8 June 2021
"I do think Bitcoin is the first [encrypted money] that has the potential to do something like change the world" – Peter Thiel, Co-founder of PayPal
Cryptocurrency is relatively a new concept as it was first introduced in 2008 in the form of bitcoins which eventually took over a year to proceed with. Bitcoins were used for the first time in 2010. Within the Indian market cryptocurrency saw a rise from the year 2017. In the recent past, it has continued to grow and thus resulted in the appreciation of the value of different cryptocurrencies despite the fear associated with it. The fear that prevails in regards to cryptocurrency includes becoming the victim of crimes associated with financing terrorism, hacking, money laundering and others. Due to such crimes the fear associated with cryptocurrencies remains high and thus no clear, accurate or precise stance with regard to cryptocurrency has been taken within the Indian market.
What is Cryptocurrency
Cryptocurrency is a virtual or digital currency that is protected by cryptography hence making it almost impossible to counterfeit. Cryptography is a form of technology used for protecting information by using codes so as to be only understood by the person who is intended to receive it. In other terms we may define cryptocurrency as a type of digital currency that is used for the purpose of trading. It is similar to normal paper currency however it is not in tangible form. Cryptocurrency is of various types such as Bitcoins, Litecoins, Namecoins and Swiftcoins.
Legality of Cryptocurrency in India and its stages of development
Cryptocurrency in India has over the recent few years gained a lot of strength. The virtual currencies market has been booming as the investors continue to invest. Although as some continue to invest there are many who are abstaining from doing so due to the misconception that investing in cryptocurrency is illegal in India. This confusion strings from the fact that the entire cryptocurrency market stands currently unregulated within India. Cryptocurrency is not illegal and hence investors are allowed to buy, sell and trade in cryptocurrencies. Although it is legal the market is still not regulated by any authority however the Government of India is moving in the direction of establishing a proper regulation so that the investors can invest within a regulated and safe environment.
We have in this article briefly set out the legal position of cryptocurrency in India:
Reserve Bank of India ("RBI") Press Release: The RBI in the month of December of 2013 issued a press release specifying certain risks that could be faced by the users of virtual currencies. This included the risks associated with Bitcoins, Litecoins and Dogecoins. It basically stated that the world of virtual currencies could expose the investors and traders within the market to grave risks like digital wallets getting hacked and financial terrorism due to the lack of any proper regulatory authority.
RBI Press Release of February 2017 and December 2017: These two press releases were issued in order to reiterate the risks associated with virtual currencies. This press release also clarified that RBI in no way had authorized any entity to dwell in virtual currencies.
Bills Proposed: In the year 2017, the Central Government constituted an inter-ministerial committee (IMC) to look into cryptocurrencies. The IMC recommended two Bills – (a) Crypto-token Regulation Bill, 2018 and (b) Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019. In terms of the Crypto-token Regulation Bill, 2018, the initial approach of the IMC did not lean towards an outright ban and it recommended (i) to prohibit persons dealing with activities related to crypto tokens from falsely posing these products as not being securities or investment schemes or offering investment schemes due to gaps in the existing regulatory framework and (ii) to regulate virtual currency exchanges and brokers where sale and purchase may be permitted. Subsequently, in terms of the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019, the IMC proposed a ban on cryptocurrencies in India and that meant buying, holding, selling, dealing in, issuance, disposal or use of cryptocurrency in the country would be prohibited.
Having said that, both these bills did not come to fruition and instead the birth of the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, took place post the Supreme Court judgment (as discussed below).
RBI Circular Imposing Ban: RBI in April of 2018 issued a circular which dealt with prohibited dealings in virtual currencies. This circular imposed a ban on dealing in virtual currency. It stated that any entity which is regulated by the RBI could not deal in virtual currencies or provide any services relating to virtual currencies, which shall include maintaining accounts, trading, opening accounts for exchanges etc. In addition to which a 3 month period was allowed to those regulated entities which were already providing such services to stop doing so. This circular negatively impacted the entities that were involved in the world of virtual currencies.
Supreme Court Judgement in the case of Internet and Mobile Association of India vs the Reserve Bank of India: This is a landmark judgement issued by the Supreme Court of India which resulted in the ban imposed on virtual currencies by the RBI as illegal and thus unenforceable.
The Supreme Court, in its judgment took two aspects into consideration; (a) Article 19 (1) (g) of the Constitution of India and (b) the doctrine of proportionality.
The Supreme Court in regards to point (a) above was of the opinion that the RBI Circular did violate Article 19 (1) (g) as it hampered people’s right to practice any profession which had been guaranteed by the Constitution of India. This Circular imposed a complete ban on entities regulated by RBI to deal in virtual currencies and thus the entities engaged in such business were left with no recourse as they were not allowed to carry on any activity henceforth.
While considering point (b) above, the Supreme Court after analysing the situation at hand was of the opinion that the RBI could not establish the harm caused by virtual currencies within their banking sector and thus the doctrine of proportionality could not be established and hence the RBI Circular was illegal and unenforceable.
