Overview
India’s Income Tax Department has raised serious concerns about major crypto exchanges allegedly deploying user-deposited funds for their own lending, staking, and trading activities—without sharing profits or securing user consent. These practices, known as “rehypothecation” and commingling of funds, are prompting alarm within regulatory circles.

Key Findings:

• Client Assets Used Without Consent
  Exchanges reportedly utilize customer-deposited tokens as collateral or capital for their own operations—such as lending or staking—without informing users or offering them a share of the yielding profits. Under current terms, users typically retain only the ability to sell their tokens.
• Thin Regulatory Safeguards
  While such arrangements may be disclosed in user agreements, they are widely viewed as risky. These practices expose clients to the kind of financial fallout seen in the collapse of global outfits like FTX, where diverted customer funds led to catastrophic losses.
• Tax Compliance and Enforcement Gaps
  The Income Tax Department uncovered token deployment practices while investigating widespread tax evasion by crypto traders—particularly around arbitrage using Tether (USDT)—but noted that enforcement tools are limited due to the absence of explicit legal prohibitions on fund misuses by crypto exchanges.

Market Implications:

1. Erosion of Consumer Trust

Clients stand to lose faith as exchanges deploy their assets without transparency or accountability. The lack of profit-sharing raises questions about equitable treatment and fair use of depositor funds.

2. Calls for Regulatory Reform

These revelations are fueling demands for comprehensive oversight—such as separation of user funds, mandated profit-sharing mechanisms, and audits—to protect investors and promote greater transparency.

3. Tax Authority Vigilance

The tax department’s findings add urgency to the broader push for crypto regulation in India, highlighting the need for clearer rules around Virtual Digital Assets (VDAs) and tighter exchange accountability.

Context: India’s Crypto Tax and Compliance Landscape

Since April 2022, India imposes a flat 30% tax on gains from VDAs and enforces a 1% TDS (Tax Deducted at Source) on all crypto transactions, with no allowance for loss offsets or deductions except the cost of acquisition. Enforcement measures such as widespread notices and compliance drives have already pressured many retail and institutional investors.

Despite this, the lack of a tailored regulatory framework governing exchanges’ use of customer deposits leaves a gap that enforcement agencies currently cannot fill.

Summary

India’s Income Tax Department has uncovered that several crypto exchanges may be using customer-deposited tokens for corporate activities like trading, staking, and lending—without informing users or sharing profits, and with inadequate regulatory oversight. These findings intersect with ongoing tax-compliance challenges and elevate the call for clearer regulations to ensure safety, transparency, and consumer protection in the Indian crypto market.