Status of Cryptocurrencies in India

Traditionally ‘money’ has always been defined in terms of the 3 functions or services that it provides namely: a medium of exchange, a unit of account, and a store of value. But in course of time, a fourth function namely that of being a final discharge of debt or standard of deferred payment was also added. This fourth function is acquired by money through the conferment of the legal tender status by a Government/central authority.

The concept of Virtual Currency (VCs) covers a wider array of “currencies,” ranging from simple IOUs (I owe you) of issuers (such as Internet or mobile coupons and airline miles), to VCs backed by assets such as gold, and ‘cryptocurrencies’ such as Bitcoin.

As digital representations of value, VCs fall within the broader category of digital currencies. However, they differ from other digital currencies, such as e-money, which is a digital payment mechanism for (and denominated in) fiat currency. VCs, on the other hand, are not denominated in fiat currency and have their own unit of account.

Reserve Bank of India (RBI) had issued a ‘Statement on Developmental and Regulatory Policies’ on April 5, 2018, which directed the entities regulated by RBI to not deal with or provide services to any individual or business entities dealing with or settling virtual currencies and to exit the relationship, if they already have one, with such individuals/business entities, dealing with or settling virtual currencies.  

Virtual currency is a digitally tradable form of value, which can be used as a medium of exchange, or a stored value which can be utilised later.  It does not have the status of a legal tender.  A legal tender is guaranteed by the central government and all parties are legally bound to accept it as a mode of payment.

Cryptocurrency is a specific type of virtual currency, which is decentralised and protected by cryptographic encryption techniques. Bitcoin, Ethereum, Ripple are a few notable examples of cryptocurrencies.  Decentralisation implies that there is no central authority where records of transactions are maintained.  Instead, anyone can create a transaction.  This transaction data is recorded and shared across multiple distributor networks, through independent computers.

Following the statement made by the RBI, they also issued a circular in exercise of the powers conferred by Section 35 A read with Section 36(1)(a) and Section 56 of the Banking Regulation Act, 1949 and Section 45JA and 45L of the Reserve Bank of India Act, 1934 (RBI Act, 1934) and Section 10(2) read with Section 18 of the Payment and Settlement Systems Act, 2007, directing the entities regulated by RBI:

• To not deal in virtual currencies nor to provide services for facilitating any person or entity in dealing with or settling virtual currencies and
• To exit the relationship with such persons or entities, if they were already providing such services to them.

The statement and circular circulated by the RBI was challenged before the Supreme Court of India to not restrict or restrain banks and financial institutions regulated by RBI from providing access to the banking services, to those engaged in transactions in crypto assets. The petitioner in the case were online and digital service industries running online crypto assets exchange platforms, the shareholders/founders of these companies and a few individual crypto assets traders.

During the budget announcement of 2018, it was specified that the government will do everything to discontinue the use of bitcoin and other virtual currencies in India, but will focus on the distributed ledger system or blockchain technology that allows organisations to record and authenticate transactions without the need of intermediaries.

The validity of the circular was challenged before the Supreme Court in various writ petitions lead by crypto-trading entities. In its decision in Internet and Mobile Association of India v. Reserve Bank of India, the Supreme Court deliberated on cryptocurrency and struck down the circular.

The Supreme Court analyzed the role of RBI in the economy as a central bank to manage currency, money supply and interest rates and recognized that the maintenance of price stability as an objective of RBI. The Supreme Court noted that cryptocurrency is capable of being accepted as valid payment for purchase of goods and services, and payment systems can be regulated by the RBI.

It was discussed that RBI has very wide powers not only in view of the statutory scheme of the  enactments mentioned above, but also in view of the special place and role that it has in the economy of the country. These powers can be exercised both in the form of preventive as well as curative measures. But the availability of power is different from the manner and extent to which it can be exercised. 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, the Supreme Court held that the order by the RBI was not proportionate with the power it possesses.

The Cryptocurrency and Regulation of Official Digital Currency Bill moves to create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India. The draft Bill bans all cryptocurrencies based on the risks associated with them such as potential use for money-laundering, risks to consumers and threat to the country’s financial stability. However, cryptocurrencies also have potential benefits such as better record keeping and more efficient cross border payments.  Several countries are trying to mitigate some of these risks through regulations.

Currently, only the entities regulated by the central bank are prohibited from dealing in, or providing services for dealing in virtual currencies.  The draft Bill prohibits any form of mining (creating cryptocurrency), issuing, buying, holding, selling or dealing in cryptocurrency in the country.  Further, it provides that cryptocurrency should not be used as legal tender or currency in India.  The Bill allows for the use of technology or processes underlying cryptocurrency for the purpose of experiment, research or teaching.

The Bill also provides for offences and punishments for the contravention of its provisions.  For instance, it states that mining, holding, selling, issuing or using cryptocurrency is punishable with a fine, or imprisonment up to 10 years, or both.  For individuals who might be in possession of cryptocurrencies, the Bill provides for a transition period of 90 days from the commencement of the Act, during which a person may dispose of any cryptocurrency in their possession, as per the notified rules.

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 majorly concerned about the use of VCs by terrorist organisations. The report of the ‘Inter-Disciplinary Committee’ was submitted and it contained certain recommendations which were as follows:

A very visible and clear warning should be issued through public media informing the general public that the Government does not consider crypto-currencies 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.

• 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.
• Those who have bought these currencies in good faith and are holding these should be advised to offload these in any jurisdiction where it is not illegal to do so.
• 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.
• If the Government agrees with the above recommendations, a committee should be constituted with members from DEA, RBI, SEBI, DoR, DoLA, Consumer Affairs, and MeitY, to suggest whether any further actions, including legislative changes, are required to make possession, trade and use of crypto-currencies expressly illegal and punishable.

On a global level, regulatory responses to cryptocurrency have ranged from a complete clamp down in some jurisdictions to a comparatively ‘light touch regulatory approach’. Where countries are prohibiting virtual currency products and services, they should take into account among other things, the impact a prohibition would have on local and global level of money laundering/terrorism financing risks, including whether prohibition would drive such payment activities underground, where they will operate without Anti Money Laundering (AML) and Combating the Financing of Terrorism (CFT) controls.