Crackdowns on Virtual Asset / Cryptocurrency Compliance: An Overview of the FIU's Resulting Actions in India (2023-2024)

The recent rapid development of cryptocurrency and digital asset markets has enabled many new forms of transaction activity, which has helped today’s global economy. Along with creating new transaction methods comes the need for much more regulatory oversight. As a result, throughout the world governments are taking a closer look at how cryptocurrencies are being used and are placing more stringent regulations on cryptocurrency businesses in order to ensure compliance with existing financial systems and anti-money laundering (AML) regulations.

With respect to India, the Financial Intelligence Unit (FIU) has increased regulatory enforcement against virtual asset service providers (VASP) since 2023. The FIU has issued multiple show cause letters to various cryptocurrency exchanges and digital asset operators for violations of AML regulations.

This is an indication of a significant shift in what regulators expect of the cryptocurrency industry. Compliance is no longer a choice but a necessary part of being a regulated organization that provides services or products to digital assets.

FIU-IND's Function

The FIU of India is the regulatory authority in charge of monitoring all financial operations to support the prohibition of money laundering and other illicit financial transactions in accordance with the PMLA.

Until recently, regulation of Virtual Asset Service Providers was not a part of the Financial Intelligence Unit's (FIU) mandate. Therefore, businesses involved in the cryptocurrency exchange industry, as well as businesses that offer wallet services and other digital assets, are now required to comply with the same type of financial oversight that businesses offering traditional financial services have always had to comply with.

As such, businesses offering cryptocurrency and/or digital asset services are now subject to the following obligations:

• Registration as reporting entities with the FIU

• Implementing an AML Program

• Monitoring of customer transactions

• Reporting any suspicious activities

Failure to fulfil these obligations could lead to enforcement actions, including, but not limited to, the imposition of civil and criminal penalties or operational restrictions.

FIU Enforcement Actions in 2023-2024

In the years 2023 and 2024, several virtual asset service providers based in or serving Indian customers received show-cause notices from FIU-IND for their continual failures to comply with applicable laws intended to promote financial transparency and to enforce anti-money laundering (AML) legislation.

These show-cause notices imposed upon various companies about their failure to fulfil their AML obligations and to offer sufficient rationale for why regulatory action should not be taken against them.

Understandably, India has shown a willingness to regulate digital assets as a measure to curb illegal or fraudulent financial activities using virtual currency.

Common Compliance Issues Identified

The following is a summary of some of the most prevalent compliance issues observed across virtual asset businesses via regulatory investigations:

Operating Without Proper FIU Registration

The most frequently noted violation was that many virtual asset service providers were operating without registries with the Financial Intelligence Unit for purposes of complying with money laundering regulations.

Establishing this registration with FIU-IND as reporting entities under the Money Laundering Regulations affords regulators the ability to monitor financial transactions and verify that entities are compliant with their obligation to report.

Entities that did not have an FIU registration were determined to be operating outside the scope of the regulatory framework.

No AML Programme

One of the most significant problems was a lack of structured programmes to prevent money laundering by the cryptocurrency companies.

Most companies simply did not have the proper components for compliance, e.g. internally established anti-money laundering policies.

They didn’t perform risk assessments and/or they didn’t have procedures to monitor transactions.

They did not have oversight from a compliance officer.

Without an AML framework in place, the companies cannot monitor for suspicious financial activities and do not have the ability to fulfil reporting requirements.

Inadequate KYC Monitoring

KYC or Know Your Customer is a critical process for financial institutions to ensure compliance. KYC allows companies to confirm the identity of their users and ensures that their users are engaging in legitimate/customary business and not engaging in fraudulent/illegal activity.

Regulators found that many cryptocurrency firms had poor or ineffective KYC processes such as:

• Not verifying the identity (ID) of the user

• No due diligence or customer verification

• Failure to monitor high risk accounts.

Weak KYC systems increase the risk of identity fraud, money laundering, and other financial crimes.

