Caught in the Middle: India's Unfinished Reckoning with Crypto and Stablecoins.

Authored by Rachana Madhusudana, pursuing BA. LLB(Hons) from Maharastra National Law University (MNLU).

Introduction

India has never quite made up its mind about virtual digital assets (“VDAs”). Over the past decade, the country’s approach has swung between outright prohibition, reluctant tolerance, and cautious formalisation, rarely settling long enough in any one position to offer the market genuine clarity. What began as a series of warnings and circulars issued by the Reserve Bank of India (“RBI”), evolved into a layered regulatory framework spanning taxation, anti-money laundering compliance, and now, a nascent framework for stablecoins.

Defining Virtual Digital Assets: The Legislative Foundation

The foundational basis for VDA regulation in India was established through Section 2(47A) of the Income-Tax Act 1961, inserted by the Finance Act 2022. The provision adopts an expansive definition, capturing any information, code, number, or token, not being Indian or foreign currency, generated through cryptographic or other means, which provides a digital representation of value exchangeable with or without consideration, and which can be transferred, stored, or traded electronically. Non-fungible tokens and digital assets notified by the Central Government are also included within this definition.

Significantly, the Finance Act 2025 further broadens this definition by inserting sub-clause (d), effective from 1 April 2026, which brings within its ambit any crypto-asset that relies on a cryptographically secured distributed ledger or similar technology to validate and secure transactions, irrespective of whether it otherwise satisfies the criteria in sub-clauses (a), (b), or (c). This amendment reflects the legislature's intent to ensure that definitional gaps are not exploited as regulatory arbitrage opportunities.

The RBI’s Early Regulatory Stance

The RBI’s initial response to virtual currencies was instinctively cautionary. Beginning with its notification dated 24 December 2013 and reiterating that position through February 2017, the regulator flagged risks without imposing formal restrictions. That changed in April 2018 when the RBI Circular dated 6 April 2018 directed all regulated entities to cease dealing in virtual currencies altogether, a measure the Internet and Mobile Association of India promptly challenged before the Supreme Court. In Internet and Mobile Assn. of India v. RBI, (2020) 10 SCC 274, the Supreme Court struck down the circular, holding that a blanket banking exclusion was disproportionate in the absence of any demonstrable harm to regulated entities. The judgment was not an endorsement of cryptocurrencies, it was a reminder that regulatory action curtailing fundamental rights must be evidence-based and minimally invasive. By reopening banking channels, the Court effectively set the stage for the legislative activity that followed.

Stablecoins: What They Are and Why They Matter

Before examining the regulatory landscape, it is worth pausing on what stablecoins actually are and why they have become impossible for policymakers to ignore. A stablecoin is a type of cryptocurrency whose value is designed to remain stable relative to a reference asset, most commonly a fiat currency like the US dollar or, as is now proposed in India, the rupee. Unlike Bitcoin or Ether, whose prices can swing dramatically within hours, stablecoins maintain their peg through various mechanisms: some hold equivalent reserves in cash or government securities (fiat-backed), some are collateralized by other crypto assets, and some rely on algorithmic supply adjustments. The practical consequence of this stability is that stablecoins behave less like speculative assets and more like digital cash, usable for everyday payments, cross-border remittances, and programmatic financial transactions without the volatility that makes ordinary cryptocurrency impractical for commerce. That functional utility is precisely what has made them attractive to Indian users, and precisely what makes their regulatory treatment a question that can no longer be deferred.

