This article is written by Chinmay Lenka, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. Here he discusses “Analysis of the Cryptocurrency Verdict and what it means for India”.
Definition of Cryptocurrency
The idea of Virtual/Cryptocurrency was to start and sustain a commodity/currency ecosystem which was based on a decentralised infrastructure mainly Blockchain technology as opposed to the conventional currency ecosystem present in all the jurisdictions around the world which are controlled and supervised by a infrastructure set up by the respective Central Banks.
Given the complex nature of crypto currency it is hard to come up with a comprehensive definition but one can understand it through this definition given by the FATF (Financial Action Task Force).
FATF has defined Virtual currency as a digital representation of value that can be digitally traded and it can function as a medium of exchange; and/or a unit of account and/or a store of value but does not have a legal tender status.[i]
According to a survey report by the Library of Congress[ii] which conducted a survey on 130 jurisdictions across the globe found out that the treatment and regulation of VCs as legal tender or currency is different in every jurisdiction throughout the globe. The measures adopted by most countries include issuing public warnings to the citizenry about the volatile and unregulated nature of the Cryptocurrencies. According to the survey some countries have chosen to restrict or ban the trade of the Cryptocurrencies, while some countries have developed their own system of cryptocurrency. Before this decision, RBI chose to effectively restrict the trading of Cryptocurrencies inside the country.
Major Types of Cryptocurrencies
There are more than 3000 kinds of cryptocurrencies in existence, all the major cryptocurrencies operate independently without a banking system to act as peer to peer digital payments system by using Distributed Ledger technology (DLT), the most famous and commonly used DLT being the blockchain technology:
- Bitcoin- Bitcoin was the first cryptocurrency to be created by its maker Satoshi Nakamoto, whose real identity is still unknown. It is the world’s leading Cryptocurrency which allows its users to transfer funds without the need of an intermediary like a Bank.
- Altcoins- After the release of Bit-coin and its open source code in 2008, thousands of cryptocurrencies have been created. The major altcoins, according to the market capitalization are Ethereum, Ripple, Bitcoin Cash, Litecoin and ESO.IO.
- Tokens- Tokens do not operate independently, but they have to use the Underlying technology provided by other cryptocurrencies. Data from CoinMarketCap, shows that there are more than 1496 tokens deployed on the blockchain platform of 24 Cryptocurrencies.
Circular issued by RBI regarding Cryptocurrency
After issuing multiple public notices since 2013 regarding the various potential financial, operational, legal, customer protection and security related risks the citizens were exposing themselves to by dealing or investing in Cryptocurrency, RBI released a circular[iii] dated April 06, 2018 which prohibited the dealing or settling of Virtual currencies in the country.
The circular directed the entities regulated by RBI-
- to not deal in VCs(Virtual Currencies) nor to provide any services facilitating any person or entity in trading of the VCs; and
- to exit any such relationships with the persons or entities within the period of three months of date of this circular.
The effect of this circular amounted to an effective ban on the trade and investment of Cryptocurrencies, however holding or exchanging cryptocurrencies was not banned.
Analysing the Judgement of Supreme Court
The Impugned circular was beset by two writ petitions. The first writ petition was filed by Various Cryptocurrency exchanges (Rajdeep Singh & Ors v. Union of India) on April 17, 2018. The second petition was filed by IAMAI (Internet and Mobile Association of India) an organisation operating as a self-regulatory body for OTT Content Providers.
Key Issues and Takeaways from the Judgment
What is the nature of Cryptocurrencies/ Virtual currencies (VCs) and RBI’s role in regulating Cryptocurrencies?
The Apex court settled the long-standing debate over the nature of Cryptocurrencies. While analysing the definitions and treatment of VCs by several jurisdictions and regulators across the globe, the court held that though the cryptocurrency cannot be treated a legal tender but they have the capacity of being treated as currency, and if an intangible asset under certain circumstances has the capacity of being used as currency, then the scheme of Powers allotted to the RBI under the RBI Act, 1934 allows the RBI to deal with it.
