Regulating Decentralized Exchanges (DEX): India’s Approach to Crypto Compliance

Introduction

Decentralized exchanges (DEXs) have emerged as a transformative force in the cryptocurrency ecosystem. Unlike traditional centralized exchanges, DEX platforms enable users to trade digital assets directly with each other via blockchain smart contracts, without an intermediary institution holding custody of funds. By design, this decentralized crypto exchange model prioritizes user autonomy and privacy – traders retain control of their private keys and transact pseudonymously.

As a result, DEXs exemplify the core crypto ethos of disintermediation. How decentralized exchange works can be understood through its peer-to-peer mechanics: users connect their crypto wallets to a DEX application, and trades are executed by automated programs (smart contracts) that match orders or utilize liquidity pools, with all transactions recorded on a public blockchain.

This innovation brings significant benefits – reduced reliance on centralized entities, greater access to global liquidity, and often lower fees. However, it also poses new challenges for regulators. By eliminating the traditional “middleman,” DEXs make it harder to enforce compliance with laws on customer identification, anti-money laundering (AML), and financial oversight.

Regulators worldwide are grappling with how to ensure crypto compliance in a world of decentralized finance. India is a prime example: the country has witnessed a crypto boom even as authorities impose strict rules on cryptocurrency trading. Indian policymakers face a delicate task – fostering innovation in blockchain and DeFi – while ensuring exchanges (centralized or decentralized) adhere to legal norms on consumer protection, taxation, and illicit finance controls.

Understanding Decentralized Exchanges (DEX)

How Decentralized Exchanges Work

A DEX is essentially a set of smart contracts on a blockchain (like Ethereum) that facilitate trades between users. Participants connect via a web or mobile interface (e.g. a DEX app) using their crypto wallets. There is no central order book or custody – instead, trades occur either through atomic swaps or via liquidity pools in an Automated Market Maker (AMM) system.

For example, on an AMM-based DEX like Uniswap, users called “liquidity providers” deposit token pairs into a pool, and the smart contract uses an algorithm (such as the constant product formula) to price assets. Traders can swap tokens against the liquidity pool; the smart contract automatically executes the swap and updates the pool reserves.

The entire process is trustless and self-executing – transactions are recorded on the blockchain and settled without any intermediary. Because users never relinquish control of their private keys to a third party, the risk of exchange custody hacks or mismanagement is minimized. This structure empowers peer-to-peer trading and often results in faster, permissionless transactions across borders.

Centralized vs Decentralized Cryptocurrency Exchange: The table below highlights key differences between a traditional Centralized Exchange (CEX) and a Decentralized Crypto Exchange (DEX):

Aspect	Centralized Exchange (CEX)	Decentralized Exchange (DEX)
Control & Ownership	Operated by a company or authority that controls the platform.	Operated by smart contracts; no single entity controls the system.
Custody of Funds	Users deposit crypto (or fiat) with the exchange which holds custody (acts as a custodian).	Users retain custody in their own wallets; funds transfer directly peer-to-peer.
KYC/Account Setup	Requires user registration, identity verification (KYC/AML checks) before trading.	No registration or personal KYC by the protocol; users trade directly from wallets (pseudonymous).
Order Matching	Order book model – the exchange matches buy/sell orders using its internal systems.	Peer-to-peer or automated market maker model – smart contracts match orders or use liquidity pools algorithmically on-chain.
Speed & Throughput	High throughput (off-chain matching engines); can handle many trades per second.	Limited by blockchain throughput and consensus speed; trades occur as fast as the network allows (often slower).
Liquidity	Often deep liquidity (many users and market makers); can be concentrated but also at risk of single-point failure.	Liquidity can be fragmented across many pools; relies on users to supply liquidity. No central party to prop up markets.
Transparency	Operations are partly opaque (trade matching and custody are off-chain, internal processes).	Fully transparent – trade rules are encoded in open-source smart contracts; transactions are on public ledger.
Regulation & Compliance	Easier to regulate: the company can implement KYC/AML, follow licensing, and be held accountable by authorities.	Challenging to regulate: no obvious entity to hold liable; anonymity of users complicates KYC/AML enforcement.

Decentralized exchanges, on the other hand, are protocols – they run on blockchain infrastructure and allow users to trade without giving up control of their assets or personal data. This lack of a central authority in DEXs provides greater privacy and control to users but also means “they struggle to identify their customers’ true identities, which regulators often see as unacceptable”. The anonymity and global reach of DEX platforms raise concerns for regulators about money laundering, terror financing, fraud, and evasion of capital controls.

