In India, over the past few years, the use of technology, including blockchain, to fuel financial transactions has boomed significantly. Such development has not gone unnoticed by most regulators such as the Reserve Bank of India (“RBI”) (Indian Central Bank) which has reacted, for the most part, favourably. Whilst the present government has supported innovation to promote a digital or cashless economy, cryptocurrency still remains an outlier.
The RBI took notice of the use of cryptocurrency in open markets around 2013 and has since responded by cautioning users, holders and traders of the use of “virtual currency” while remaining silent on the legality of its use, including in 2017. Similarly, other regulators, such as the Enforcement Directorate and Income Tax Department, have been swift in their actions to shut down businesses associated with cryptocurrency by conducting raids under the guise that the use of cryptocurrency was in violation of foreign exchange and anti-money laundering regulations.
In light of the above, most entities dealing in cryptocurrency took a backseat in their operations from 2017 onwards, especially after the RBI prohibited cryptocurrency for regulated entities, when global and as well local markets seemed to be moving towards an economy being driven by technology. In fact, while the Indian government remained silent on the definition of “cryptocurrency”, it continued to support “pre-paid” instruments or tokens issued by private players in exchange of products or services being offered on their platform. In fact, regulators have since supported the use of “blockchain”, demonstrated by RBI’s Blockchain whitepapers in 2017 and 2019 deliberating upon the use of blockchain while merely commenting on one such use of cryptocurrency as a medium of exchange to secure transactions.
Pursuant to the previous finance minister’s budget speech in 2018, the government had constituted an inter-disciplinary committee which included representatives from the RBI, to examine: (i) the status of cryptocurrency in India and globally; (ii) the existing global regulatory and legal structures governing cryptocurrency; and (iii) measures to address issues relating to consumer protection and money laundering.
Despite the contents of the above report remaining confidential, per publicly reported news sources, the government is moving towards a wholesale ban on the use of cryptocurrency.
After the RBI circular dated April 6, 2018 (“Circular”), the dealing of cryptocurrency in India today has been substantially blocked. Through the Circular, the regulator banned all RBI regulated entities (i.e., banks, financing institutions, non-banking financing institutions) from dealing in cryptocurrency. These entities were provided a three-month period within which all accounts dealing with cryptocurrency had to be shut down. Consequently, while the RBI per se did not ban cryptocurrency, it chocked any financial dealing contemplated by a buyer, seller or trader in cryptocurrency.
Other regulators, such as the Securities Exchange Control Board of India (“SEBI”) have continued to remain silent on its stance on cryptocurrency.
Several stakeholders have approached the judiciary by filing petitions before the Indian Supreme Court (“SC”) in order to compel the government to provide clarity.
The two primary petitions seeking to address the legality of cryptocurrency were filed by (i) Vijay Pal Dalmia and Siddharth Dalmia through civil writ petition 1071 of 2017 on June 2, 2017 (“Dalmia Petition”), and (ii) Dwaipayan Bhowmick through civil writ petition 1076 of 2017 on November 03, 2017 (“Bhowmick Petition”).
The Dalmia Petition was filed against the Union of India (through the cabinet secretary), Ministry of Home Affairs, Ministry of Finance and the RBI (“Respondents 1”), seeking an order to direct Respondents 1 to “restrain/ban the sale/purchase of or investment in, illegal cryptocurrencies and initiate investigation and prosecution against all parties which indulged in the sale/purchase of cryptocurrency”.
The grounds for the stated petition, as available on public sources, was based on: (i) the anonymous nature of cryptocurrency transactions which makes them well-suited for funding terrorism, corruption, money laundering, tax evasion, etc.; (ii) production and introduction of new cryptocurrency has been generated by private parties, without the intervention of the government, and hence violating the Constitution; (iii) the use of cryptocurrency has been in contravention of several laws such as FEMA and the Prevention of Money Laundering Act, 2002; (iv) ransomware attacks have occurred through the use of Bitcoin; (v) illegal cryptocurrency provides an outlet for personal wealth that is beyond restriction and confiscation; (vi) cryptocurrency exchanges have encouraged “benami” transactions and made it difficult for government authorities to identify such transactions; and (vii) trading of illegal cryptocurrency bypasses prescribed KYC Norms.
Pursuant to the above petition, the Bhowmick Petition was filed against the Union of India through the Ministry of Finance, Ministry of Law and Justice, Ministry of Electronic and Information Technology, SEBI, RBI, Income Tax Dept.
(through its secretary) and the Enforcement Directorate (through its joint director) (“Respondents 2”) seeking an “issuance of direction to regulate the flow of bitcoins as well as requiring the constitution of a committee of experts to consider prohibition/regulation of bitcoins and other cryptocurrencies”.
The grounds for the petition, as available from public sources, inter alia include: (i) Bitcoin trading/transactions, being unregulated, lack accountability; (ii) investigators can only track Bitcoin holders who convert their bitcoins to regular currency; (iii) counterfeiting of cryptocurrency is not an issue so long as the miners keep the blockchain secure; (iv) bitcoins may be used for trade and other financial activities without accountability, having an effect on the market value of other commodities; (v) conversion of Bitcoin into foreign exchange does not fall under the purview of the RBI, making such transactions highly unsafe and vulnerable to cyber attacks; (vi) presently, no regulator has the power to track, monitor and regulate cryptocurrency transfers; (vii) cryptocurrency has the potential to support criminal, anti-social activities, like money laundering, terrorist funding and tax evasion; and (viii) use of cryptocurrency could result in financial implications if left unchecked.
