What Are The Consumer Protection Concerns With Crypto-Assets?

The article was published in Medianama on July 8, 2022

Crypto-asset regulation is at the forefront of India’s financial regulator’s minds. On the 6th of June, the Securities and Exchange Board of India (SEBI) in a response to the Parliamentary Standing Committee on Finance expressed clear consumer protection concerns associated with crypto-assets.

This statement follows multiple notices issued by the Reserve Bank of India (RBI) warning consumers of the risks related to crypto-assets, and even a failed attempt to prevent banks from transacting with any individual trading crypto-assets. Yet, in spite of these multiple warnings, and a significant drop in trading volume due to the introduction of a new taxation structure, crypto-assets still have managed to establish themselves as a legitimate financial instrument in the minds of many.

Recent global developments, however, seem to validate the concerns held by both the RBI and SEBI.

The bear market that crypto finds itself in has sent shockwaves throughout the ecosystem, crippling some of the most established tokens in the space. Take, for example, the death spiral of the algorithmic stablecoin Terra USD and its sister token Luna—with Terra USD going from a top-10-traded crypto-token to being practically worthless. The volatility of token prices has had a significant knock-on effect on crypto-related services. Following Terra’s crash, the Centralised Finance Platform (CeFi) Celsius—which provided quasi-banking facilities for crypto holders—also halted all withdrawals. More recently, the crypto-asset hedge fund Three Arrows also filed for bankruptcy following its inability to meet its debt obligations and protect its assets from creditors looking to get their money back.

Underpinning these stories of failing corporations are the very real experiences of investors and consumers—many of whom have lost a significant amount of wealth. This has been a direct result of the messaging around crypto-assets. Crypto-assets have been promoted through popular culture as a means of achieving financial freedom and accruing wealth quickly. It is this narrative that lured numerous regular citizens to invest substantial portions of their income into crypto-asset trading. At the same time, the crypto-asset space is littered with a number of scams and schemes designed to trick unaware consumers. These schemes, primarily taking the form of ‘pump and dump’ schemes, represent a significant issue for investors in the space.

It seems, therefore, that any attempt to ensure consumer protection in the crypto-space must adopt two key strategies:

• First, it must re-orient the narrative from crypto as a simple means of getting wealthy—and ensure that those consumers who invest in crypto do so with full knowledge of the risks associated with crypto-assets
• Second, it must provide consumers with sufficient recourse in cases where they have been subject to fraud.

In this article, we examine the existing regulatory framework around grievance redressal for consumers in India—and whether these safeguards are sufficient to protect consumers trading crypto-assets. We further suggest practical measures that the government can adopt going forward.

What is the Current Consumer Protection Framework Around Crypto-assets?

Safeguards Under the Consumer Protection Act and E-commerce Rules

The increased adoption of e-commerce by consumers in India forced legislators to address the lack of regulation for the protection of consumer interests. This legislative expansion may extend to protecting the interests of investors and consumers trading in crypto-assets.

The groundwork for consumer welfare was laid in the new Consumer Protection Act, 2019 which defined e-commerce as the “buying or selling of goods or services including digital products over digital or electronic network.” It also empowered the Union Government to take measures and issue rules for the protection of consumer rights and interests, and the prevention of unfair trade practices in e-commerce.

Within a year, the Union Government exercised its power to issue operative rules known as the Consumer Protection (E-Commerce) Rules, 2020 (the “Rules”), which amongst other things, sought to prohibit unfair trade practices across all models of e-commerce. The Rules define an e-commerce entity as one which owns, operates or manages a digital or electronic facility or platform (which includes a website as well as mobile applications) for electronic commerce.

The definition of e-commerce is not limited only to physical goods but also includes services as well as digital products. So, one can plausibly assume that it would be applicable to a number of crypto-exchanges, as well as certain entities offering decentralized finance (DeFi)  services. This is because crypto tokens—be it cryptocurrencies like Bitcoin, Ethereum, or Dogecoin—are not considered currency or securities within Indian law, but can be said to be digital products since they are digital goods.

The fact that the digital products being traded on the e-commerce entity originated outside Indian territory would make no difference as far as the applicability of the Rules is concerned. The Rules apply even to e-commerce entities not established in India, but which systematically offer goods or services to consumers in India. The concept of systematically offering goods or services across territorial boundaries appears to have been taken from the E-evidence Directive of the European Union and seeks to target only those entities which intend to do substantial business within India while excluding those who do not focus on the Indian market and have only a minuscule presence here.