The Regulatory Landscape of Cryptocurrency in India

India’s stance on cryptocurrency has evolved significantly over the past decade, oscillating from early caution to attempts at outright bans, and more recently towards regulation and taxation.

As of 2025, cryptocurrencies are not recognized as legal tender in India, but it is not illegal to buy, sell, or hold crypto assets. This middle-ground approach – neither fully banning nor fully permitting crypto – has resulted in a patchwork of regulations using existing laws (for investor protection and financial stability) while a comprehensive crypto-specific law is still awaited.

Legality and Recognition under Indian Law

Legal Status: The Indian government and the Reserve Bank of India (RBI) have consistently maintained that cryptocurrencies are not legal tender – meaning they are not officially sanctioned as currency to settle debts or payments. In 2017, the Finance Ministry issued statements clarifying that virtual currencies have no sovereign backing and are not coins or notes.

However, holding or trading crypto is not per se illegal. In fact, a 2020 ruling by the Supreme Court of India struck down the RBI’s earlier ban on banks dealing with crypto businesses, affirming that in absence of a law, trading in crypto is a legitimate activity.

The RBI had issued a circular in April 2018 barring regulated financial institutions from providing services to any individual or business dealing in cryptocurrencies, effectively choking exchanges’ access to banking. This prompted a court challenge, and in Internet and Mobile Association of India v. RBI,AIR 2021 Supreme Court 2720, the Supreme Court overturned the RBI ban on grounds of disproportionality.

Post-judgment, RBI formally acknowledged the lifting of the ban in a notification dated May 31, 2021, instructing banks that they cannot quote the quashed 2018 circular as a reason to deny services, and instead should conduct customer due diligence per KYC/AML norms and FEMA rules for crypto transactions.

Thus, since 2020, crypto trading through exchanges is lawful in India, but unregulated in the sense that there was (and still is) no dedicated statute governing crypto assets. The government has prepared draft bills – notably the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which proposed banning private cryptos and creating a CBDC framework – but as of now, no such bill has been passed into law.

India’s approach has therefore been to manage crypto under existing legal frameworks, treating it de facto as a digital asset/commodity subject to taxes and compliance requirements rather than as a currency.

Key Indian Laws Applicable to Crypto (IT Act, PMLA, FEMA, etc.)

In absence of a single “Crypto Act,” various pre-existing laws and regulations have been extended or interpreted to cover cryptocurrency activities. The following are especially pertinent for exchanges and crypto transactions in India:

• Information Technology Act, 2000 (IT Act): The IT Act provides a legal framework for electronic records and intermediaries. While it does not explicitly mention cryptocurrencies, crypto exchanges can be considered “intermediaries” under the Act when they provide a platform for communication or transaction between parties. Section 79 of the IT Act offers safe harbor to intermediaries, provided they follow due diligence guidelines.

In 2022, the Indian Computer Emergency Response Team (CERT-In), acting under Section 70B of the IT Act, issued directions to crypto exchanges, wallet providers, and VPNs to maintain detailed user records and transaction logs for 5 years and report certain cyber incidents within 6 hours.

These rules – aimed at improving cybersecurity and incident reporting – indirectly enforce a level of record-keeping compliance on crypto service providers even though the IT Act doesn’t regulate financial aspects of crypto. The CERT-In directive of April 28, 2022 specifically mandates VASPs (Virtual Asset Service Providers) to collect KYC information and maintain records of financial transactions, complementing the later AML laws under PMLA.

• Prevention of Money Laundering Act, 2002 (PMLA): The PMLA is India’s primary AML/CFT law, and it has become the cornerstone of crypto compliance in recent years. In March 2023, the Government of India issued a pivotal notification (S.O. 1072(E) dated 07/03/2023) bringing certain crypto-related activities into the definition of “designated business or profession” under PMLA. Specifically, the following services involving Virtual Digital Assets (VDA) now make an entity a “reporting entity” under PMLA:

a. Exchange between virtual digital assets and fiat currencies (e.g. crypto exchange offering INR-Bitcoin trades).

b. Exchange between one or more forms of virtual digital assets (crypto-crypto swaps).

c. Transfer of virtual digital assets (moving assets from one address or person to another).

d. Safekeeping or administration of virtual digital assets or instruments enabling control over VDAs (custodial wallets, vault services).

e. Participation in and provision of financial services related to an issuer’s offer and sale of a VDA (this would cover activities around initial coin offerings or token sales).