Inadequate Reporting of Suspicious Activities

Among other things, the rules for Money Laundering Prevention (AML), provided that institutions like ours must report any Suspicious Transaction Reports (STR) which indicate unusual or potentially illegal financial activities to the appropriate Financial Intelligence Agency (FIU). 

Many Crypto / Virtual Currency (VC) issued payment systems do not have proper systems in place to record this information and therefore do not submit STR's, nor do they have adequate systems to detect suspicious activities. This ultimately undermines the entire intelligence network that enables authorities to detect, track and prevent illegal financial activity.

Effects of FIU Enforcement on Operations of Virtual Asset Firms

The Financial Intelligence Unit's (FIU) enforcement actions have created large impacts on any affected virtual asset firm's operations. 

Restrictions On Operations

Companies that do not have adequate Anti Money Laundering (AML) compliance in place may find that regulators impose restrictions on their ability to provide services. This can include the imposition of additional compliance requirements before an organization is allowed to continue operating.

Website Blocking

Additionally, authorities have stated that crypto platforms that do not achieve compliance may face website blocking orders, thus preventing any Indian resident from accessing these types of platforms and removing them from the market.

Heavy Financial Penalties

There are significant financial penalties associated with regulatory violations. Companies who do not meet their obligations regarding Anti-Money Laundering (AML) may have to pay fines or face other types of enforcement actions.

Banking Relationship Disruptions

One of the biggest consequences for crypto businesses is losing support from banks. Banks are very careful about compliance risks, and therefore banks may suspend or terminate banking services to cryptocurrency platforms that are flagged by regulators for violating AML requirements.

If a cryptocurrency exchange cannot obtain a banking partner, it will struggle to process deposits, withdrawals, and other payment services in an efficient manner.

Why Legal and Compliance Support Matters

The importance of having legal and compliance support is highlighted by the level of enforcement activity by the FIU.

Many virtual asset startups prioritize technological advancement and platform development; however, they do not place an emphasis on regulatory compliance or legal guidance. The regulatory landscape for digital assets is changing quickly.

The consequences of not having legal guidance and compliance expertise are:

• Delayed responses to changes in regulations

• Inability to implement a compliant system

• Unanticipated enforcement actions

• Banking service disruption

Legal advisors and compliance consultants will help businesses to develop systems that will comply with government expectations and anticipate regulatory developments.

Why Proactive Compliance is Important

In the digital asset business, trust is essential. Users, investors and professional partners expect companies to operate with transparency and responsibility.

A well-designed compliance framework represents a company's commitment to financial integrity and responsibility to regulators.

Elements of a proactive compliance program include:

• Registering with applicable regulators

• Implementing comprehensive anti-money laundering (AML) policies

• Conducting thorough customer identification and verification (KYC)

• Monitoring transactions for fraudulent activity

• Maintaining appropriate reporting procedures

Successful implementation of these elements will put companies ahead of their competition when transitioning from unregulated to regulated marketplaces.

Looking Ahead: The Future of Crypto Regulation in India

As we move forward, India's regulation around cryptocurrencies is developing and expanding with time. To date, the government has not created a complete regulatory system concerning digital assets; however, enforcement actions by the government suggest they take financial compliance seriously.

Additionally, the virtual asset services industry needs to prepare itself for greater regulation in the future.

Companies that focus on compliance by ensuring they have a transparent business model will be able to lead growth from new regulation changes and remain operation socially.

The enforcement actions from FIU in 2023-24 are a benchmark for regulation of cryptocurrency in India and require virtual asset companies to operate at the same level of compliance as traditional financial institutions.

Failure to comply with AML requirements can lead to operational restrictions, website blocking or suspension, penalties, and loss of access to banking.

The message for crypto companies is unequivocal - regulatory compliance is a prerequisite for long-term viability.

By establishing strong compliance frameworks and seeking expert legal assistance, businesses will not only mitigate regulatory risk but also foster trust with users, regulators, and financial counterparts in an increasingly regulated digital assets market.