Whether Cryptocurrencies form the part of the credit system of the country
It was held by the court that RBI under Section 3 is the sole body for the Management of the currency which includes the power to issue bank notes U/s 22(1) of the RBI Act, 1934 and also plays an important role in the development of Monetary policy for the country and therefore anything that poses a threat or has an impact to the financial system of the country can be regulated or prohibited by RBI, regardless of the activity falling within the credit or payment system. The expression “Management of the currency” appearing in Section 3(1) also includes something which is capable of faking or playing the role of the currency.
Whether RBI had the power to prohibit Cryptocurrencies as res extra commercium and whether the circular was indeed a prohibition on the trading of Crypto or not
The court did not opine that the power of RBI to regulate as given under Section 45JA of the RBI Act does not include the power to regulate and the power to regulate confers a wide meaning and it shall also include the power to prohibit. The court held that although the power to prohibit something as res extra commercium (something which cannot form a part of the commercial activities) is a legislative function and cannot be executed via an executive fiat, the special role of RBI in the country’s economic sphere cannot be ignored and it is well settled that RBI has the power to both frame policy and issue directions for enforcement, and such directions become supplemental to the Act.
Furthermore, the court rejected the view that the effect of the circular was a complete prohibition on use or trading of VCs, the circular only affects the entities controlled by the RBI and directs them to not provide any services facilitating the trade of VCs, this power is given to the RBI under Section 36(1) of the Banking Regulations Act, 1949 which states that RBI can caution or prohibit the banking companies against entering into certain types or classes of transactions. Accordingly the court held that the prohibition only affected those who wish to utilise banking services to trade or convert the Cryptocurrencies and the online platforms who provided such services in lieu of service charges or commission from such services, in fact the peer to peer transactions are still going on.
Can RBI regulate Cryptocurrency exchanges and banks involved in cryptocurrency exchanges as “Payments system” under section 18 of the Payments and Settlement Systems Act, 2007?
The Court opined that since under section 18 of the Act, RBI is empowered to make policies for system providers, system participants, any other person or any other person or any such agency, and the circular is directed at banks who are “System Participants” as defined under Section 2(1)(p), RBI has the power to frame policies and issue directions to banks who are system participants.
Did RBI reach satisfaction while issuing the impugned circular? Was there application of mind by RBI?
The court held that it cannot be held that RBI omitted to take relevant consideration and there is non application of mind while issuing the circular as:
- Since 2013, RBI had been issuing circulars and conducting research on the emerging advantages and disadvantages of Virtual currencies. The issued public circulars pointed out the relevant risks and about the highly volatile nature of cryptocurrencies to any person or entity involved in trade of such VCs. This sequence of actions taken by the RBI from 2013 to 2018 shows that they have been working around this issue for almost five years and cannot be held guilty for non-application of mind.
- Court held that RBI was not required to write a thesis or write a judgement while gaining satisfaction towards issuance of the circular as there has been a series of steps taken by them over the past 5 years.
Whether RBI needed to pass a direction only in relation to anonymous VCs and no other kinds of VCs?
The court identified that VCs can be closed or unidirectional or bidirectional depending on the schemes with which the entities come up and the question whether pseudo anonymous VCs should have been left out of the scope of regulation is for the experts to decide and not this court, hence whether RBI should have adopted different measures for different types of VCs is irrelevant.
Whether the Impugned circular issued by the RBI will have the same significance as an executive decision or a legislation?
The court opined that RBI is a special statutory body which holds a vital role in the economy of the country and it has been assigned certain irreplaceable and unassignable powers which exclude even the central government “It is a creature, created with a mandate to get liberated even from its creator” and hence RBI is a special creature unlike other statutory bodies and in terms of policy decisions made by the RBI, it cannot be held that such policy decisions, presently the Impugned circular shall not require any pre judicial deference and putting the policy decision on a lower scale as to legislative and executive decisions undermines and threatens the scheme of the RBI Act itself.
Does the issuance of the impugned circular pass the proportionality test and Article 19(1)(g) challenge?