Under this notification, any person or business carrying out the above for or on behalf of another is classified as a reporting entity for PMLA purposes. In effect, crypto exchanges, brokers, wallet providers, and even DEX platforms facilitating such transactions fall under the purview of PMLA. They must adhere to the same AML requirements as other regulated entities like banks or securities intermediaries.

These compliance obligations under PMLA include: conducting thorough Customer Due Diligence (KYC) to verify user identity (using official ID documents like PAN, Aadhaar, passport, etc.); record-keeping of all transactions and clients; reporting suspicious transactions and cash transactions above prescribed thresholds to FIU-India; and maintaining records of beneficial owners if customers represent entities.

In fact, following the March 2023 amendment, the Financial Intelligence Unit (FIU–IND) issued detailed AML/CFT Guidelines for VDA service providers on 10 March 2023. These guidelines align with FATF standards, including mandating the “Travel Rule” for crypto transfers – i.e. VASP exchanges must obtain, verify, and transmit originator and beneficiary information for VDA transfers above certain thresholds.

There are also enhanced due diligence requirements for transactions involving unhosted wallets (self-custody wallets) to mitigate risks. By extending PMLA to crypto, India has effectively legalized crypto trading under a regulated paradigm, rather than banning it, focusing on disclosure and traceability to combat illicit use.

It’s worth noting that the PMLA notification is broad enough that even individuals using decentralized exchanges or self-hosted wallets are not exempt if their activities involve proceeds of crime. The law applies to any person (natural or legal) who carries out those activities, so even a decentralized exchange operator or a person facilitating trades could be liable if money laundering occurs through the platform. The challenge, of course, is identifying and enforcing this when the service is decentralized – a point we’ll revisit when discussing DEX-specific issues.

• Foreign Exchange Management Act, 1999 (FEMA): FEMA governs cross-border capital flows and currency dealings in India. One question that arose early was whether cryptocurrency is to be treated as “currency” or as some other asset under FEMA. FEMA’s Section 2(h) defines “currency” and Section 2(m) defines “foreign currency,” which refer to currency notes, postal notes, money orders, etc., recognized by the RBI.

Crypto does not fit these definitions – it is neither Indian currency nor foreign currency as per FEMA. This means sending crypto abroad is not a straightforward foreign exchange transaction. Some legal analyses suggest that crypto could be treated as a goods/commodity under FEMA, which would imply that cross-border crypto transfers might be treated as import/export of goods.

In practice, the lack of explicit classification has led to ambiguity. What is clear is that if an Indian resident were to transfer crypto to a non-resident or vice versa, without RBI approval, it might violate Section 3 of FEMA, which restricts dealings in foreign exchange except through authorized persons. Indian authorities have indeed been keeping an eye on this: the Enforcement Directorate (ED) has conducted investigations and raids on crypto exchanges for alleged FEMA violations, especially related to moving funds abroad via crypto without authorization.

For example, ED has probed instances of remittances sent out using Tether (USDT) and other cryptocurrencies by Indian traders, suspecting evasion of the Liberalized Remittance Scheme limits. While no clear-cut FEMA regulations for crypto exist yet, one can infer that using a DEX or any crypto route to circumvent currency controls or facilitate undeclared cross-border transfers is unlawful.

Indian exchanges, to be safe, geofence certain services and discourage direct INR-to-crypto outbound transfers that could conflict with FEMA. This is an area where a future regulatory framework might provide clarity (e.g., classifying crypto as capital assets for FEMA purposes).

• Income Tax Act, 1961 – Crypto Taxation: In 2022, India introduced a rigorous tax regime for cryptocurrencies, which indirectly enforces compliance by requiring tracking of transactions.

The Finance Act, 2022 defined “Virtual Digital Asset (VDA)” in the Income Tax Act and set out two main tax provisions: Section 115BBH imposes a flat 30% tax on any income from the transfer of VDAs (with no offset of losses or deductions allowed except cost of acquisition), and Section 194S requires a 1% Tax Deducted at Source (TDS) on every transfer of a VDA above certain thresholds.