AML Compliance, Taxation, and Reporting: The Emerging Regulatory Architecture

Through Notification S.O. 1072(E) dated 7 March 2023, the GOI designated VDA Service Providers which are engaged in exchange, transfer, safekeeping, or administration of VDAs, or provision of financial services related to VDA issuances, as "Reporting Entities" under the PMLA, 2002. The AML & CFT Guidelines for Reporting Entities Providing Services Related to Virtual Digital Assets, updated on January 8, 2026, prescribe a comprehensive governance framework requiring VDA-SPs to register through the FINGate portal, conduct KYC procedures on beneficial owners, retain wallet addresses and transaction hashes, submit Suspicious Transaction Reports, and comply with the FATF-derived Travel Rule for originator and beneficiary information. Aligning with India's international commitment to implement the Crypto-Asset Reporting Framework (“CARF”) by 2027, the Finance Bill 2025 proposed a new Section 285BAA under the Income Tax Act, mandating designated Reporting Entities to furnish information on crypto-asset transactions which has been effective since April 1, 2026. India's tax treatment of VDAs, introduced through the Finance Act, 2022, is among the most stringent globally. Section 115BBH of the Income Tax Act 1961, imposes a flat 30% tax on income arising from the transfer of VDAs, with no deductions available except the cost of acquisition. Losses from VDA transfers cannot be set off against any other income, nor carried forward to subsequent assessment years.

Additionally, Section 194S, effective from July 1, 2022, requires tax deduction at source at the rate of 1% on payments made as consideration for VDA transfers. This provision operates even where consideration is given wholly in kind or in another VDA, placing a compliance obligation on the transferor to ensure the tax liability is satisfied before the transaction is settled.

The Digital Rupee and India’s CBDC Experiment

RBI released a Concept Note on Central Bank Digital Currency on 7 October 2022 (“CBDC”), defining the digital rupee as legal tender issued by the central bank in digital form, exchangeable at par (1:1) with fiat currency, and functioning as a direct liability of the Reserve Bank, not of a commercial bank. The legal foundation for the digital rupee was established by the Finance Act 2022, which amended the definition of "bank note" in the Reserve Bank of India Act 1934 to include currency issued in digital form.

The RBI has piloted the Digital Rupee in two segments: the wholesale variant (e₹-W), launched on November 1, 2022, for settlement of secondary market transactions in government securities; and the retail variant (e₹-R), launched on December 1, 2022, distributed through banks via digital wallets and supporting both person-to-person and person-to-merchant transactions. Like physical cash, the CBDC bears no interest and can be converted into other forms of money.

The Stablecoin Question: Global Frameworks and India’s Ambivalence

Globally, stablecoins which are cryptocurrencies designed to maintain a stable value by pegging to fiat currencies, commodities, or financial instruments, have attracted significant regulatory attention. In October 2021, IOSCO and the Bank for International Settlements recommended that stablecoins be regulated as financial market infrastructure. The European Union's Markets in Crypto-Assets Regulation (“MiCA”), which took effect in 2023, strictly regulates algorithmic stablecoins and requires all others to hold assets in custody at a 1:1 reserve ratio. In the United States, the GENIUS Act, signed into law in 2025, requires stablecoin issuers to publicly disclose reserve compositions monthly and hold liquid assets such as US dollars or short-term Treasuries. These frameworks offer India workable reference points.

India's position remains characterized by internal tension. While unofficial estimates suggest India has over 314 million stablecoin users, the largest globally, and approximately 60% of foreign exchange conversions by Indians are conducted through stablecoins, official regulatory acknowledgment has been ambivalent. Finance Minister Nirmala Sitharaman, speaking at the Kautilya Economic Conclave on 3 October 2025, signalled that nations must "prepare to engage" with stablecoins as transformative instruments reshaping capital flows. However, the RBI Deputy Governor T. Rabi Sankar, speaking on 12 December 2025, maintained that stablecoins lack the basic attributes of money, do not carry a sovereign promise to pay, and pose systemic risks that outweigh their claimed advantages.

The ARC Initiative: India’s First Rupee-Backed Stablecoin

The most consequential private-sector development in India's digital asset landscape is the Asset Reserve Certificate (“ARC”), a regulated, rupee-pegged stablecoin being developed by Polygon and Anq, designed for 1:1 parity with the Indian Rupee and backed by high-quality assets including G-Secs and Treasury Bills, which was proposed to be rolled out in the first quarter of 2026. ARC tokens are minted only upon equivalent INR reserve deposits, encompassing cash, fixed deposits, and government securities. However, Polygon and Anq have not obtained the necessary authorization required under Section 5 of the Payment and Settlement Systems Act 2007.