In order to evaluate the prohibition under Article 19(1)(g) the court defined two categories of trade of cryptocurrencies i.) the purchase and sale of VCs between individuals or entities and ii.) the business of online exchanges which provide services facilitating buying and selling, the storing or of VCs in wallets and conversion of of VCs into real currency, and the buying of VCs can be categorised as a hobby or a business. The persons engaged in the categories of (hobbyists, traders of VCs and VC exchanges) do not fall in the ambit of Article 19(1)(g) and the persons in these categories are not impacted by the circular. However, the entities falling under the category of running an online exchange/ business shall come under the ambit of Article 19(1)(g) and they suffered a huge blow from the impugned circular. Considering these factors, the courts held that since the number of investors in the Indian crypto market was around 20 lakhs and average daily trade volume was at least Rs. 150 crores at the time of filing the petition, it cannot be held that the actions taken by RBI seeing it as a threat can be held to be violative of Article 19(1)(g).
In order to check the test of proportionality, the court assessed whether there were lesser intrusive measures available and whether RBI had looked into such measures. It was observed by the court that RBI has not reported that the trading of Cryptocurrencies has adversely impacted the way RBI regulated entities function and that the report submitted by the Inter-ministerial Committee in February 2019 had submitted that a complete prohibition of Cryptocurrencies shall be a bit extreme.
It was accordingly held by the court that RBI had imposed the circular disconnecting the lifeline of Cryptocurrency exchanges and trade despite i.) Not finding anything wrong with how these exchanges operate and ii.) the fact that VCs are not banned. Since RBI failed to show that there was any damage faced by its regulated entities, it holds the stand that VCs have not been banned and more importantly since there have been two draft bills for regulation of Cryptocurrencies which do not recommend any such prohibition measures, the court held the impugned measure (circular) to be disproportionate.
The Impugned circular dated 06-04-2018 was set aside by the Supreme Court as it was held to be unconstitutional.
Regulatory approach taken by major Cryptocurrency/Blockchain Friendly Jurisdictions
It is evident that the Government and the Central Bank is not welcoming the Cryptocurrency payments system. However, it is interesting to look at the regulatory approach taken by the World’s major Crypto-friendly countries-
Regulatory approach taken in these Countries/ Regions
Current status/ recognition of Virtual Currency
United States Of America
In 2019 a total number of 21 Bills have been tabled across the USA. 8 of these bills seek to address the issues of funding terrorism and money laundering, evasion of sanctions by the countries using such Digital Currencies.[iv] 5 bills seek to increase and explore the use of blockchain technology. The Blockchain Promotion Act of 2019[v] seeks to explore how government agencies can explore the use of Blockchain. Some States have passed favourable legislations exempting Cryptocurrencies from state securities laws and money transmission statutes.[vi] Wyoming has passed a bill to exempt VCs from property taxation[vii] Colorado has passed a bill to promote blockchain for government record-keeping, Arizona has pledged to become the first state to accept taxes in cryptocurrency, Georgia may do the same. States like California, New York and New-Mexico have issued warnings against investing in Cryptocurrency.[viii]
There is no uniform definition of “Cryptocurrency”, which is often referred to as “Virtual Currency”, “digital assets”, “cryptoassets” and “crypto”. Most Jurisdictions have stuck to using more tech-relevant definitions.[ix]
Accounting for some of the largest Initial Coin offerings, Switzerland’s leading regulatory approach towards cryptocurrency is extremely adoptive and positive. Swiss Financial Market Supervisory Authority (FINMA) guidelines include persons who exchange cryptocurrencies for fiat money and vice versa as well as for a different cryptocurrency on a commercial basis (cryptocurrency exchanges), and to custodian wallet providers in the Anti-Money Laundering legislation.[x] Currently FINMA does not have any guidelines in place for Initial coin offerings since the Federation Council feels that each coin offering is specific and has to be dealt case by case.[xi] Professional Cryptocurrency trading is done, all profits are taxable and cryptocurrencies which are identified as Business assets are identified on the balance sheet.[xii]
Swiss law does not define the term Crypto/ virtual currency. However in a 2014 report[xiii] defined it as “A virtual currency is a digital representation of a value which can be traded on the Internet and although it takes on the role of money – it can be used as means of payment for real goods and services – it is not accepted as legal tender anywhere. (…) Virtual currencies exist only as a digital code and therefore do not have a physical counterpart for example in the form of coins or notes. Given their tradability, virtual currencies should be classified as an asset.”
