Cryptocurrency and India

What is Cryptocurrency?

Before we go to the legality of and the battles over it between the Reserve Bank of India (RBI) and Indian Judiciary, it is essential to first get an idea of what cryptocurrency is. After a basic search on the internet and watching a few videos trying to explain the concept of cryptocurrency, I have gathered a bit of knowledge about it.

Firstly, what is money? Money represents value. I do some work for you, you give me money in exchange for the value I gave you. I can then use that money to get something of value from someone else in the future. People initially used bars of gold, wheat, salt, etc., as a form of money. But as it became difficult to carry gold around and also as some commodities that represented money were difficult to divide and use, like a live animal, for example, paper money was invented.

A bank or government would offer to take possession of your bar of gold, say about 1000 Rupees and would give you bills amounting to 1000. And if you wanted your gold back, you simply took 1000 Rupees in bills back to the bank to redeem them for the actual form of money, in this case, that gold bar, whenever you needed. And so, the paper began its use as money. However, over time, this bond between bills and gold was broken and eventually, the governments told their people that the government itself would be liable for the value of that paper money. So people continued to trade with paper backed by the government’s promise.

Even though there is no actual commodity backing paper money, people trusted the government and that’s how fiat money was created. Fiat is a Latin word that means “by decree”. Meaning, the dollars and rupees or any currency have value because the government orders it to. This is what is “legal tender”. Coins or banknotes must be accepted if offered as payment. So the value of today’s money actually comes from a legal status given to it by a central authority, in this case, the government.

What caused the invention of cryptocurrency? Fiat money has certain drawbacks. It is centralised and it is not limited by quantity. You have a central authority that controls and issues it. In this case the government or Reserve Bank. The government or central bank can print as much as they want. This causes issues like inflation.

Once fiat money was in place, then came digital money. The authorities around the world moved to make money digital and for the authorities to keep track of who owns what. Today, we majorly use credit cards, wire transfers, and other forms of digital money. The amount of physical money in the world is almost negligible and is getting smaller with each year that passes.

But this led to the problem of “double spend”. Double-spending is the risk that a digital currency can be spent twice. A holder could make a copy of the digital token and send it to a merchant or another party while retaining the original. The solution to this today is for it to be centralised. The banks keep a ledger on their computer which keeps track of who owns what. We trust the bank and the bank trusts its computer.

But when an authority has so much power, it then leads to problems like corruption, mismanagement and the risk that at any point in time the government can decide to freeze your account and deny you access to your funds. Even in the case of hard cash, the government can cancel the legal status of your currency as was done in India a few years back. There was a need to combat these issues and therefore, the invention of cryptocurrency.

In October 2008, a document was published online by someone called Satoshi Nakamoto. The document suggested a way of creating a system for a decentralised currency called Bitcoin. Bitcoin is a form of cryptocurrency. This system claimed to create digital money that solves the double-spend problem without the need for a central authority. At its core Bitcoin is a transparent ledger without a central authority. 

A bank’s ledger is not transparent and it is stored on the bank’s main computer. You can’t sneak a peek into the bank’s ledger, and only the bank has complete control over it. Bitcoin, on the other hand, is a transparent ledger. At any point in time, one can see all of the transactions that are taking place. The only thing you can’t figure out is who owns these balances and who is behind each transaction.

Interesting fact - a developer named Laszlo Hanyecz, on May 22, 2010, published a post back in 2010 asking for someone to sell him 2 pizzas in exchange for 10,000 Bitcoins. Someone did. And now the price of these two Pizzas is worth well over 100 million dollars.

But where does cryptocurrency gets its value? Let’s take Bitcoin as an example of cryptocurrency. Bitcoin is a commodity and the market sets the price of it based on supply and demand. Just like oil or any other commodity. If you have a particular market for Bitcoin where there is a huge supply of Bitcoin and not much demand for Bitcoin, the price will be low and vice versa. One would have to ascertain the price of Bitcoin from the exchange one uses.

A major advantage of cryptocurrency is that it is decentralized. There’s no one computer that holds the ledger. But, every computer that participates in the system keeps a copy of the ledger, also known as the Blockchain. Blockchains, which are organizational methods for ensuring the integrity of transactional data, is an essential component of many cryptocurrencies.

At the same time, cryptocurrencies face criticism for a number of reasons, including their use for illegal activities, exchange rate volatility, and vulnerabilities of the infrastructure underlying them. However, they also have been praised for their portability, divisibility, inflation resistance, and transparency. Many experts believe that blockchain and related technology will disrupt many industries, including finance and law. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.

This is the best I could do when I tried to explain what cryptocurrency is. To learn more about cryptocurrency, there is plenty information available on the internet by various Cypherpunk (This is a term that I learnt when I was reading Hon’ble Justice V Ramasubramanian’s order dated March 04, 2020, lifting the ban on the trading of cryptocurrencies) one can access. The article below is for those who have understood cryptocurrency and are enthusiastic about learning its legal status in India.

