MUMBAI (BLOOMBERG) - India's dithering on whether to embrace digital assets is causing thousands of developers, investors and entrepreneurs to leave for places with more friendly regulation, according to the co-founder of the country's most famous crypto start-up.

"The brain drain is absolutely crazy," Mr Sandeep Nailwal, whose Polygon operates the biggest so-called Layer 2 protocol for the Ethereum blockchain system, said in an interview from Dubai.

India, with an estimated 15 million active crypto users, has been stuck in regulatory limbo since the Supreme Court in 2020 overturned a central bank ban on digital tokens. The government this year unveiled a tax on crypto transactions without formally declaring that it would not ban trading, a move that became emblematic of the confusion.

On Tuesday (March 15), Finance Minister Nirmala Sitharaman said the government has yet to make a final call on whether to ban virtual coins or regulate them. At the same time, she acknowledged the industry's potential as a source of tax income. The government imposes a 30 per cent tax on digital coin transactions.

Mr Nailwal, who co-founded Polygon in 2017, relocated to Dubai two years ago. The emirate is aspiring to be a crypto hub for the Middle East - just as it is for traditional financial services - and on Wednesday, it adopted a law for regulating digital assets.

Powerhouse?

Polygon's eponymous protocol is used by developers to make Ethereum transactions cheaper and faster. It has some 7,000 decentralised apps (or dapps), more than 130 million unique users, and handles over three million daily transactions. Last month, Polygon raised US$450 million (S$611.5 million) by selling its Matic token to investors led by Sequoia Capital India.

"I want to live in India and promote the Web3 ecosystem," the 34-year-old said. "But overall, the way the regulatory uncertainty is there and how big Polygon has become it doesn't make sense for us or for any team to expose their protocols to local risks."

On the face of it, India has the potential to be a crypto powerhouse. The population of 1.4 billion people skews young, with a growing, well-educated middle class. That, combined with a less-developed traditional financial system, has led to the world's second-highest crypto adoption rate behind Vietnam, according to blockchain research firm Chainalysis. Overall crypto transactions jumped 641 per cent between July 2020 and June last year, Chainalysis said in an October report.

China, the only country with a larger population, last year declared all cryptocurrency transactions illegal.

Governments around the world have long grappled with the need to tame the worst excesses of an industry beset by speculation, fraud and hacking incidents, while at the same time harnessing its explosive growth and potential for innovation. Countries from Singapore to the United States are now moving toward a more structured approach to regulating the sector.

Investors and entrepreneurs around the world have clamoured for more clarity. Bitcoin surged as much as 11 per cent on Thursday as word got out of an impending executive order from US President Joe Biden to coordinate the government's approach to crypto.

Crypto's foe

Even as Indians embrace digital assets and the government warms to the potential for tax revenue, the industry still faces determined opposition from the central bank. And while it is not uncommon for central banks to express scepticism towards crypto, the Reserve Bank of India's criticism has been particularly withering.

Governor Shaktikanta Das last month compared the asset class unfavourably to the 17th-century Dutch tulip market bubble. A few days later, his deputy said cryptocurrencies are akin to Ponzi schemes, threaten financial stability and should be banned.

Mr Edul Patel, the co-founder of Mudrex, an automated digital asset trading platform backed by Y Combinator, chose to set up his company in the US in 2019 after the central bank cut off crypto-related businesses from India's payment network. The central bank's move was later reversed by the Supreme Court.

Right now, many Indian crypto companies, developers and founders are trying to move to places like Dubai, Mr Patel said in an interview. One selling point for Dubai is its "sandbox approach", something India lacks for crypto, he said. Governments often use so-called sandbox set-ups as a testing ground for promising but unproven financial technologies.

Mr Patel also cited Dubai's proximity to India and open, transparent and friendly taxation regime for creators.

"I've often heard the joke that Dubai is the best city in India," said Mr Nitin Sharma, the Bengaluru-based founding partner of venture capital firm Antler, which plans to invest in Indian start-ups focused on blockchain and Web3 applications. "And once you have well-known founders or start-ups move, it starts to attract many others, creating a community."