Emergence of Cryptocurrency in Indiaash@min
From the ‘Cryptocurrency and Regulation of Official Digital Currency Bill, 2021’ to be tabled in the Parliament and the proposed Reserve Bank of India backed ‘Digital Currency’ plans, to the massive popularity of Non-Fungible Tokens (NFTs)- cryptocurrency seems to be the new buzzword in our country.
Know the Terms:
Blockchain is simply a chain of blocks with each block encrypted with information about transactions in a cryptographic form. This ledger is immutable and decentralized i.e. it is not owned by any one person or an entity. Blockchain is thus, the underlying base of cryptocurrency but was further developed beyond that.
Let’s now briefly understand Cryptocurrency. It would be difficult to say if it can be boxed and defined as a payment system, a commodity, security or negotiable instrument. It is however a subset of Virtual Currency (VC) that are digitally traded through “(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 advent of Virtual Currencies rests on its creation for a specific community-example gaming industry. Riot points in League of Legends are earned either after clearing levels in the game or exchanging points for fiat currency but are useful only in the League of Legend and its allied universe.
Crypto thus, is a decentralized virtual currency i.e. its units, though not considered a legal tender are created and handled without any overseer/owner.
The easiest way to obtain cryptocurrency is through fiat money, exchange platforms or through an advanced tech involving a complex process of ‘mining’. They can also be issued as tokens through Initial Coin Offerings (ICO) which can be oversimplified as a comparison to an IPO in a stock market.
There are thousands of cryptocurrencies in the market now, most popular being Bitcoin, Ethereum, Binance Coin, etc. What has led to the immense growth and interest in blockchain backed technology, is chiefly the increased transparency that transactions through this medium provide.
Tracing the History: Timeline in India
In early 2008, the world heard of Bitcoins for the first time, through an anonymously published paper by one or more developer(s) using the name Satoshi Nakamoto (presumed pseudonymous), titled Bitcoin: A Peer to Peer Electronic Cash System. They also mined the foremost block referred to as the ‘genesis block’ and 2 years later the first actual sale took place using 10,000 Bitcoins for buying two pizzas. It didn’t take long for Indian crypto-exchanges such as Unocoin, Coinsecure, PocketBits etc. to come up in the industry and RBI swiftly followed with a Press Release in Dec 2013 cautioning users, traders of virtual currencies (VC) due to lack of regulatory framework in India and its security related risks. The demonetization-led digitalization further saw a surge of new users with renewed interest which led to two more RBI Press Releases in 2017 reiterating the earlier raised concerns followed by a statement by the Ministry of Finance comparing virtual currencies to Ponzi schemes.
In the same year two PILs were filed in the Supreme Court, regarding the question of legality and regulation of cryptocurrency in India; currently pending judgement.
A High Power Inter-Disciplinary Committee constituted in Nov 2017 submitted a detailed report essentially accepting the advantages of Distributed Ledger Technologies like blockchain particularly for cross border payments, by banks/financial firms, SEBI, etc. yet recommending the ban of private cryptocurrency except which may be issued by the government. The reasons recorded in this report have been immensely criticized for the lack of data-backed assertions in the same.
The Indian government and RBI continued on their stance cautioning the public but without an enforceable legal directive. A committee formed by RBI in 2018 mentioned that instead of an extreme measure like ban, regulatory mechanisms would be more effective. But in a complete one-eight, , RBI circular dated 6 April, 2018 prohibited its regulated entities (commercial and co-operative banks, Payments banks, small finance banks, NBFCs, and Payment System Providers) in not only dealing in virtual currencies but also prohibiting services to all entities which deal with the same. Thus, all cryptocurrency platforms, which relied on banking channels, could no longer use them and could not sustain themselves. A number of exchanges through the Internet and Mobile Association of India filed a Writ Petition in the Supreme Court later that year. The Court held that (i) a virtual currency is not a legal tender in India but has potential of creating a parallel monetary system hence definitely falls within the jurisdiction of the RBI; (ii) non-access to banking services is a violation of petitioners’ fundamental rights under Article 19(1) (g) of the Constitution. The Court contended that the measure did not fulfil the test of proportionality as RBI could not prove any semblance of damage suffered by its regulated entity for the strict ban. It also referred to the EU Parliament report on Cryptocurrencies and Blockchain in July 2018 stating that “if a legislator does not want to outright ban these cryptocurrencies, a good argument to support is that cash is also fully anonymous and lawful – the only way to find out who uses them is to require users to register mandatorily” and both the RBI and Government have been unable to take a call despite several committees and studies. While the case did not determine the legality of cryptocurrency/virtual currencies, it served as a temporary respite to restart the functioning of crypto-exchanges.