RBI and cryptocurrency

The “Statement on Developmental and Regulatory Policies” dated April 05, 2018, issued by RBI stated that,

“13. Ring-fencing regulated entities from virtual currencies. 

Technological innovations, including those underlying virtual currencies, have the potential to improve the efficiency and inclusiveness of the financial system. However, Virtual Currencies (VCs), also variously referred to as cryptocurrencies and crypto assets, raise concerns of consumer protection, market integrity and money laundering, among others.

Reserve Bank has repeatedly cautioned users, holders and traders of virtual currencies, including Bitcoins, regarding various risks associated in dealing with such virtual currencies. In view of the associated risks, it has been decided that, with immediate effect, entities regulated by RBI shall not deal with or provide services to any individual or business entities dealing with or settling VCs. Regulated entities which already provide such services shall exit the relationship within a specified time. A circular in this regard is being issued separately.” On April 06, 2018, the RBI issued a circular, prohibiting the dealing of Virtual Currencies. The circular stated that, 

“In view of the associated risks, it has been decided that, with immediate effect, entities regulated by the Reserve Bank shall not deal in VCs or provide services for facilitating any person or entity in dealing with or settling VCs. Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer/receipt of money in accounts relating to purchase/ sale of VCs.

3. Regulated entities which already provide such services shall exit the relationship within three months from the date of this circular. 

4. These instructions are issued in exercise of powers conferred by section 35A read with section 36(1)(a) of Banking Regulation Act, 1949, section 35A read with section 36(1)(a) and section 56 of the Banking Regulation Act, 1949, section 45JA and 45L of the Reserve Bank of India Act, 1934 and Section 10(2) read with Section 18 of Payment and Settlement Systems Act, 2007.”

Supreme Court’s Verdict

Hon’ble Justice V Ramasubramanian, vide his judgment dated March 04, 2020, held,

“…While we have recognized elsewhere in this order, the power of RBI to take pre-emptive action, we are testing in this part of the order the proportionality of such measure, for the determination of which RBI needs to show at least some semblance of any damage suffered by its regulated entities. But there is none. When the consistent stand of RBI is that they have not banned VCs and when the Government of India is unable to take a call despite several committees coming up with several proposals including two draft bills, both of which advocated exactly opposite positions, it is not possible for us to hold that the impugned measure is proportionate.

7.1. Therefore, in the light of the above discussion, the petitioners are entitled to succeed and the impugned Circular dated 06-04-2018 is liable to be set aside on the ground of proportionality. Accordingly, the writ petitions are allowed and the Circular dated 06- 04-2018 is set aside.”

Though, essentially the Hon’ble Supreme Court made trading of cryptocurrency legal, what, I think, makes the order so much more worthy of reading is the discussion on the background of cryptocurrency. Hon’ble Justice V Ramasubramanian, in a rather elaborate and an interesting read of judgment has spoken enough about the subject matter that would appeal to the prospective dealer of cryptocurrency, to help familiarise the evolution of cryptocurrency and help make informed decisions about dealing with the same. Given below are just some extracts of the order where the apex court has discussed the pros and cons of cryptocurrency and views from all around the world.

Background

In June 2013, vide its Financial Stability Report, RBI took note of technology risks in changing business environment. The Report stated that “Globally, the use of online and mobile technologies is driving the proliferation of virtual banks, virtual currencies (Box 3.4) and provision of banking and payment services by unlicensed entities. While leveraging on technology has resulted in many benefits, especially, in extending the reach of the financial services, these developments pose challenges in the form of regulatory, legal and operational risks.” The report defined virtual currency as “A virtual currency can be defined as a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community”.

The order of the Supreme Court further discusses the Financial Action Task Force (FATF), an inter-governmental organization founded in 1989 on the initiative of G-7. A report titled “Virtual Currencies – Key Definitions and Potential AML/CFT Risks” issued by them in June 2014 defined Virtual Currency as a digital representation of value that can be traded digitally and functioning as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but not having a legal tender status. The FATF submitted a report in October 2015 on “Emerging Terrorist Financing Risks”. The report took note of different methods of terrorist financing, such as self-funding, crowdfunding, social network fundraising with prepaid cards etc. Coming to virtual currencies, the report noted the following:

“Virtual currencies such as bitcoin, while representing a great opportunity for financial innovation, have attracted the attention of various criminal groups, and may pose a risk for TF (terrorist financing). This technology allows for anonymous transfer of funds internationally. While the original purchase of the currency may be visible (e.g., through the banking system), all following transfers of the virtual currency are difficult to detect. The US Secret Service has observed that criminals are looking for and finding virtual currencies that offer: anonymity for both users and transactions; the ability to move illicit proceeds from one country to another quickly; low volatility, which results in lower exchange risk; widespread adoption in the criminal underground; and reliability. 

