The Shadowy Realm of P2P Transactions in India (1/2)

---

P2P Transactions: Comparing Centralized & Decentralized Exchanges

Cryptocurrency users looking to engage in peer-to-peer (P2P) transactions may be drawn to centralized exchanges, but there are some important things to consider before using them. While these transactions may be between two individuals, the exchange acts as a middleman and is involved in facilitating the transaction. This means that the exchange still has control over the transaction and can potentially censor or block it. Additionally, P2P transactions on centralized exchanges often require the use of a third-party escrow service, which adds another layer of complexity and potential security risks.

Decentralized exchanges (or DEXs, such as Uniswap and Sushiswap) take a different approach to P2P transactions. They do not involve a central authority and often have built-in mechanisms for handling escrow and dispute resolution. This can make them a more secure and user-friendly alternative for P2P transactions.

Ultimately, the choice between centralized and decentralized exchanges for P2P transactions comes down to the specific needs and preferences of the user. Both types of exchanges have their own advantages and drawbacks, and it is important for users to carefully consider their options and choose the platform that aligns with their values and goals.

The Fiat to Crypto Gateway 

Both decentralized and centralized exchanges face the challenge of providing a secure and legitimate on-ramp solution for converting fiat currency into cryptocurrency. On centralized exchanges (such as Coinbase, Binance, Zebpay, CoinDCX, Mudrex etc.) users typically need to deposit funds into the exchange’s bank account or use a credit or debit card, but this can be risky due to the potential for hacks and other issues, including regulatory challenges like the one in India. Decentralized exchanges often rely on decentralized finance protocols, such as 0x or the Compound protocol, to facilitate the conversion of fiat currency into cryptocurrency, but this requires users to have a certain level of technical expertise and can be complex to set up and use.

To get their fiat currency onto a decentralized exchange, users typically need to first set up a wallet that is compatible with the blockchain the exchange uses. For example, if the exchange is built on the Ethereum blockchain, the user will need to set up an Ethereum wallet. This usually involves downloading and installing wallet software, such as MetaMask or MyEtherWallet, and in some cases, it may also require users to purchase some of the native cryptocurrency of the blockchain, such as Ether (ETH). To do this, users can either use a centralized exchange to buy ETH with fiat, or they can use a service that allows them to purchase it directly with fiat, such as LocalEthereum.

The Indian Experience: 2018 to Present

Peer-to-peer (P2P) transactions on cryptocurrency exchanges became a popular option in India after the Reserve Bank of India’s (RBI) 2018 circular that prohibited banks and other financial institutions from providing services to businesses dealing in cryptocurrency. Exchanges considered it to be safe and legal way of bypassing the RBI circular since they were using escrow services to hold the funds during the transaction, and holding cryptocurrency itself was not illegal in India (nor is it now, to be frank).

‘P2P’ became a sort of buzzword in Indian crypto circles post 2018. While it did have its critics, both the term and the method continued to gain a sort of de facto legitimacy which extends to this day. And it is not difficult to see why. If banks were prohibited from transacting with centralized exchanges, the main fiat-to-crypto gateway was blocked. If users could not use fiat currency to buy crypto, then exchanges would have to cease operations. In fact, some did make a conscious choice to stay away from P2P precisely because…

Well, we’ll let them say it:

“By using a peer-to-peer model with banking channels, a crypto exchange passes on the counter-party risk to its users. While using your bank account to transact cryptocurrencies is against RBI’s notification, the counter-party risk we are referring to is much greater. We do not want to expose our users to the risks of answering different law enforcement divisions across the country for ending up with an unlawful counter-party in a P2P transaction. Zebpay has invested heavily to ensure legal compliance of its exchange transactions, and a P2P model cannot match the scale and safety of the traditional exchange model that we saw in India until 2018.” (Zebpay, FAQ page, May 2019, emphasis added)

We will return to this scary foreshadowing momentarily after our brief history. The long and short of it is that most exchanges, in the wake of the 2018 circular, continued to use the P2P method of matching buy-sell orders through their platform and escrowing user funds during the transaction. The buyer and seller then completed the transaction using methods such as bank transfers or other payment methods. This allowed users to buy and sell cryptocurrency without needing to use the services of a bank or other financial institution, at least directly.