ARC is being designed to complement and not to compete with the RBI's digital rupee. Under the proposed two-layer digital money system, the CBDC handles final settlement and monetary oversight, while ARC operates on blockchain rails as a programmable interaction layer capable of supporting payments, remittances, DeFi experimentation, and smart-contract-driven business transactions. ARC's initial issuance will be limited to corporate and institutional accounts, with retail adoption anticipated in subsequent phases. The significance of ARC lies in its potential to retain domestic liquidity that currently flows into offshore dollar-backed stablecoins, increase demand for sovereign debt instruments through mandatory G-Sec backing, and lower the cost and latency of cross-border remittances.

Conclusion and Recommendations

The trajectory of VDA regulation in India has been reactive rather than anticipatory. Each legislative intervention, whether the 30% flat tax, the PMLA designation, or the definitional expansion under the Finance Act 2025, has followed rather than preceded market developments. That pattern is not peculiar to India, but it is increasingly costly. As global regulation accelerates through frameworks like MiCA and CARF, and as private-sector stablecoin initiatives like ARC push the frontier of programmable digital currency, the space for deferred decisions is narrowing. What India needs now is not another circular or notification but a standalone, forward-looking legislative framework that addresses VDAs and stablecoins as a coherent category of financial instruments and not as residual risks to be managed through existing law.

Several recommendations follow from the analysis above. First, India should enact a dedicated Virtual Digital Assets Act that consolidates the existing patchwork of tax provisions, AML obligations, and payment regulations into a single, coherent statute. The current arrangement where VDAs are defined under the Income Tax Act, regulated for AML purposes under the PMLA, and subject to payment oversight under the PSS Act, creates compliance uncertainty and inhibits institutional participation. Consolidation would also allow the law to treat different asset types on their own terms. A rupee-backed stablecoin and a speculative token are not the same instrument for regulatory purposes, and a statute that treats them identically serves neither market well. Second, the RBI should establish a stablecoin-specific authorization pathway under the Payment and Settlement Systems Act 2007. The ARC initiative, whatever its current authorization gaps, demonstrates that private-sector appetite for a rupee-backed stablecoin is real and technically feasible. Rather than leaving that appetite unregulated or forcing it offshore, the RBI would do well to prescribe minimum reserve requirements, audit obligations, and governance standards that permit responsible issuance within a defined regulatory perimeter. The EU’s approach under MiCA, which distinguishes between e-money tokens pegged to a single fiat currency and asset-referenced tokens with broader backing, offers a workable template. Third, the tax treatment of VDAs deserves serious reconsideration. The 30% flat rate with no loss set-off, while administratively simple, has suppressed on-chain activity and pushed volume to offshore platforms, which is precisely the outcome the regime was designed to prevent. A more calibrated approach distinguishing, for example, between short-term speculative gains and long-term holdings, or between trading income and stablecoin-denominated payments, would better align with India’s broader goal of building a domestic digital asset ecosystem rather than merely taxing it.

Finally, India must resolve the institutional ambiguity between the Ministry of Finance and the RBI on the question of stablecoins. The divergence between Finance Minister Sitharaman’s call to engage with stablecoins and Deputy Governor Sankar’s categorical rejection is not merely a disagreement between personalities, it reflects an unresolved question about which institution has primacy over this asset class. Until that question is answered, neither the market nor regulators can plan with any confidence. A formal inter-agency framework, with clearly delineated responsibilities between the RBI, SEBI, and the Ministry of Finance, is a prerequisite for any coherent regulatory architecture. India has the demographic scale, the technical talent, and the growing regulatory infrastructure to become a serious player in the global digital asset economy. What is missing is the political will to move from managing uncertainty to governing it.