The TDS threshold is ₹50,000 per year for specified persons (such as individuals with business income below a limit) and ₹10,000 for others. In effect, every time someone sells or trades crypto, the exchange or facilitating platform must deduct 1% of the transaction value and remit it to the government, which helps the tax department track the volume of crypto transactions. This move was one of the world’s strictest crypto tax policies and had a notable impact on trading volumes on Indian exchanges in 2022–23.

From a compliance perspective, both centralized and decentralized exchanges triggering taxable events are affected – however, enforcing TDS on a decentralized exchange is problematic since there’s no intermediary to deduct the tax. Nonetheless, any Indian exchange or platform with legal presence in India must implement these tax deductions. Failure to do so could attract penalties under the Income Tax Act.

• Goods and Services Tax (GST): Although not explicitly mentioned in the user prompt, it’s worth noting that the government has also considered the applicability of GST to crypto transactions. The ambiguity is whether crypto trading is a supply of goods or services.

As of now, 18% GST is generally applied on the commissions or fees charged by exchanges (since providing a trading service is considered under GST). There have been discussions about whether the crypto asset itself should incur GST (as “intangible goods”), but no concrete rule yet. Indian exchanges currently pay GST on their platform fees to remain compliant.

• RBI Act and Securities Laws: Cryptocurrencies currently do not neatly fall under “securities” as defined by the Securities Contracts (Regulation) Act, 1956, nor under commodities regulated by any specific regulator (though one could argue some tokens might qualify as securities or derivatives). SEBI (Securities and Exchange Board of India) has so far taken a backseat, given no official classification of crypto as a security.

However, SEBI has been involved in investor education, warning about crypto risks. The RBI, apart from its stance on not recognizing crypto as currency, has expressed concern that widespread crypto adoption could undermine monetary policy and financial stability. This has influenced the strict measures (like the 30% tax, which was partly aimed to disincentivize crypto trading without banning it).

Additionally, India’s push towards a Central Bank Digital Currency (CBDC) – the digital rupee pilot – reflects the RBI’s strategy to provide a state-backed digital alternative while cautioning against private crypto. All said, until new legislation comes, crypto exchanges in India operate under the broad oversight of Ministry of Finance (for AML and taxation) and compliance with general laws, rather than a specialized crypto regulatory body.

India’s Approach to Regulating Decentralized Exchanges (DEX)

Decentralized exchanges, by virtue of their design, present a vexing issue for regulators. In India, the laws and rules outlined above technically cover many activities a DEX facilitates – but enforcing those rules on a protocol with no central operator is far from straightforward. Here we analyze how India’s regulatory approach tackles (or struggles with) DEX compliance:

1.      Anti-Money Laundering Compliance on DEXs: With the March 2023 inclusion of VDA activities under PMLA, any business “carrying on” exchange or transfer of crypto is a reporting entity. A purely decentralized exchange protocol (e.g., smart contracts on Ethereum) does not have a traditional business owner – it might be governed by a decentralized community or automated entirely.

Indian authorities have signaled that lack of a central operator does not exempt transactions from scrutiny. If a money laundering offense is committed using crypto (whether via a DEX or not), involved persons can still be prosecuted under PMLA as “abetting” or “assisting” in laundering. However, the practical compliance burden (like doing KYC) falls on entities that interface with users.

• Indian DEX interfaces or operators: If an Indian team develops or runs a front-end for a DEX (even if the smart contracts are decentralized), that team could be deemed a reporting entity. They would then be expected to implement KYC onboarding for users or restrict access to ensure no anonymous misuse – otherwise they face liability.

We have not yet seen public cases of Indian DeFi developers being prosecuted, but the legal possibility exists. Internationally, regulators have taken action in similar situations. India’s enforcement so far has focused on centralized exchanges, but the law is in place to go after DEX-linked entities if needed.

• Users of DEXs: Indian users who trade on DEXs are not immune to law. If a user converts, say, illicit funds through a decentralized exchange, they can be charged with money laundering as the principal offender even if the platform itself cannot be easily shut down.

The government’s stance is essentially that PMLA applies to the activity, regardless of the medium. The March 2023 notification and subsequent guidance emphasize that using “decentralized crypto wallets” is not a shield against the law – any “act or omission” that is part of a money laundering process falls under PMLA, even if done by an individual through a DEX.