There’s a Crow in Escrow

Perceptive readers would have noted the value of the last word in the preceding paragraph. As long as fiat currency was involved, banks had to be involved in some way too, right? But they could not do so directly because of the RBI circular.

So now what? 

Enter Tycho Nestoris, the shadowy counter-party Zebpay warned us against.

Tycho is pals with all the major and minor banks in India. He also has a lot of crypto buddies all over, including in the exchanges. One day, he was approached by Grimtounge who wanted to buy 100 crowcoins from Qarl in exchange for 200 INR. But since banks had withheld their services to exchanges, Qarl was unable to transfer INR directly into his crypto wallet. 

Tycho offered to step in and create an escrow account to mediate the transaction. The plan was simple: Grimtongue would send Tycho 110 crowcoins, who would hold it in his crypto wallet until he received 200 INR in his bank account from Qarl. Once this was confirmed, Tycho would send 100 crowcoins to Qarl’s crypto wallet and keep 10 for his shadowy service. 

This went on smoothly for sometime. All that the RBI could see was the INR flow from Qarl to Tycho and then from Tycho to Grim, which they assumed was a legitimate consideration for some good or service. They did not look under the hood because they didn’t need to. The amounts were insignificant and nothing untoward had been reported by any of the parties. 

One day, however, they saw a 15 crore INR transaction from Tris to Tycho. Since Tris was a known fraudster, the RBI suspected something fishy and immediately suspended his bank account. Meanwhile, since Tycho had already received the money, he transferred crowcoins to Qarl’s crypto wallet and the INR consideration to Grimtongue who, as we know, loves selling crowcoins. 

But wait…

Why did Tycho send the crowcoins to Qarl? Was it not Tris who sent him the INR? Was he not the real counter-party in this escrow deal? 

Well, you see, Tycho has a lot of friends. Once Qarl had tested his escrow service he went on and told Tris about it. But Tris had been involved in a lot of murky crypto-dealings of late, so his KYC-AML authentication with the exchange was still pending. He had somehow managed to open a new bank account (possibly under a false name), through which he wanted to buy crowcoins. Qarl offered to be Tris’s crypto custodian. He created another wallet using his own authenticated account and gave Tris the private keys to it. This is the account to which the crowcoins were sent. 

Just for the imaginary record, Grim was a good guy. He had done his KYC and the exchange trusted him. So when he transferred a huge amount of crypto to a wallet belonging to Qarl (also KYCed), they just assumed that it was part of Tycho’s routine P2P stuff. 

A few weeks later, the police nabbed Tris, and through him, Grim and Qarl for money laundering. Tycho, as usual, escaped.

Is P2P through a Centralized Exchange really P2P?

After the 2020 Supreme Court judgment which struck down the RBI circular, the crypto industry entered a sort of shadow ban (which we covered elsewhere). It seems that banks were being unofficially discouraged by RBI to provide services to crypto exchanges. Basically, it was the perfect environment for shadowy characters like Tycho to pop up. 

To be fair to him though, he performed his function to the best of his ability. As someone working alone, it was often difficult for him to KYC his entire clientele. He was simply the crow in the escrow, providing an invisible channel for something that could not become visible. Asking him to do KYC checks would be like ordering quinoa salads in an Amritsari dhaba. It just wouldn’t work.

The real tragedy of the story is, of course, Grim. He thought he was dealing with Qarl when in fact he was dealing with Tris. To put it legally, Tris was the ‘beneficial owner’ of Qarl’s crypto wallet. 

All of this to say that P2P transactions carry a host of legal risks, which we will outline for you in our next post.  

---

P.S: nothing in this post or on our blog amounts to professional advice. It is purely for purposes of instruction and education. Crypto is risky and volatile, please DYOR.

P.P.S: crowcoins are a real thing.