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Legality of Virtual Digital Assets in India: Private Key & Seed Phrase Extraction
Introduction
India’s engagement with Virtual Digital Assets has undergone a remarkable transformation. From the Reserve Bank of India’s attempted prohibition in 2018 to the current framework of taxation and anti-money laundering oversight, the regulatory journey reflects the government’s struggle to balance innovation with financial stability concerns. At the core of cryptocurrency ownership lies the concept of private keys and seed phrases—cryptographic elements that determine true control over digital assets. This article examines the evolving legal framework governing VDAs in India, with particular emphasis on the contentious questions surrounding private key custody, extraction, and property rights.
Statutory Definition of Virtual Digital Assets
The Finance Act of 2022 brought Virtual Digital Assets into India’s statutory framework by amending the Income Tax Act of 1961. Section 2(47A) defines VDA as any information, code, number, or token generated through cryptographic means that provides a digital representation of value. [1] This definition encompasses cryptocurrencies, non-fungible tokens, utility tokens, and governance tokens while excluding central bank digital currencies and traditional securities. The breadth of this definition reflects the government’s intention to capture the full spectrum of crypto-assets under regulatory oversight.
The classification carries significant implications. By defining VDAs in taxation legislation rather than through dedicated cryptocurrency regulation, the government acknowledged that Indians may legally hold and trade these assets while subjecting them to stringent tax obligations. This approach differs markedly from China’s outright ban or El Salvador’s adoption of Bitcoin as legal tender, positioning India in a middle ground of cautious recognition.
The Supreme Court’s Landmark Intervention
The watershed moment in Indian cryptocurrency jurisprudence came on March 4, 2020, when the Supreme Court delivered its judgment in Internet and Mobile Association of India v. Reserve Bank of India. [2] The case challenged the RBI’s April 2018 circular that prohibited banks from providing services to individuals or entities dealing in virtual currencies. A three-judge bench comprising Justice Rohinton Fali Nariman, Justice Aniruddha Bose, and Justice V. Ramasubramanian struck down the circular on grounds of proportionality.
The Court’s reasoning centered on the absence of empirical evidence demonstrating harm to regulated entities from cryptocurrency trading. While acknowledging the RBI’s authority to regulate matters affecting the monetary and credit system, the Court held that an outright ban was disproportionate to the stated objectives of consumer protection and financial stability. The judgment referenced the European Union’s July 2018 report, which recommended against total bans, demonstrating that less restrictive regulatory alternatives existed.
Critically, the Supreme Court did not declare cryptocurrencies legal or endorse their use. Rather, it removed an unreasonable restriction on the fundamental right to carry on any occupation under Article 19(1)(g) of the Constitution. This careful distinction preserved the government’s ability to regulate cryptocurrencies through proper legislation while invalidating an administrative action lacking adequate justification. The principle of proportionality established in this case has become foundational for subsequent cryptocurrency-related litigation and regulatory actions.
Current Taxation and Anti-Money Laundering Framework
Following the Supreme Court’s decision, the government adopted a two-pronged approach centered on taxation and anti-money laundering compliance. The Finance Act of 2022 introduced Section 115BBH, imposing a flat thirty percent tax on income from VDA transfers. [3] This provision allows no deductions except acquisition costs, making cryptocurrency transactions significantly less attractive than other investment classes. Additionally, Section 194S mandates a one percent tax deduction at source on payments for VDA transfers, creating transparency in cryptocurrency transactions.
The taxation regime represents implicit recognition of VDA legitimacy. By taxing cryptocurrency income at rates exceeding most asset classes, the government effectively acknowledged that Indians may legally profit from virtual digital assets, even while denying them legal tender status. However, the prohibitive structure, with no provision for loss set-off or carry-forward, has been criticized for potentially driving activity to offshore platforms or unregulated markets.
The second pillar emerged through amendments to the Prevention of Money Laundering Act in March 2023. [4] The Ministry of Finance notified changes bringing Virtual Digital Asset Service Providers under the PMLA framework as reporting entities. This amendment defined VDASPs to include any person engaged in exchange between VDAs and fiat currencies, transfer of VDAs, or safekeeping and administration of VDAs. VDASPs must now register with the Financial Intelligence Unit of India, implement know-your-customer procedures, maintain transaction records for five years, and report suspicious transactions.