Since 2017, the Payments Services Act requires Cryptocurrency exchanges to be registered under it, and provides a definition to Cryptocurrency.[xiv] Under the Japanese law, virtual currency is not listed as “securities”. The Bank Of Japan does neither treats Cryptocurrency as “money” nor equates it with fiat currency.[xv]
The Payment Services Act provides a complicated definition of Cryptocurrency. Though the definition is complicated, in short, a cryptocurrency which is usable as a payment method to an unspecified person and not denominated in fiat currencies falls under Virtual Currency. For example, Bitcoin, Litecoin, Dogecoin, Ether and XRP fall under Virtual Currencies.[xvi]
Singapore is a business-friendly, low-tax and technology friendly jurisdiction for Cryptocurrencies. In January 2020, Monetary Authority of Singapore announced that the Payment Services Act, 2019[xvii] brings the Digital Payment Token services- which are all Crypto Businesses under the current Anti- money laundering (AML) and counter terrorist- financing (CFT) rules. The Cryptocurrency businesses will have to register with MAS and after the registration, they will have to apply for a Payments Institution license within 6 months of the registration.[xviii]
The Payments Services Act, 2019[xix], defines Cryptocurrency as “Digital Payments Token”.
Possible Impact of the Judgement on the Cryptocurrency Ecosystem in India
The Judgement has come as a much-needed short term relief to the Crypto-exchanges inside the country as they will continue their operations. The banks and other financial institutions (regulated by RBI) could participate in the trade of Cryptocurrencies and Crypto-assets. However, the judgement has not deliberated on the benefits of the circulation of Cryptocurrency in the economy, neither does the judgement say that RBI does not have the power to regulate these Cryptocurrencies.
The potential market of cryptocurrency in India is undisputedly exponential with immense potential. According to the 2017 study[xx] by PHD Chamber of Commerce and Industry, the combined trading volumes of all crypto-exchanges could be in Rs. 200-250 crore per month and roughly Rs. 1200-1500 crores worth of Bitcoins are traded in India. As reported in the judgement itself, India is estimated to contribute between 2 and 10% of the global asset industry, and the total number of investors in the Indian Crypto Market was approx. 20 Lakhs and the average daily trade volume was at least Rs. 150 crores in 2018.
The banks and other financial institutions will be cautious to engage in the trade of Cryptocurrency as the approach and attitude of RBI and government towards Cryptocurrencies has not been favourable, and there is no guarantee as to whether such similar restrictions as imposed through the quashed circular will not be imposed. India is severely lagging in adopting and promoting the Blockchain technologies and Cryptocurrencies, and the long-term impact of the judgement on the Cryptocurrency market shall depend upon what paths the lawmakers and regulators choose.
[i] https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions -and-potential-aml-cft-risks.pdf
[vi] https://www.acc.com/sites/default/files/resources/vl/membersonly/Article/1489775_1. pdf Pg.479
[vii] https://cointelegraph.com/news/wyoming-unveils-first-ever-crypto-custody-rules-for-bl ockchain-banks
[viii] https://www.acc.com/sites/default/files/resources/vl/membersonly/Article/1489775_1. pdf Pg. 479
[ix] https://www.acc.com/sites/default/files/resources/vl/membersonly/Article/1489775_1. pdf Pg. 480
[xii] https://assets.kpmg/content/dam/kpmg/ch/pdf/ordinance-on-banks-and-savings-ban k s-en.pdf
[xiv] https://www.acc.com/sites/default/files/resources/vl/membersonly/Article/1489775_1. pdf, Pg. 351
[xv] https://www.acc.com/sites/default/files/resources/vl/membersonly/Article/1489775_1. pdf Pg. 351
[xvi] https://www.acc.com/sites/default/files/resources/vl/membersonly/Article/1489775_ 1 .pdf Pg. 351
[xviii] https://www.coindesk.com/singapore-announces-new-aml-rules-for-crypto- business
[xx] https://www.phdcci.in/wp-content/uploads/2018/11/Industry-Perspective- on-B itcoins .pdf
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