The Apex Court ruled that the RBI Circular violated Article 19 (1) (g) of the Constitution of India as it adversely impacted the business of entities that dealt in virtual currencies and that doctrine of proportionality could not be established between the activity and the measure taken, which in this case is, dealing in virtual currencies and banning any activity associated with virtual currencies, respectively. Since the RBI could not establish the loss that occurred to the banks due to the activity carried out in virtual currencies the doctrine of proportionality could not be established between the activity and the measure taken and thus the RBI Circular was declared as illegal and thus unenforceable.
Notification by the Ministry of Corporate Affairs ("Ministry"): The Ministry issued a Notification on March 24, 2021 wherein Schedule III of the Companies Act, 2013 was amended. The Notification has made it mandatory for companies to disclose within their balance sheets if they have traded in any virtual currencies or cryptocurrencies.
Cryptocurrency and Regulation of Official Digital Currency Bill 2021: The Government is in the process of introducing a new bill titled “Cryptocurrency and Regulation of Official Digital Currency Bill, 2021”(“New Bill”) which is similar in spirit to its previous versions, however, intends to ban private cryptocurrencies in India with certain exceptions to promote the underlying technology and trading of cryptocurrency and provide a framework for creating an official digital currency which will be issued by the RBI. The New Bill is likely to be introduced by the Government in the next Lok Sabha session.
From the above circulars and judgment, it can be understood that the RBI was initially not in favour of virtual currencies / cryptocurrency and prohibited any transaction of any regulated entity in virtual currencies / cryptocurrency, however, the Supreme Court in its landmark judgement stated that such a ban is illegal making it favourable to deal in cryptocurrencies for various entities.
Currently, with the Government proposing to introduce the New Bill, we are witnessing a paradigm shift in the Government’s stand vis-à-vis cryptocurrency in the Indian market. The authorities are opening up to the concept of dealing in cryptocurrency in a regulated environment and the fact that the Ministry has made it mandatory for companies to disclose their trade in virtual currencies and cryptocurrencies is a positive step in that direction. While the objective of introducing a law related to virtual currency / cryptocurrency is to streamline the process of trading and holding in a safer technological environment, however, even with the introduction of state-owned cryptocurrency which shall be regulated by the RBI, the risk factor involved in investment and holding of cryptocurrency shall remain the same.
Need for Regulation
Since there is a boom in the virtual currencies market in the recent past and the fact that it is presently unregulated, this is the appropriate time for a regulation to establish a structured and efficient environment to regulate such activities. For any regulation to be a success it must not only protect the interest of the investors but it must also be able to anticipate and include the prospective risks associated with the market in order to avoid any mishaps from happening.
Some of the reasons for which India is in dire need of a regulation to monitor the activities within the cryptocurrency market are set out below:
Increase in the number of investors within the market: In recent years the number of investors investing in cryptocurrency has been on the rise thus the players within the market have exponentially increased thereby increasing the risk associated within the market which leads us to the need of a regulation.
Technological risks associated: This market completely revolves around the use of technology and thus any minute failure in any form of technology used could result in grave losses.
Possibility of cyber-crime: All transactions that occur within cryptocurrency transactions are all in the virtual world and thus there is a high possibility of cyber-crimes occurring. It is important to have regulations in place to safeguard against the occurrence of such cyber and other crimes.
Possibility of money laundering and financing terrorism: The possibility of occurrence of crimes occurring that can hamper the public interest at large such as financing terrorism cannot be ruled out with virtual currency transactions since they are quick and fairly discreet. This gives rise to the requirement of having a regulation in place which considers all these aspects.
Protecting the rights of investors: Since no regulation exists at present, the investors participating within this market do not have any protection, leaving them in a state of constant risk. Once regulations are prevalent which safeguard their interest then not only will the current investors feel safeguarded but others who have not yet invested will also feel safe to invest. Having said that, the risk factor involved in investment and holding of cryptocurrency shall still exist.
An entrepreneur once stated that "Bitcoins will do to banks what email did to the postal industry". This statement is very apt looking at the increase in the value of bitcoins. We must realise that the field of cryptocurrency is just gaining strength and in the coming years it will gain more and more power and for it to run successfully a proper regulation will have to be in place in order to avail the benefits available via cryptocurrencies like that of quick transfer, security and cost efficiency but these will not be available to the investors unless a proper regulation is in place as the chaos which may occur due to the absence of a regulation being prevalent may lead to grave difficulties.
Cryptocurrency has made a place for itself in many countries throughout the world and the fact that its value is continuing to rise makes it easier for non- accepting countries to slowly and gradually lean in favour of it. In India the Finance Minister Nirmala Sitaraman, stated that India will not be shutting all doors in regards to cryptocurrency. Hence, it may be inferred that the Government may be open to allowing dealings in cryptocurrency if the transactions are carried out in a regulated environment.
Investors who want to invest in cryptocurrency are eagerly waiting for the Government’s next action in relation to virtual currencies. If the Government is able to adopt a flexible yet a well regulated environment for virtual currencies then it could bring forth financial benefits to many as the value of cryptocurrencies continues to rise.
For further information, please contact:
Vasudha Luniya, Senior Associate, Clasis Law
Ankita Mehra, Associate, Clasis Law