As part of compliance, India’s regulators might require intermediaries like Internet Service Providers (ISPs) or app stores to take down access to non-compliant DEX platforms if they become prevalent channels for illicit transfers. In extreme scenarios, websites of popular DEXs could be blocked in India (similar to how certain online betting or torrent sites are blocked) to enforce AML rules, though users could still access via VPN or Tor.

This kind of measure has precedents (for example, some countries have blocked Tornado Cash, a DeFi mixer, to enforce sanctions). India has not announced any such blocking as of now, but the option exists if DEX usage explodes in a way that undermines AML efforts.

Another compliance approach is self-regulation by the DeFi community: Indian exchanges and startups are exploring solutions like decentralized identity (DID) and on-chain KYC attestations, where users can retain anonymity but prove they have been verified by a credible authority. Such innovations might allow DEXs to integrate compliance checks without centralizing control. While not mandated by law yet, it’s a space to watch as regulators globally, including in India, push for “same activity, same risk, same regulation” even in DeFi.

2. Taxation and Reporting Challenges: Centralized exchanges in India have implemented the 1% TDS on crypto trades – which regulators use to get data on transactions. Decentralized exchanges do not have a built-in mechanism to deduct TDS.

This means from the tax authority’s view, DEX trades are often not reported unless the individual voluntarily discloses them. This is an obvious gap in enforcement. The income tax law places the obligation of TDS on the “payer” or “exchange” facilitating the transfer.

In a DEX, there’s arguably no centralized “exchange” performing that function. The government could, in theory, hold a known DEX operator (if identifiable) liable for not implementing Section 194S. Or, more practically, it relies on the fact that all crypto transactions, even on DEXs, are traceable on public ledgers.

The tax department could use blockchain analytics to identify large traders and then enforce tax collection. Indeed, India has been investing in blockchain forensic capabilities and has reportedly requested data from exchanges about off-chain transfers to self-custody wallets.

From a compliance perspective, those Indian traders who believed using a DEX or overseas wallet would avoid the tax net are at risk of non-compliance penalties. The government’s open stand is that tax applies irrespective of the platform, so crypto gains via DEX trades are taxable just like any other capital gain.

The difference is just the difficulty in tracking. Going forward, if India introduces a licensing regime for crypto service providers, they may require even decentralized protocol operators to integrate tax deduction features or provide transaction data to the government.

3. Consumer Protection and Technical Risks: While not a direct “compliance” issue, regulators (including India’s) are concerned about consumer risks on DEXs – scams, loss of funds (e.g., if a user sends funds to a wrong contract), smart contract bugs, etc.

A centralized exchange in India can be approached by authorities to, say, reimburse users or freeze assets in case of a hack or fraud. With DEXs, there is no such recourse – code is law. Indian law (such as the IT Act’s provisions on intermediaries) does not provide an easy way to assign liability if a smart contract fails or is exploited.

For now, India has addressed this by educating the public (through RBI and SEBI warnings that crypto investing is at one’s own risk) and by refusing to underwrite any losses.

If a major incident occurred on a DeFi platform affecting Indian users, they would likely have to resort to general laws (e.g., file a police case for cheating if it was a rug pull scam, though enforcement across borders is tough). This is an acknowledged gap – proper legal protection and standards for crypto products are lacking, which the proposed but delayed crypto bill was expected to tackle.

4. Licensing and Registration: India does not yet have a formal licensing regime specifically for cryptocurrency exchanges or DEX platforms. However, effectively, registration with FIU-IND and compliance with PMLA has become a de facto requirement for exchanges to operate without enforcement actions. In 2023, several prominent exchanges (including foreign ones serving Indian customers) registered and even paid penalties to get in line with FIU directives.

5. Enforcement Outlook: India’s enforcement so far has focused on fiat on/off ramps (the easiest choke point). ED and income tax authorities have targeted exchanges like WazirX, CoinSwitch and others for various compliance issues (from AML lapses to FEMA violations). As long as DEX usage in India remains a fraction of the crypto market, enforcement is likely to keep targeting the bigger, centralized players who facilitate entry and exit from crypto.

However, India is fully aware of global trends. The government’s official statements, including during its G20 Presidency in 2023, emphasize that crypto assets are borderless and require international collaboration to regulate.