The FIU-IND has demonstrated aggressive enforcement of these requirements. In January 2024, show-cause notices were issued to nine major offshore cryptocurrency exchanges, including Binance, KuCoin, and Kraken, for non-compliance. [5] The government subsequently directed internet service providers to block access to non-compliant platforms, effectively cutting off Indian users from unregistered exchanges. This enforcement trajectory demonstrates regulatory resolve while highlighting the government’s intermediary-focused approach—targeting exchanges and wallet providers rather than individual users.
Judicial Recognition of Cryptocurrency as Property
The most significant recent development in Indian cryptocurrency jurisprudence came from the Madras High Court in October 2025. In Rhutikumari v. Zanmai Labs Pvt. Ltd. & Ors., Justice N. Anand Venkatesh delivered a landmark judgment explicitly recognizing cryptocurrency as property under Indian law. [6]
The case involved an investor whose XRP holdings on the WazirX exchange were frozen following a cyberattack in July 2024 that compromised approximately $230 million in Ethereum-based tokens. The investor had purchased 3,532.30 XRP tokens worth approximately ₹1.98 lakh in January 2024, which had appreciated to over ₹9.5 lakh. When WazirX froze all user accounts and proposed socializing losses across all users under a Singapore court-approved restructuring scheme, the investor approached the Madras High Court seeking protection.
Justice Venkatesh conducted an extensive analysis drawing on global jurisprudence, including the High Court of England and Wales’ decision in AA v. Persons Unknown, the New Zealand High Court’s judgment in Ruscoe v. Cryptopia Ltd., and the United States federal court’s ruling in SEC v. Ripple Labs. The Court held that cryptocurrencies, while neither tangible property nor currency, possess all essential characteristics of property. Cryptocurrencies are identifiable, transferable, and controlled exclusively through private keys, satisfying traditional legal tests for property.
The judgment explicitly rejected the exchange’s argument that user assets could be redistributed to cover losses from a cyberattack affecting different tokens. Justice Venkatesh emphasized that the investor’s XRP holdings were maintained in a separate wallet unaffected by the breach. The Court held that virtual digital assets held by exchanges are “meant to be held in trust” with a fiduciary duty owed to asset owners, relying on the Bombay High Court’s earlier decision in Zanmai Labs Private Limited v. Bitcipher Labs LLP. [7]
Significantly, the Madras High Court anchored its analysis in statutory recognition, citing Section 2(47A) of the Income Tax Act’s classification of cryptocurrencies as virtual digital assets. The Court observed that in the Indian legal regime, cryptocurrency is treated as a VDA and not as a speculative transaction, providing statutory foundation for property characterization. The Court also invoked Supreme Court precedents establishing that property encompasses anything capable of ownership, enjoyment, and beneficial possession, even if intangible.
The implications of this judgment extend far beyond the immediate case. By recognizing cryptocurrencies as property held in trust by exchanges, the Court imposed fiduciary duties on custodial service providers to safeguard user assets. This trust relationship, grounded in the unique control mechanism of private keys, establishes that exchanges cannot unilaterally interfere with user holdings or redistribute assets without consent. The decision provides legal foundation for investors to seek judicial protection for VDA holdings, even in cases involving foreign arbitration clauses or offshore corporate structures.
Private Keys and Seed Phrases: The Technology of Control
Understanding the legal implications of private key and seed phrase extraction requires grasping the underlying technology. In blockchain systems, a private key is an extremely long alphanumeric string, typically 256 bits for Bitcoin and Ethereum, that cryptographically proves ownership of assets associated with a specific blockchain address. The private key enables its holder to authorize transactions, effectively transferring control over associated digital assets. Unlike traditional financial accounts with passwords that service providers can reset, blockchain private keys are cryptographically deterministic—whoever possesses the private key has absolute, irreversible control over associated assets.
