Indian Crypto Startups Brace For Compliance Storm Under New KYC Mandates

India's Financial Intelligence Unit has updated protocols for high risk clients, including recurring bi-annual reauthentication and verification from external sources

The higher costs, along with an already ambiguous regulatory environment, could force businesses to move abroad increasing the exodus of crypto startups from India

India’s Financial Intelligence Unit (FIU) has updated protocols for cryptocurrency exchanges to improve anti-money laundering (AML) and KYC measures in an effort to curb illegal activities in the crypto sector.

The updated guidelines include mandatory live detection through selfies and geo-tracking during the onboarding process, along with additional compliance measures for crypto exchanges.

While the move was welcomed by many industry players as a sign of strengthening regulations to boost retail investor confidence, others said that the costs of complying with these guidelines will hinder the growth of crypto startups.

“Exchanges will face higher operational and compliance costs due to enhanced verification, monitoring systems, and reporting requirements. Integrating these rules will require investments in technology, compliance teams, and partnerships with KYC providers, but it also reduces regulatory risk in the long run,” said Sathvik Vishwanath, cofounder and CEO of crypto exchange Unocoin.

The higher costs, along with an already ambiguous regulatory environment, could force businesses to move abroad increasing the exodus of crypto startups from India, industry players told Inc42.

Gupta was referring to the directive that exchanges will have to appoint full-time designated directors and principal officers tasked with overseeing the company’s compliance efforts.

Crypto exchanges, which onboarded customers on their platform through documents till now, will have to integrate a software that verifies customers’ presence during onboarding by detecting eye or head movement in live selfies as a way to deter the use of deepfakes and static images.

Updated KYC rules require exchanges to ask for a secondary government-issued ID in addition to the new users’ PAN card, along with an OTP verification for their email ID and phone number. During the onboarding process, crypto exchanges are also expected to collect geo-tagging information like latitude and longitude, date, timestamp, and IP address from where the user is creating an account.

Exchanges also need to carry out bank account verification through the “penny-drop” method, where a very small amount of money is charged from the chosen account to verify that it is active and belongs to the registering user.

As per the guidelines, exchanges must ensure that KYC documents provided during onboarding are only one initiating the account creation and accessing the platform through live face verification and geo-tagging mechanisms.

The exchanges will also have to update KYC for high-risk clients every six months, and annually for all other users. They will have to preserve information such as name, address and transaction details for at least five years, or longer if there is an ongoing investigation.

High-risk clients include those linked to tax haven countries or jurisdictions grey and black-listed by the Financial Action Task Force (FATF), along with politically exposed persons or non-profit organisations. Exchanges will have to gather information from open sources and consult independent databases to perform enhanced due diligence for such entities.

The new rules were not surprising for industry players, as the policy environment in India seems to be aimed at discouraging crypto investments. From high taxation and TDS on crypto transactions to requirement for registration of crypto exchanges with FIU, the regulations have hit the Indian crypto players hard.

A number of startups operating in the virtual digital assets segment moved to friendlier jurisdictions like Singapore and Dubai from India in the past few years, while new funding has more or less dried up for the sector. The new rules are expected to lead to more such migration.

It is pertinent to note that the RBI has been a staunch critic of cryptos due to perceived macroeconomic risks. In 2018, the central bank, through a circular, banned financial institutions from providing services related to crypto transactions to exchanges.

While the decision was reversed by the Supreme Court in 2020, the central bank has continued to express caution regarding VDAs. In June last year, RBI governor Sanjay Malhotra reiterated that VDAs could hamper the country’s financial stability and monetary policy, adding that a government committee continues to look into the matter.

Recently, the Supreme Court also pulled up the central government for the lack of clear regulations on an asset class that is taxed heavily.

Meanwhile, the stance of authorities seems to be unchanged on VDAs. Last week, it was reported that the income tax department raised concerns over risks associated with VDAs. The department told the parliamentary standing committee on finance that VDAs could be used to move funds through a system without regulated financial intermediaries.