Law enforcement agencies are also concerned about the use of virtual currencies (VC) by terrorist organisations. They have seen the use of websites affiliated with terrorist organisations to promote the collection of bitcoin donations.”

The order dated March 04, 2020, also mentioned The Bank of International Settlements (“BIS”) which is a body corporate established under the laws of Switzerland, way back in the year 1930 pursuant to an agreement signed at Hague on 22-01-1930. It is owned by 60 Central Banks of different countries including RBI, has several committees, one of which is “Committee on Payments and Market Infrastructure” (CPMI). This committee started taking note of digital currencies while dealing with innovations in retail payments. This committee formed a sub-group within the CPMI Working Group on Retail Payments, to undertake an analysis of digital currencies.

On the basis of the findings of the subgroup, CPMI of BIS submitted a report in November 2015 on Digital currencies. The sub-group identified three key aspects relating to the development of digital currencies one of which was that the assets featured in digital currency schemes, typically have some monetary characteristics such as being used as a means of payment but are not backed by any authority. Though the report stated that the impact of digital currencies on the mainstream financial system is negligible as at that time, some of the implications indicated in the report may actually materialize if there was the widespread adoption of digital currencies. Two risks were noted in the report and they were consumer protection and operational risks.

The Supreme Court’s order further added that the Government of India, Ministry of Finance, constituted, in April 2017, an Inter-Disciplinary Committee comprising of the Special Secretary (Economic Affairs) and representatives of the Departments of Economic Affairs, Financial Services, Revenue, Home Affairs, Electronics and Information Technology, RBI, NITI Aayog, and State Bank of India. The task of the Committee was to (i) take stock of the status of VCs in India and globally, (ii) examine the existing global regulatory and legal structures and (iii) suggest measures for dealing with VCs. The report of the Inter-Disciplinary Committee was submitted on 25-07-2017 and it contained certain recommendations such as:

(i) A very visible and clear warning should be issued through public media informing the general public that the Government does not consider cryptocurrencies such as bitcoins as either coins or currencies. These are neither a legally valid medium of exchange nor a desirable way to store value. The Government also does not consider it desirable for people to use or invest in something which has no real underlying asset value.

(ii) A very visible and clear warning should be issued, through public media, advising all those who have been offering to buy or sell these currencies or offering a platform to exchange these currencies, to stop this forthwith.

(iii) All consumer protection and enforcement agencies should be advised to take action against all those who, despite these warnings, indulge in buying/selling or offering platform for trading of these currencies, since the presumption would be that it is being done with illegal, fraudulent or tax-evading intent.…etc.

Also, the Central Board of Direct Taxes (CBDT), by an Office Memorandum dated 05-03-2018, submitted to the Department of Economic Affairs, a draft scheme proposing a ban on cryptocurrencies. But the draft scheme advocated a step-by-step approach, as many persons had already invested in cryptocurrencies. The scheme also contained advice to carry out legislative amendments before banning them.

And, a communique issued by G-20, after the meeting of its Finance Ministers and Central Bank Governors on March 19-20, 2018 also acknowledged that technological innovation including that underlying crypto-assets has the potential to improve the efficiency and inclusiveness of the financial system and the economy more broadly. But it also noted that crypto-assets do raise issues with respect to consumer and investor protection, market integrity, tax evasion, money laundering and terrorist financing. Though crypto assets lacked the key attributes of sovereign currencies, they could, at some point, have financial stability implications. Therefore, the communique resolved to implement FATF standards and to call on international standard-setting bodies to continue their monitoring of crypto-assets and their risks.

On April 02, 2018, RBI sent an e-mail to the Government, enclosing a note on regulating crypto-assets. It was with reference to the record of discussions of the last meeting of the Inter-Ministerial Committee on virtual currency. This note examined the pros and cons of banning and regulating cryptocurrencies and suggested that it had to be done, backed by suitable legal provisions. Immediately thereafter, the Statement dated April 05, 2018, and the Circular dated April 06, 2018, came to be issued by RBI. Around the same time, the Inter-Ministerial Committee submitted its initial report, (or a precursor to the report) along with a draft bill known as Crypto Token and Crypto Asset (Banning, Control and Regulation) Bill, 2018.

While the fate of 2018 Bill is not known, a fresh bill called ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’ has been submitted. 

