PMLA framework covers notified VDA services and requires FIU-IND registration. Tax liability does not create legal-tender status, and India lacks a comprehensive VDA market-regulation statute.

Prelims MCQ 2

Which one of the following best describes the technology-neutral approach in the proposed Securities Markets Code?

(a) Every blockchain token is automatically treated as a security (b) No digitally recorded instrument can be treated as a security (c) Legal rights and economic characteristics determine whether a tokenised instrument is a security (d) Only the RBI can decide whether any asset is a security

Answer: (c) Legal rights and economic characteristics determine whether a tokenised instrument is a security

Explanation:

A tokenised share, bond or investment-scheme unit can remain a security. A cryptocurrency that lacks the statutory features of a security or derivative may fall outside the Code.

UPSC Mains Questions

1. India’s tax and anti-money-laundering rules for Virtual Digital Assets create compliance obligations but do not amount to comprehensive market regulation. Examine the remaining gaps in licensing, custody, market conduct, investor protection and institutional accountability. Suggest a function-based regulatory architecture.
2. A supervised Self-Regulatory Organisation can serve as a bridge during rapid technological change, but it may also reproduce industry conflicts of interest. Critically assess the parliamentary panel’s interim proposal for VDAs and specify the safeguards needed for legitimacy and effective enforcement.
3. Virtual Digital Assets are borderless, while financial regulation remains largely national. Discuss the need for international coordination on AML/CFT, data-sharing, stablecoins and offshore platforms, while preserving India’s monetary sovereignty, innovation capacity and consumer protection.

Sources: Standing Committee on Finance, Lok Sabha and The Indian Express.

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