This includes DeFi and DEX activities, which can easily cross jurisdictions. We may see India supporting global efforts (through FATF, G20, BIS, etc.) to craft frameworks for DeFi oversight. Domestically, law enforcement may increasingly leverage technology (blockchain analytics tools) to trace illicit flows through DEXs. If a DEX becomes a hotspot for laundering or terrorism financing, we can expect a strong reaction – possibly invoking the Unlawful Activities (Prevention) Act (UAPA), 1967 or IT Act provisions to shut down access, and prosecuting individuals involved.

International Perspectives: US, EU, and Singapore Regulatory Approaches

To put India’s crypto compliance approach in context, it’s useful to compare it with other major jurisdictions. We look at how the United States, the European Union, and Singapore are regulating cryptocurrency exchanges (including DEXs), as these regions often set benchmarks for global norms.

United States

The United States does not have a single unified crypto law; instead, multiple regulators assert jurisdiction based on the nature of the crypto activity (securities, commodities, currency, etc.). For exchanges and DEXs, key U.S. regulatory aspects include:

• AML Regulation (FinCEN): The U.S. Financial Crimes Enforcement Network (FinCEN) treats cryptocurrency exchanges as Money Services Businesses (MSBs) under Bank Secrecy Act (BSA) rules. Any person or entity “accepting and transmitting” value (including crypto) is generally a money transmitter and must register with FinCEN, implement an AML program, conduct KYC, and report transactions (e.g. Suspicious Activity Reports). Notably, in 2019 FinCEN issued guidance clarifying that this applies even to so-called “decentralized” arrangements if there are persons with some measure of control.

For example, the operator of a decentralized trading platform who profits from it or can shut it down may be considered a money transmitter. DEXs that truly have no central operator present a gap – FinCEN cannot register or fine a piece of software. However, developers or anyone who aids in its operation could fall under regulatory scope.

The U.S. Treasury Department in April 2023 released a DeFi Illicit Finance Risk Assessment, acknowledging the misuse of DeFi in money laundering and recommending strengthening AML regulations for the sector. There’s also legislative movement: in July 2023, a group of bipartisan U.S. Senators introduced a bill to require DeFi services to meet the “same AML compliance obligations” as other financial institutions.

This proposed law explicitly aims to close the perceived AML loopholes in DeFi by imposing KYC duties on “anyone controlling a DeFi project” or, if truly nobody controls it, potentially holding all users responsible for compliance – a very controversial approach.

• Securities and Exchange Commission (SEC): The SEC has taken the stance that many crypto tokens may qualify as securities (especially under the Howey test for investment contracts). If a token traded on a DEX is a security, then in theory the DEX could be an unregistered securities exchange.

In 2018, the SEC charged the founder of EtherDelta – a smart contract-based token exchange – for operating an unregistered securities exchange, since the platform facilitated trading of tokens that were deemed securities. This enforcement was notable as EtherDelta was a decentralized platform; it signaled that having a smart contract does not immunize one from securities law if there is a person behind it (in that case, the founder who created and maintained the web interface).

More recently, in 2023, the SEC’s lawsuits against major exchanges (like Coinbase and Binance) implied that even certain DeFi services offered or facilitated by those companies could be within SEC’s purview. The SEC has not directly sued a fully decentralized protocol yet, but it has warned of “regulatory arbitrage” via DeFi. U.S. regulators also watch DEX governance tokens – if holders of a token (like UNI for Uniswap) benefit from the DEX’s operation, the token itself could be seen as a security, bringing the platform under SEC oversight.

• Commodity Futures Trading Commission (CFTC): The CFTC oversees derivatives and commodities trading. Cryptos like Bitcoin and Ether are considered commodities in the U.S. The CFTC has acted against some DeFi protocols offering derivative products without compliance.

In 2021, the CFTC fined the operators of a decentralized trading protocol (bZeroX) for illegally offering leveraged and margined retail commodity transactions; notably, when the protocol attempted to decentralize into a DAO (Ooki DAO), the CFTC still pursued enforcement, even serving the DAO via online forums.

This was highly debated, but it shows the CFTC’s view: if DeFi replicates regulated activities (like futures trading), it will enforce regulations on those behind it. The outcome of the Ooki DAO case (in 2022–23) could set precedents on whether a DAO can be held liable as an unincorporated association in the U.S.

• State Laws (BitLicense etc.): On top of federal law, states like New York require a BitLicense for any virtual currency business serving New York residents, which includes strict AML/KYC, consumer protection, and audit requirements. A decentralized protocol itself wouldn’t apply for a BitLicense, but any entity (even a website or app) providing access in those jurisdictions might inadvertently run afoul if not careful. This patchwork often leads some DeFi platforms to restrict access from certain U.S. states or the U.S. altogether.

