Onward & Outward Exploring India’s Web3 Startup Exodus

The author is Arnav Mathur, second year student at NALSAR University of Law.

INTRODUCTION

In recent years, India has witnessed a remarkable rise in Web3 startups, driven by their potential to revolutionize industries using blockchain, cryptocurrencies, and decentralized technologies. However, an alarming trend has emerged as many of these startups opt to incorporate abroad, leaving India behind.

This article explores the factors behind this exodus, including the lack of a regulatory framework, high tax liabilities, and the constant threat of internet shutdowns. By delving into these challenges, the article sheds light on the implications of these for India's entrepreneurial landscape and highlights the opportunities for reform.

Examining the experiences of entrepreneurs and the broader impact, the article seeks to ignite a dialogue on the urgent need for supportive ecosystems and regulatory clarity to retain India's position as a hub for Web3 innovation.

WHAT IS WEB3?

Web 1, in its nascent stage, served as a channel for information dissemination. However, this read-only platform posed challenges in terms of usability, limiting its accessibility to only a portion of the population.

In response, Web 2 emerged, commonly known as the social web, which has integrated into our daily lives through internet giants like Google and Facebook. Nevertheless, amidst the convenience brought forth by these technological behemoths, concerns surrounding their competence with data handling have now taken centre stage. Alarming instances of data exploitation, security breaches, and privacy infringements have sparked a need for change.

This environment has given rise to Web 3.0 —a paradigm shift aimed at restoring user control over their online data. At its core, Web3 is a realm of ongoing development revolving around the concept of a decentralized web. It aspires to establish trust in digital interactions by circumventing the involvement of centralized entities such as governments and large corporations. This is realized through implementing blockchain technology, which leverages cryptographic principles, distributed networks, and ledger systems to facilitate decentralized data storage and sharing.

By combining the fundamental tenets of decentralization, user ownership, and enhanced privacy, Web3 endeavours to create a more equitable and inclusive digital ecosystem. Its overarching goal is to empower individuals with greater autonomy, bolster security measures, and active participation in the digital economy.

WEB3 IN INDIA

India's ascent in the Web3 market marks a departure from the domination of developed nations that shaped the landscapes of Web1 and Web2. Remarkably, India harbours 11 per cent of the global Web3 talent pool, securing its position as the third-largest talent reservoir in this sector, trailing only the United States and China. This talent pool is experiencing exponential growth, with a projected surge of 120 per cent in the coming years. Further, India's Web3 ecosystem boasts over 450 startups, which have attracted a substantial investment amounting to $1.3 billion during the past two years. However, approximately 60% of these Web3 startups are registered abroad.

FACTORS FOR THE EXODUS

OVERVIEW

India's most renowned Web2 startups, including Flipkart and Ola, hold a surprising story. They are not registered entities in India; instead, they are registered in Singapore. Unsurprisingly, for the rising stars of the nascent Web3 industry, incorporating in Dubai, Singapore, the British Virgin Islands, and Estonia is a mere question of ‘when’.

To understand the ‘why’, let us picture the push factors: Absence of clear and comprehensive regulations, higher tax considerations, frequent internet shutdowns, bank accounts being frozen, barrages of notices, lack of mentorship, lack of recognition, and the list goes on.

These challenges and conducive pull factors in other jurisdictions are enough for any entrepreneur to relocate from India.

However, since these firms hire primarily from India, why does it matter where they incorporate? The answer to this argument is simple: the capital generated by these startups does not flow into India.

The outflow of capital also undermines India's potential to become a Web3 innovation and entrepreneurship hub. The departure of these startups results in an ultimate brain drain, depriving India of talented individuals and hindering its ability to keep up with global Web3 advancements.

Now, let us delve deeper into these considerations to gain a comprehensive understanding.

REGULATORY FRAMEWORK

Like uncharted territory waiting to be explored, the lack of clear regulations poses a hurdle for entrepreneurs seeking to navigate technologies such as the Metaverse and NFTs. The absence of well-defined regulations casts a shadow of ambiguity and impedes innovation.