A seed phrase, introduced through Bitcoin Improvement Proposal 39, consists of a sequence of twelve to twenty-four common words serving as a human-readable backup for an entire hierarchical deterministic wallet. Rather than requiring users to secure multiple complex private keys for different addresses, the seed phrase encodes the master key from which all subsequent private keys can be mathematically derived. However, the seed phrase is functionally equivalent to possessing all private keys simultaneously. Anyone obtaining a user’s seed phrase gains complete and permanent access to all addresses derived from that seed.
The distinction between custodial and non-custodial wallet arrangements hinges entirely on private key possession. In custodial arrangements typical of centralized cryptocurrency exchanges, the service provider generates, stores, and controls private keys on behalf of users. Users interact through traditional authentication, while the exchange maintains actual private keys in secure storage. Conversely, non-custodial wallets place exclusive control of private keys with users, embodying the cryptocurrency community’s ethos of “not your keys, not your coins.”
The legal implications of this technological architecture are substantial. When an exchange holds private keys on behalf of users, it functions as a custodian or trustee with attendant fiduciary duties. The exchange’s control over private keys creates a relationship fundamentally different from that of users who hold their own keys. This distinction becomes critical in insolvency scenarios, where courts must determine whether cryptocurrency held by an exchange constitutes exchange property or trust property belonging to users—precisely the question addressed by the Madras High Court in the WazirX case.
Legal Issues Surrounding Private Key Extraction
The question of when private keys or seed phrases may be legally extracted or compelled raises fundamental tensions between property rights, privacy, and law enforcement interests. In law enforcement investigations, authorities may seek to seize digital assets or compel disclosure of private keys when cryptocurrencies have been used in criminal activity. Unlike traditional financial assets held in bank accounts, which can be frozen through court orders directed to financial institutions, self-custodied cryptocurrencies can only be accessed with the private key held by the suspect.
The Prevention of Money Laundering Act provides authorities with broad powers to provisionally attach property, freeze accounts, and seize records. However, the Act predates cryptocurrency proliferation, and its provisions do not explicitly address digital asset seizure requiring private key disclosure. The question of whether authorities may compel seed phrase disclosure implicates constitutional protections against self-incrimination under Article 20(3) of the Constitution, which prohibits compelling accused persons to be witnesses against themselves.
The Supreme Court has held that self-incrimination protection extends to testimonial compulsion but not to production of material evidence or physical samples. In the cryptographic key context, if the seed phrase exists as a written or electronically stored record, authorities may have grounds to seize it as material evidence. However, if the seed phrase exists only in the suspect’s memory, compelling its disclosure may constitute prohibited testimonial compulsion. The Information Technology Act of 2000 provides another potential framework through Section 69, authorizing government agencies to intercept, monitor, or decrypt information, though this primarily addresses communications interception rather than compelling cryptographic key disclosure.
The absence of specific statutory guidance on compelling seed phrase disclosure creates legal uncertainty. While investigating agencies possess legitimate interests in accessing cryptocurrency assets linked to criminal activity, the absence of clear legislative authority raises questions about the legality of coercive measures to extract private keys. Courts will likely need to balance law enforcement interests against constitutional protections and property rights, applying proportionality principles similar to those articulated in the Internet and Mobile Association case.
International Cooperation and Cross-Border Challenges
The borderless nature of cryptocurrency creates particular challenges for Indian regulators and courts. Private keys can be stored anywhere globally, and blockchain networks operate across multiple jurisdictions simultaneously. India has actively participated in global standard-setting efforts for cryptocurrency regulation. At the 2023 G20 Summit held in New Delhi, India advocated for coordinated international regulatory approaches and recommended adoption of the Financial Stability Board’s synthesis paper on crypto-asset regulation. [8] The government has emphasized that unilateral regulatory actions risk driving cryptocurrency activity to more permissive jurisdictions, creating regulatory arbitrage undermining domestic policy objectives.
The Financial Action Task Force has issued guidance on virtual assets and virtual asset service providers, requiring jurisdictions to regulate VASPs for anti-money laundering and counter-terrorism financing purposes. India’s implementation of FATF recommendations through PMLA amendments reflects this international framework. However, enforcement remains challenging when users access unregistered exchanges through virtual private networks or conduct peer-to-peer transactions without intermediaries. The decentralized nature of blockchain technology enables individuals to transact directly using non-custodial wallets, bypassing registered VASPs entirely and limiting intermediary-focused regulation effectiveness.
