Introduction
A decade after the emergence of cryptocurrencies, regulatory outlooks from the traditional finance sector (“TradFi”) toward banking activities in the digital assets sector (“DeFi”) have evolved significantly. This shift signifies growing institutional acceptance of digital assets as legitimate financial instruments.
This paper considers the evolution of regulatory and banking positions on cryptocurrency in the United States of America viz-a-viz India, and how India’s state of play is impacting the digital assets sector. The paper further explores possible avenues and arguments regarding the integration of DeFi into the broader financial system run by TradFi, including positive knock-on effects.
Regulatory Impact: United States of America
US regulators initially adopted a restrictive approach to regulating the DeFi sector. The 2022 supervisory letters from the Office of the Comptroller of Currency (‘OCC”) and Federal Deposit Insurance Corporation (“FDIC”) required banks to obtain prior approval for engaging in crypto-related activities, including custody services and stablecoin reserve management, effectively creating a financing bottleneck for crypto entities.
The regulatory landscape for cryptocurrencies has changed significantly in recent months. The OCC’s Interpretive Letter 1183, and similar Federal Reserve and FDIC actions eliminated advance approval requirements, allowing banks to engage with crypto entities within standard banking and OCC risk management and compliance frameworks, for functions such as transaction settlement, trade execution, record keeping, valuation, tax services, reporting, or other appropriate custodial services.
Legislative developments, such as the Senate’s recent passage of the GENIUS Act mandating that stablecoins be fully backed and regularly audited, indicate regulatory acceptance and adoption of cryptocurrency into the financial ecosystem. These actions may encourage banks and FI’s to venture further into the digital assets space. In response, major US banks have begun expanding their crypto-related offerings.
Global card networks have also taken steps towards integrating crypto into TradFi, by introducing ‘Web3’ cards (similar to debit/ credit cards but backed and funded by crypto assets) and enabling digital crypto payments and spends at specified merchants where such card networks are enabled.
Regulatory Outlook: India
Mainstream financial institutions’ engagement with the digital assets space in India has had a turbulent history, catalysed by a cautious and conservative regulatory outlook. The Reserve Bank of India’s (“RBI”) April 6, 2018 (“2018 Circular”) circular prohibited all regulated entities (including banks) from dealing in or providing services to individuals or businesses dealing in virtual currencies.
The Hon’ble Supreme Court struck down the RBI circular on March 4, 2020. While affirming the RBI’s regulatory authority, the Hon’ble Supreme Court held that outright denial of banking access without justification was unconstitutional.
In May 2021, the RBI issued a clarification (“2021 Circular”) instructing banks not to refer to the 2018 Circular, but to continue enforcing Anti-Money Laundering/ Counter Financing of Terrorism (“AML/CFT”) and other relevant regulatory norms, enabling banks to engage with crypto entities within familiar and known parameters that satisfy the compliance requirements in India.
Despite the 2021 Circular being issued, the RBI stance remains cautious, warning against risk and volatility associated with crypto assets. The RBI governor recently stated that crypto remains a regulatory concern as it has the potential to hamper financial stability and monetary policy. While India has shifted from outright prohibition to measured engagement, banking services for digital assets remain scarce. This is despite a strong international push for recognition of crypto assets as a new and developing asset class.
It is important to note that the existing AML/CFT regime for Virtual Digital Asset Service Providers (“VDASPs”) includes comprehensive safeguards, including mandatory registration with the Financial Intelligence Unit of India (“FIU-IND”), Know Your Customer (“KYC”) provisions, travel rule compliance, Suspicious Transaction Report (“STR”) filing, transaction monitoring, record maintenance, and regular compliance reporting.
Way Forward
Global regulatory headwinds point to identifying and mitigating specific risks rather than isolating cryptocurrency from the broader financial ecosystem. Successful integration requires balanced frameworks that address regulatory concerns while enabling innovation.
The US model demonstrates that collaboration between banks, financial institutions, and crypto entities, within the established risk and compliance metrics, lead to regulatory certainty while integrating emerging fintech sectors with existing infrastructure. With the passing of the GENIUS Act, stablecoin issuers are now applying for banking licenses to hold reserves and cryptocurrency assets for institutional clients. This step by DeFi players significantly boosts consumer and market confidence in legitimising a sector once seen as a hub of only bad actors.
With established AML/ CFT frameworks and active FIU-IND monitoring of VDASP activities, a review of the digital asset industry’s position in India may be warranted. Planned synergies between TradFi and DeFi would not only allow innovation in these sectors, but also enable such sectors to keep up with international developments, thereby benefitting the entire financial system.