One area where this uncertainty looms large is the realm of Virtual Digital Assets (VDAs). The result of the absence of clear guidelines herein is hesitation, reluctance, and a missed opportunity for entrepreneurs to fully unleash their resources and expertise in VDAs. This hinders the development of Web3 solutions emerging from India and dampens the enthusiasm of potential investors and stakeholders who yearn for regulatory clarity. Consequently, the Indian market is witnessing promising startups and top talent seeking greener pastures with regulatory clarity, leaving a void of economic opportunities and intellectual capital.

In stark contrast, jurisdictions like Dubai rise to the occasion, actively fostering an environment of favourability by crafting rules and regulations tailored to attract Web3 entrepreneurs. These jurisdictions position themselves as epicentres for this industry, capitalizing on the potential unleashed by regulatory certainty in India.

The need for a comprehensive legal framework becomes increasingly apparent to overcome these challenges. Just as the Information Technology Act of the 1990s laid the groundwork for governing the vast expanse of the Internet and Web2, proactive legislative and policy frameworks are now vital for effective Web3 regulation. Countries such as the UAE, Switzerland, and Japan lead the way, recognizing the importance of establishing frameworks to navigate the complexities of this emerging technology.

TAXATION

"I don't wait till regulation comes into place for taxing people who are earning profits," the Indian Finance Minister said when asked how a nation can tax something it does not acknowledge is legal.

India's current taxation landscape for the Web3 industry adds an extra layer of uncertainty and burden for entrepreneurs. With the imposition of a blanket 30% tax on virtual digital assets since April 1, 2022, and a 1% TDS per transaction since July 1, 2022, the impact on startups and innovators has been significant. While the intention to generate revenue for the government is understandable, the ramifications of taxation policies extend beyond the financial burden. By taxing activities lacking legal recognition, the perception of a hostile business environment casts a shadow over the potential for Web3 innovation to flourish within the country.

As a result, the consequences reverberate throughout the industry, pushing startups to seek refuge in more favourable jurisdictions. Countries like the UAE, where personal income tax is non-existent, including zero income tax on cryptocurrency gains, have become increasingly irresistible. Similarly, Singapore offers a taxation regime that encompasses NFT trading but spares capital gains from NFTs.

INTERNET SHUTDOWN CAPITAL

Astonishing data compiled by global digital rights group Access Now revealed that India enforced 84 shutdowns in 2022, outstripping Ukraine, a country grappling with a war. This number is not even a comprehensive description as there is no official record of shutdowns by State Governments in India.

These frequent disruptions have detrimental effects on the digital economy in general and Web3 startups specifically, impeding their operations, eroding investor confidence, and hindering global competitiveness. By depriving startups of vital internet access, India risks stifling innovation, limiting economic opportunities, and hampering the growth potential of the Web3 sector.

To foster a thriving Web3 ecosystem, India must address this issue by promoting internet freedom and ensuring uninterrupted access to support the growth of startups and attract investment.

RECOMMENDATIONS

The establishment of a robust regulatory framework is paramount. Such a framework would provide clarity and stability and foster an environment conducive to innovation. Transparency and regular updates on the progress of regulatory frameworks are essential to instill confidence among crypto users and Web3 startups. Timely communication of policy developments will provide much-needed reassurance and nurture faith in the industry. State governments, such as Telangana, have already established Web3 regulatory sandboxes and deployed blockchain technology for improved operations.

India must re-evaluate its taxation policies and consider the broader implications to retain its position as a leading player in the Web3 landscape. Striking a balance between revenue generation and providing a supportive environment for innovation is crucial. By doing so, India can rekindle the allure of startups and control the outflow. The narrative is still being determined, and India has an opportunity to rewrite its story.

Further, collaboration between higher learning institutions and the industry is critical to deepen the talent pool in this domain. Initiatives that provide training and certification in Web3 technologies can help develop a skilled workforce to drive innovation in the sector.

CONCLUSION

In the realm of Web3 startups, India finds itself at a crossroads, where the choice between regulatory stagnation and entrepreneurial liberation will shape its destiny in the digital era.

Therefore, to ensure a thriving Web3 ecosystem in India, it is crucial to establish a robust regulatory framework, strike a balance in taxation policies, ensure uninterrupted internet access, foster collaboration between institutions and industry, and communicate progress transparently.

By embracing these recommendations, India can chart its path onward and inward, becoming a beacon of innovation, retaining talent, and driving the future of Web3 technologies.