The Role of Central Bank Digital Currency
India’s development of the Digital Rupee represents the Reserve Bank of India’s alternative vision for digital payments. Launched in pilot form in December 2022, the Digital Rupee is a direct RBI liability, backed by government faith and credit, designed to provide digital asset benefits while maintaining central bank control and monetary sovereignty. The RBI has been explicit about concerns regarding private cryptocurrencies, particularly their potential to undermine monetary policy effectiveness, facilitate illicit transactions, and create financial stability risks through volatility.
The coexistence of private cryptocurrencies and the Digital Rupee creates an interesting dynamic. The government has not banned private VDAs, instead choosing heavy taxation and stringent anti-money laundering regulation while simultaneously promoting the Digital Rupee as a safer, government-backed alternative. From a legal perspective, the Digital Rupee represents legal tender, while private cryptocurrencies do not. However, the property recognition granted by the Madras High Court suggests that Virtual Digital Assets have legal standing as assets even without legal tender status, enabling owners to assert property rights and seek judicial protection against unlawful interference.
Conclusion
India’s approach to Virtual Digital Asset regulation reflects a pragmatic attempt to address challenges posed by decentralized technologies within existing legal frameworks. Rather than enacting dedicated cryptocurrency legislation, the government has extended taxation and anti-money laundering regimes to cover Virtual Digital Assets, creating a system acknowledging their existence while subjecting them to significant regulatory oversight. Judicial recognition of cryptocurrencies as property, most notably in the Madras High Court’s Rhutikumari judgment, has provided crucial legal clarity regarding ownership rights and fiduciary duties.
The fundamental question of private key and seed phrase control remains at the heart of cryptocurrency’s legal challenges. These cryptographic elements represent more than access credentials—they embody the essence of ownership in blockchain systems. The law’s treatment of private keys will shape cryptocurrency regulation for years to come, as courts balance legitimate law enforcement interests, property rights, constitutional protections, and cryptographic technology’s practical realities. As India moves forward, comprehensive cryptocurrency legislation will eventually emerge, probably incorporating elements from international frameworks while addressing India-specific concerns about financial stability and monetary sovereignty.
References
[1] Income Tax Act, 1961, Section 2(47A). Available at: https://www.incometax.gov.in/
[2] Internet and Mobile Association of India v. Reserve Bank of India, (2020) 10 SCC 274. Available at: https://indiankanoon.org/doc/12397485/
[3] Income Tax Act, 1961, Section 115BBH. Available at: https://www.incometax.gov.in/
[4] Prevention of Money Laundering Act, 2002, as amended March 2023. Available at: https://www.drishtiias.com/daily-updates/daily-news-analysis/regulating-virtual-digital-asset-1
[5] CoinDCX, “Crypto Legal Status in India 2025.” Available at: https://coindcx.com/blog/cryptocurrency/crypto-legal-status-in-india/
[6] Rhutikumari v. Zanmai Labs Pvt. Ltd. & Ors., Madras High Court (October 25, 2025). Available at: https://www.livelaw.in/high-court/madras-high-court/madras-high-court-recognises-cryptocurrency-as-property-says-it-can-be-held-in-trust-307853
[7] Zanmai Labs Private Limited v. Bitcipher Labs LLP, Bombay High Court (October 7, 2025). Available at: https://chambers.com/articles/indias-crypto-crossroads-madras-high-court-declares-cryptocurrency-as-property
[8] Outlook Money, “Virtual Digital Asset: Government Clarifies Plans For VDA Regulation” (December 17, 2024). Available at: https://www.outlookmoney.com/cryptocurrency/virtual-digital-asset-government-clarifies-plans-for-vda-regulation
[9] Global Legal Insights, “Blockchain & Cryptocurrency Laws & Regulations 2026 | India.” Available at: https://www.globallegalinsights.com/practice-areas/blockchain-cryptocurrency-laws-and-regulations/india/