Additionally, the Rules impose certain duties and obligations on e-commerce entities, such as:

• The appointment of a nodal officer or a senior designated functionary who is resident in India, to ensure compliance with the provisions of the Consumer Protection Act;
• The prohibition on the adoption of any unfair trading practices, thereby making the most important requirements of consumer protection applicable to e-commerce;
• The establishment of a grievance redressal mechanism and specifying an outer limit of one month for redressal of complaints;
• The prohibition on imposing cancellation charges on the consumer, unless a similar charge is also borne by the e-commerce entity if it cancels the purchase order unilaterally for any reason;
• The prohibition on price manipulation to gain unreasonable profit by imposing an unjustified price on the consumers;
• The prohibition on discrimination between consumers of the same class or an arbitrary classification of consumers that affects their rights; etc.

The Rules also impose certain liabilities on e-commerce entities relating to the tracking of shipments, the accuracy of the information on the goods or services being offered, information and ranking of sellers, tracking complaints, and information regarding payment mechanisms. Most importantly, the Rules explicitly make the grievance redressal mechanism under the Consumer Protection Act, 2019 applicable to e-commerce entities in case they violate any of the requirements under the Rules.

What this means is that at present crypto-exchanges and crypto-service providers clearly fall within the ambit of consumer protection legislation in India. In real terms, this means that consumers can rest assured that in any crypto transaction their rights must be accounted for by the corporation.

With crypto related scams exploding globally following 2021, it is likely that Indian investors will come into contact, or be subject to various scams and schemes in the crypto marketplace. Therefore, it is imperative that consumers and investors the steps they can take in case they fall victim to a scam. Currently, any consumer who is the victim of a fraud or scam in the crypto space would as per the current legal regime, have two primary redressal remedies:

• Lodging a criminal complaint with the police, usually the cyber cell, regarding the fraud. It then becomes the police’s responsibility to investigate the case, trace the perpetrators, and ensure that they are held accountable under relevant legal provisions.
• Lodging a civil complaint before the consumer forum or even the civil courts claiming compensation and damages for the loss caused. In this process, the onus is on the consumer to follow up and prove that they have been defrauded.

Filing a consumer complaint may impose an extra burden on the consumer to prove the fraud—especially if the consumer is unable to get complete and accurate information regarding the transaction. Additionally, in most cases, a consumer complaint is filed when the perpetrator is still accessible and can be located by the consumer. However, in case the perpetrator has absconded, the consumer would have no choice but to lodge a criminal complaint. That said, if the perpetrators have already absconded, it may be difficult even for the police to be of much help considering the anonymity that is built into technology.

Therefore, perhaps the best protection that can be afforded to the consumer is where the regulatory regime is geared towards the prevention of frauds and scams by establishing a licensing and supervisory regime for crypto businesses.

A Practical Guide to Consumer Protection and Crypto-assets

What is apparent is that existing regulations are not sufficient to cover the extent of protection that a crypto-investor would require. Ideally, this gap would be covered by dedicated legislation that looks to cover the range of issues within the crypto-ecosystem. However, in the absence of the (still pending) government crypto bill, we are forced to consider how consumers can currently be protected and made aware of the risks associated with crypto-assets.

On the question of informing customers of the risks associated, we must address one of the primary means through which consumers become aware of crypto-assets: advertising. Currently, crypto-asset advertising follows a code set down by the Advertising Standards Council of India, a self-regulating, non-government body. As such, there is currently no government body that enforces binding advertising standards on crypto and crypto-service providers.

While self-regulation has generally been an acceptable practice in the case of advertising, the advertising of financial products has differed slightly. For example, Schedule VI of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, lays down detailed guidelines associated with the advertising of mutual funds. Crypto-assets can, depending on their form, perform similar functions to currencies, securities, and assets. Moreover, they carry a clear financial risk—as such their advertising should come under the purview of a recognised financial regulator. In the absence of a dedicated crypto bill, an existing regulator—such as SEBI or the RBI—should use their ad-hoc power to bring crypto-assets and their advertising under their purview.

This would allow for the government to not only ensure that advertising guidelines are followed, but to dictate the exact nature of these guidelines. This allows it to issue standards pertaining to disclaimers and prevent crypto service providers from advertising crypto as being easy to understand, having a guaranteed return on investment, or other misleading messages.

Moreover, financial institutions such as the RBI and SEBI may consider increasing efforts to inform consumers of the financial and economic risks associated with crypto-assets by undertaking dedicated public awareness campaigns. Strongly enforced advertising guidelines, coupled with widespread and comprehensive awareness efforts, would allow the average consumer to understand the risks associated with crypto-assets, thereby re-orienting the prevailing narrative around them.

On the question of providing consumers with clear recourse, current financial regulators might consider setting up a joint working group to examine the extent of financial fraud associated with crypto-assets. Such a body can be tasked with providing consumers with clear information related to crypto-asset scams and schemes, how to spot them, and the next steps they must take in case they fall victim to one.

Aman Nair is a policy officer at the Centre for Internet & Society (CIS), India, focusing on fintech, data governance, and digital cooperative research. Vipul Kharbanda is a non-resident fellow at CIS, focusing on the fintech research agenda of the organisation.