Subsequent to the aforementioned petitions, industry participants such as Kali Digital had filed writ petitions challenging the constitutionality of the Circular and reiterated the need for clarity on regulation. Other stakeholders, such as the Internet and Mobile Association of India had also filed intervention applications in the Bhowmick Petition in order to draw attention to the impact any regulation on cryptocurrency may have to their businesses. It had also challenged the RBI Circular as being unconstitutional and highlighted to the Supreme Court on the hindrance to their businesses in light of the Circular.
While the above matters remain sub judice, the Supreme Court in February, 2019 provided the Indian Government, a period of four weeks, to frame a policy on cryptocurrency, which is still awaited.
There have been recent reports that the Government is looking to introduce a new legislation on cryptocurrency and looking at introducing a jail term for “holding, selling or dealing in cryptocurrency”, making it a “non-bailable” offence. This, if affected, will further impact the future of the cryptocurrency business in India.
Set out below are possible reasons for such a ban and the way forward for the cryptocurrency business in India.
RBI’s primary reason is to protect its investors, since cryptocurrency lacks any intrinsic value and affords anonymity to its holder. Per news reports, the RBI is determined to “ring-fence gullible investors and lenders from scams, several of which have happened internationally”. Given the nature of trades, an imposition of know-your-customer regulations does not per se assist in reducing the threat of fraudulent transactions since it may be difficult to identify the original holder of cryptocurrency.
In fact, an anonymous holder possesses other problems, such as inadequate recourse available in case of illegal activity, since an accused must be an “identifiable party” for the judiciary to call upon and hold accountable for such illegal activity. Therefore, while any currency including fiat currency could facilitate illegal transactions and tax evasion, cryptocurrency could go a step further and protect a party engaging in such activities, rendering common holders vulnerable.
A commonly cited reason for distrust by governments/regulators that is associated with investor protection is the lack of control exerted by central authorities over cryptocurrency. While rendering the banking system redundant may not immediately seem problematic, regulators worry that an investor would have no recourse in the event a payment is hacked or there is a failure of transfer of funds due to a technical glitch. Further, the lack of a banking system would also be alarming for most investors given that the system supports immediate provision of funds as well as income through interest over funds already earned by the investor.
In fact, the anonymous nature and lack of intrinsic value of cryptocurrency are the primary distinguishing factors from “prepaid instruments”, the latter being completely legal and regulated today. Prepaid instruments and payment systems are regulated by the Payments and Settlement Act, 2007 (“PSSA”) and RBI Master Directions on Issuance and Operation of Prepaid Payment Instruments dated October 11, 2017 (“Master Directions”). The intent of the PSSA is to regulate prepaid instruments, i.e., payment systems that affect electronic transfers. The Master Directions define prepaid instruments as “payment instruments that facilitate purchase of goods and services, including financial services, remittance facilities, etc., against the value stored on such instruments”. In fact, the regulations further specify that these instruments may be loaded/reloaded with cash, by debit to a bank account, by credit and debit cards, and other PPIs (as permitted from time to time). The electronic loading/reloading of PPIs shall be through payment instruments issued only by regulated entities in India and shall be in INR only. Based on the above, the instrument is merely acting as a mode to transfer regulated currency, similar to a bank transfer.
Therefore, unlike cryptocurrency, whose value (if any) may be contingent upon its demand/supply, pre-paid instruments do have an intrinsic value associated with them as well as their holder being clearly identifiable.
Given that cryptocurrency is often associated with speculation, one could explore whether the acceptance of certain cryptocurrencies such as tokens could constitute a deposit or a security. The (Indian) Securities Exchange Board, unlike the RBI, continues to remain silent on the subject, possibly since, in India, a security has been defined to include “shares, scrips, stocks, bonds, debentures, debenture stock, or other marketable securities of a like nature in an incorporated company or body corporate”. While, cryptocurrency may be arguably marketable, it is not in the nature of shares, scrips, stocks, debentures, etc.
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issued in relation to a body corporate. However, should the regulator see scope in regulating cryptocurrency and initial coin offerings akin to securities and initial public offerings, similar to other overseas jurisdictions, the definition of a “security” may see revision.
Similarly, debt/deposits in India are associated with the repayment of money. It is arguable that the issuance of cryptocurrency could create a debt on the part of the issuer to the extent that the consideration for the issuance is treated as a debt until cryptocurrency is transferred to the purchaser.
While the aforementioned regulations seem possible, the anonymity of the parties involved in the transaction may continue to pose a hurdle to the regulation of cryptocurrency even as a deposit or security.
While industry participants await the government’s decision on cryptocurrency and details regarding the contours of a possible ban, most stakeholders argue that, like every “banned activity”, the activity does not come to a halt but instead moves to jurisdictions permitting such activity, as the Indian experience also suggests post-2017 after the RBI Circular. On the same basis, stakeholders are still trying to sensitise the Government about the potential of disruptive technologies such as cryptocurrencies, capitalise on the burgeoning revenue potential and work with the industry.
It has previously been reported that the RBI itself looked to launch a digital currency using blockchain technology and, despite its discomfort with cryptocurrency, has promoted the use of blockchain. In light of this, even if the Government were to introduce a wholesale ban on cryptocurrency in India, it is likely to be a regressive step, in turn also affecting the growth and development of the nascent blockchain industry in India, which has shown immense potential. The devil being in the details, it will be useful to wait until the contours of the proposed Indian cryptocurrency law are finalised.