European Union (MiCA and AML Regime)

The European Union took a significant step by introducing a comprehensive regulatory framework called MiCA (Markets in Crypto-Assets Regulation). Passed in 2023, MiCA provides a unified approach across EU member states for regulating crypto assets and service providers. Key points relevant to exchanges and DEXs:

• Licensing of Crypto-Asset Service Providers (CASPs): Under MiCA, any business providing crypto asset services (including operating a trading platform, exchanging crypto for fiat or other crypto, custody services, etc.) in the EU will need to be authorized by a national regulator and adhere to prudential, consumer protection, and conduct requirements.

This is similar to how traditional financial services are licensed. For centralized exchanges, this means they must obtain a license (like an e-money or investment firm license under MiCA depending on services) and will be supervised entities. They have to maintain sufficient capital, segregate customer assets, provide disclosure in whitepapers for tokens they list, etc.

• Treatment of Decentralized Services: Notably, MiCA does not explicitly apply to fully decentralized platforms with no identifiable operator. Recital language in MiCA suggests that if no entity is identifiable that provides the service, then the regulations do not apply. In other words, a fully decentralized exchange (operating purely via smart contracts with governance by a distributed community) might escape direct regulation under MiCA. However, the line can be blurry – if there is any legal entity or even a dev team receiving fees, EU regulators may consider them within scope.

According to legal analyses, “only partially decentralised crypto services are subject to MiCA, while fully decentralised services provided without intermediaries are excluded”. The EU intentionally left DeFi out of MiCA’s first iteration, but it is keeping an eye on it. There are ongoing discussions and a planned report on DeFi by 2024-25 to decide if further regulation is needed.

• AML/CFT (Anti-Money Laundering) Rules: Separately from MiCA, the EU has robust AML laws. The 5th Anti-Money Laundering Directive (AMLD5) already brought crypto exchanges and custodians under AML obligations in the EU (requiring KYC, transaction monitoring, etc.).

And more recently, the EU has agreed on a new Transfer of Funds Regulation (TFR) update that will enforce the Travel Rule for crypto transactions (meaning CASPs must include originator/beneficiary information with crypto transfers, similar to wire transfers).

Moreover, the EU is establishing a new Anti-Money Laundering Authority (AMLA) that will oversee crypto compliance among other things. Under these regimes, even if a DEX isn’t licensed under MiCA, if any EU-based entity is involved (like a DAO member in the EU or a front-end), they could be seen as a “obliged entity” for AML. Practically, though, enforcement in the EU will likely target centralized gateways (on/off ramps, fiat exchanges) rather than pure DeFi code.

The EU’s stance can be summarized as fostering innovation but not allowing clear risks: for example, regulators have mused that even if DeFi is not directly regulated by MiCA, authorities won’t hesitate to act if investors are harmed or if DeFi is used to bypass sanctions/AML laws.

• Consumer Protection and Market Integrity: MiCA imposes strict rules on market abuse (like insider trading and market manipulation in crypto assets) and requires whitepapers for token issuances, akin to prospectuses. These provisions largely target centralized issuance and trading. For DeFi, again, it’s a grey area – but if a decentralized exchange were manipulated (say via Oracle manipulation or rug pulls), MiCA itself might not cover it, though general EU cybercrime or fraud laws could.

Singapore

Singapore has positioned itself as a crypto-friendly hub but with strong regulatory oversight. The Monetary Authority of Singapore (MAS) regulates crypto exchanges primarily under the Payment Services Act (PSA), 2019 and related guidelines:

• Licensing as Digital Payment Token (DPT) Service: Under the PSA, any entity providing digital payment token services (essentially dealing in cryptocurrencies) in Singapore must obtain a license (either a Major Payment Institution license or a Standard Payment Institution license, depending on scale).

This covers services like operating a cryptocurrency exchange, transferring crypto, or safeguarding crypto on behalf of customers. Many exchanges (like Crypto.com, DBS’s Digibank exchange, etc.) have received licenses or in-principle approvals.

The licensing entails compliance with AML/CFT requirements, technology risk management, and user protection measures as set by MAS. Singapore, being a FATF member, implemented the Travel Rule as well for crypto transactions above a threshold, effective 2020 for licensed firms.