The Annual Report of RBI for the year 2017- 2018, also discussed the cryptocurrency and it said,

“The cryptocurrency eco-system may affect the existing payment and settlement system which could, in turn, influence the transmission of monetary policy. Furthermore, being stored in digital/electronic media – electronic wallets – it is prone to hacking and operational risks, a few instances of which have already been observed globally. There is no established framework for recourse to customer problems/disputes resolution as payments by cryptocurrencies take place on a peer-to-peer basis without an authorised central agency which regulates such payments. There exists a high possibility of its usage for illicit activities, including tax avoidance…”

“At a global level, regulatory responses to cryptocurrency have ranged from a complete clamp down in some jurisdictions to a comparatively ‘light-touch regulatory approach’. The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have emerged as the primary regulators of cryptocurrencies in the United States, where these assets like most other jurisdictions, do not enjoy the legal tender status. Asian countries have experienced an oversized concentration of crypto players – Japan and South Korea account for the biggest shares of crypto-asset markets in the world. In the case of Bitcoins, half of the transactions worldwide are carried out in Japan. In September 2017, Japan approved transactions by its exchanges in cryptocurrencies. China’s exchanges hosted disproportionately large volumes of global Bitcoin trading until their ban recently.

Having discussed the above among several other contributing facts from all around the world on the subject matter that are essential for these particular writs and after looking at various contentions regarding the Role of RBI, its powers as dictated by statutes in the country, and recognizing the power of RBI to issue the impugned Circular, the Supreme Court finally ruled by setting aside the Circular dated April 06, 2018, on the grounds of proportionality and thereby making it legal to trade in cryptocurrencies.

The Future

As of today, it does not get said enough that, cryptocurrency has several advantages. Cryptocurrency is decentralized. There’s no one computer that holds the ledger. But, every computer that participates in the system keeps a copy of the ledger, also known as the Blockchain. If one desires to take down the system, he would have to take down thousands of computers which hold such ledger and are constantly being updated therein.

It is a form of money that no government or bank can control. It gives you complete control over your money. You alone can access your funds. No government or bank can decide to freeze your account or confiscate your holdings. It also cuts a lot of the middlemen from the process of transferring money. This means that in many cases it is cheaper to use than traditional wire transfers or money orders. Cryptocurrency opens up digital commerce to people around the world who don’t have access to the current banking system. Today, with a mobile phone they can start trading using cryptocurrencies. Today there are several merchants online and offline that accept Bitcoin. You can book a flight or a hotel with Bitcoin if you like. There are even Bitcoin debit cards.

However, the road toward acceptance by the majority of the public is a long one. As regards the future of cryptocurrency in India, it is pertinent to note that the RBI might still approach the Supreme Court seeking to file a review petition challenging the above verdict. Apart from that, the Indian government has still not reached finality on its stand regarding cryptocurrency. The “Banning of Cryptocurrency and Regulation of Official Digital Currency Bill 2019” has been submitted and it was drafted by an Inter-Ministerial Committee, set up by the Union on India headed by former Finance Secretary Subhash Chandra Garg. The committee was tasked with studying all aspects of cryptocurrency and providing recommendations for the country’s crypto policy. Though the status of the Bill currently is unknown, it is important to note the report of the Inter-Ministerial Committee dated February 28, 2019, not only recommended a ban but also specifically endorsed the stand taken by RBI to eliminate the interface of institutions regulated by RBI from cryptocurrencies.

The use of cryptocurrency has always been a point of contention with its legality being a mystery to the public. The lack of a traditional government or bank-backed system to regulate its use makes cryptocurrencies the target of several concerns such as it being a conduit for black money or anonymously funding terrorism. However, it cannot be denied that cryptocurrencies have gained popularity worldwide and the cryptocurrency market in India has also been slowly gathering momentum. Cryptocurrencies have gathered support from a huge number of population and futurists have expressed their support tremendously. However, the other half of the population has also been against it citing reasons that it could promote illegal activities.

Though companies in India have now launched crypto-trading solutions, in the absence of definitive regulation on the nature of the cryptocurrency market, it is unlikely that financial institutions and the banking sector would be inclined towards investing in virtual currencies. Having said that, it is also a point of debate within the country whether a country like India cannot regulate these currencies like other countries by amending existing taxation laws, the Foreign Exchange Management Act (FEMA) 2016 etc. or by appointing an authority like SEBI or RBI, for the regulation of such cryptocurrency. Even the Supreme Court observed that the circular disconnected the banking sector from cryptocurrency exchanges despite the RBI not having found anything wrong with the functioning of these exchanges. It was also noted that before issuing the circular, the RBI did not explore the availability of alternative and less intrusive measures such as regulating cryptocurrency trading and cryptocurrency exchanges.

Finally, though the Supreme Court has set aside the circular, it only seems to be a sort of temporary relief and the future of cryptocurrency lies in the hands of the legislature as we await the outcome of the bills being drafted and submitted in the Lok Sabha year after year. And until then, it is only for us, as consumers, to weigh the pros and cons related to the evolution of cryptocurrency and take into account everything around the world that has been shaping the future of cryptocurrency before we venture into this realm.