Subsequent studies continued to look into the feasibility of a Central Bank Digital Currency (CBDC) with officials mulling over this proposal for the last 3 years. The Government, though has advocated for the use of blockchain technology as mentioned in the 2018-2019 budget speech and also setting up Apiary– Centre of Excellence in Blockchain Technology under the MeitY’s Software Technological Parks India (SPTI) society. Yet experts point that blockchain without crypto-assets severely hampers the functioning of this decentralized system; without an economic incentive providing value public blockchain would limit/restrict the transactions akin to cutting off its leg.
Based on the number of committees, groups and studies set up, the Government finally proposed the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021. The proposed draft prohibits all private cryptocurrencies in India. It is yet to be tabled and discussed in the Parliament but involves questions of holding, selling, disposing off or any kind of trade through cryptocurrencies in India and shall finally decide on its legality. Notably, in a detailed study by an eminent crypto-lawyer, this Draft Bill may be considered arbitrary to the extent that: .
The concerns of dealing with any new technology though, are valid. The RBI itself brought the case of GainBitcoin scam before the Supreme Court highlighting the regulatory lacunae in India but another Asian economic power Japan also witnessed a series of similar cases. Instead of an outright ban, Japan on the other hand, regulated the cryptocurrency business through amending its Payment Services Act. All crypto exchanges are mandated to register with the Financial Services Agency which acts as the governing body for every aspect. Since 2018, Singapore has also promoted and developed virtual infrastructure and recently enacted the Blockchain and Cryptocurrency Regulation 2020. Imitating a digital currency like China, is not advantageous for India. Firstly, the digital yuan is in complete control of the government, to the point where the government can even track user spending. Secondly because India already has a robust digital payment system in place- UPI. In a welcome move, on May 31, 2021 the RBI notified financial institutions that the 2018 circular should not be cited to caution investors of virtual currencies. This clarification came after major Indian banks including SBI cited the 2018 circular, which has been struck down by the Supreme Court (mentioned above) to its users threatening suspension of their accounts. This institutions may continue to carry out due diligence with respect to KYC, Anti-Money Laundering, Prevention of Money Laundering Act and/or FEMA. The move is a likely relief, confirming the legality of dealing with virtual currencies.
This amplifies the need for a balanced regulatory framework, which would include taking different approaches to individual types of crypto assets. For example, assessing the Payment tokens (such as Bitcoin, Litecoin), Security Tokens (representing an underlying asset) and Utility tokens (Golum, Ether which provide a right to use some of the network’s products/service) without a blanket prohibition on bonafide businesses under the same. Drawing inferences from other nations, such as the Model Draft proposed by Uniform Law Commission (U.S), and similar precedents can also be tailored to meet the evolving demands in the Indian context. While Security tokens can be regulated by SEBI but the trading of Payment and/or Utility tokens as ‘digital goods’ through an e-commerce marketplace represents a regulatory vacuum. This is because of a lack of mandate for such marketplaces to follow anti-money laundering requirements or a licensing body too ensure KYC compliance. The Centre should thus notify any crypto-asset business as a ‘designated business/profession’ under Prevention of Money Laundering Act, 2002 similar to jurisdictions like Australia, US, Canada, Japan, etc.
The crypto market is estimated to have hit the $2 trillion-mark, Indian firms have leveraged on this, local artists too are venturing into NFT’s- thus already fostering an ecosystem with immense potential. Developed economies around the world including US, EU, Switzerland or recently Germany have evolved regulatory mechanism to include cryptocurrency. In October 2020, the Financial Action Task Force in its detailed recommendations also advocated for a license or registration process to monitor virtual assets specifically for anti-money laundering and/or countering financial terrorism risks with proportionate sanctions. A ban will likely shift this underground and augment the same national security concerns that are being brought up currently. India needs a well-developed regulatory framework which also takes into consideration the growing security issues (relating to people’s economic and financial safety) and the environmental concerns (relating to energy consumption by crypto currencies) from mining of cryptocurrencies.
“A judicious look at crypto-assets should lead us to neither crypto-condemnation nor crypto-euphoria. Policymakers should keep an open mind and work toward an even-handed regulatory framework that minimizes risks while allowing the creative process to bear fruit.”
Authors: Abhilasha Bhatnagar is a Partner and Disha Devadas is an Associate at Ashraya Legal.