• AML and KYC: Singapore’s regulations require full KYC for customers of crypto services, transaction monitoring, and reporting of suspicious transactions to the Singapore police’s financial intelligence unit. There have been instances where Singaporean regulators took action against service providers for AML lapses. The city-state has also issued specific guidance on mitigating risks of dealing with anonymity-enhanced cryptocurrencies or mixers.
• Treatment of DEX/DeFi: Singapore has been proactive in studying DeFi. MAS has stated that if a DeFi platform is providing services analogous to regulated activities, it may fall under existing laws.

For example, if a DEX facilitates trading of security tokens, it could be considered an organized market under the Securities and Futures Act (SFA), requiring approval or recognition by MAS. In 2022, MAS launched Project Guardian, a pilot project exploring DeFi protocols in wholesale funding markets under a controlled environment, to understand risks and benefits of DeFi.

This indicates MAS’s approach: engage with the technology, potentially allow it in sandbox settings, but ensure any financial service (even delivered via smart contract) that hits the mainstream is appropriately regulated.

For now, a truly decentralized, autonomous DEX with no Singapore entity likely isn’t directly regulated (similar to the EU stance). But any facilitator or Singapore-based participant could incur obligations. Singaporean regulators have a broad authority to order blockchain analysis, freeze illicit funds, and sanction entities. Singapore’s laws also have extraterritorial reach for AML – meaning if a Singapore citizen ran a DEX that was used for money laundering, MAS could claim jurisdiction.

Alignment with International Standards and the Road Ahead

Given the inherently global nature of cryptocurrencies and DeFi, India recognizes that unilateral regulation has limitations. International cooperation and standard setting are critical for effective oversight.

In 2023, during India’s G20 Presidency, the government made crypto regulation a priority discussion point. The Finance Minister of India called for a coordinated global approach, stating that crypto assets are borderless and require international collaboration to prevent regulatory arbitrage.

This led to support from bodies like the IMF and Financial Stability Board (FSB). The FSB in October 2023 released high-level recommendations for crypto-asset regulation, emphasizing “same activity, same risk, same regulation” and specifically noting that DeFi should not be left outside the scope simply due to its novel structure. India has endorsed these principles, indicating that its domestic approach will be guided by such global norms.

FATF Standards: India is a member of the Financial Action Task Force (FATF) and has largely aligned its AML laws with FATF’s recommendations for Virtual Asset Service Providers. FATF’s guidance (revised as recently as 2021) explicitly addresses DeFi, suggesting that if a DeFi arrangement has a “owner/operator”, that person/entity should be considered a VASP and held accountable for AML purposes.

If truly no person in control, then there is a gap which jurisdictions need to monitor. By bringing VDA activities into PMLA and implementing the Travel Rule, India is following FATF’s playbook. The FIU-IND AML Guidelines for crypto entities in March 2023 even reference unhosted wallet due diligence, reflecting FATF concerns.

This alignment means Indian exchanges won’t find refuge elsewhere by being lax – to operate globally, they anyway need to meet these standards. Likewise, foreign exchanges entering India must meet Indian AML rules which are equivalent to FATF’s global baseline.

Inter-operability and Legal Recognition: One challenge is how India’s laws (like recognizing VDA in tax law, or as property under PMLA) will be treated abroad. For example, if India requests information from a foreign DEX or tries to enforce an order against a protocol based overseas, mutual legal assistance treaties and cooperation will come into play.

Common definitions (like what is a VDA, what constitutes a reporting entity) will help in cross-border enforcement. India’s definition of VDA is broad, encompassing cryptocurrencies, tokens, NFTs, etc., which is in line with how other countries define “virtual assets”.

Conclusion

India’s journey in regulating cryptocurrencies and specifically decentralized exchanges is ongoing. The country has opted for a formal-yet-cautious approach – not embracing crypto as mainstream (no legal tender status, high taxes) but also not banning it outright.

Instead, India is building a compliance architecture around crypto: entities must follow KYC/AML norms, transactions are taxed and reported, and violators face penalties. When it comes to DEXs, India asserts that the same laws apply, though in practice enforcing them is complex. The current approach can be summarized as “Regulate the peripheries and monitor the core” – regulate the fiat gateways, the known operators, and the users as much as possible, and monitor on-chain activity for risks, intervening when necessary.

Understand the legal pitfalls of digital lending with RBI’s new rules. Read more to keep your lending practices safe.