“Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us.” – Thomas Carper, US-Senator
The world today is taking a technological turn, with the onset of breakthroughs in almost all fields. The financial sector is also not alien to these changes; therefore, it was not entirely unexpected that virtual currencies would exist one day. The terms virtual currency or cryptocurrency, often used interchangeably, do not refer to a digital manifestation of your existing money, rather, they are used to denote a currency which only exists digitally and is issued by private developers, the prime examples being Bitcoins, Ripple and Ether.
The legal status of cryptocurrencies in India however, is a little complicated.
Reserve Bank of India on the 6th of April 2018 notified by means of a circular that all entities associated with RBI must not engage in any activity related to the purchase or sale of virtual currencies. This in effect banned cryptocurrency and all other related activities in India. A writ petition was filed by the Internet and Mobile Association of India in the apex court against the circular. On 4th of March 2020, the Supreme Court quashed the Reserve Bank of India circular that declared the trading of such virtual currencies illegal, stating that since virtual currencies do not enjoy a status that is at par with conventional money, the RBI may only intervene in such matters if it impacts the monetary or economic system of the country adversely. This de jure means that cryptocurrencies are not illegal, however, they are still not recognized as legal tender. Why are virtual currencies not recognized as legal tender even after being legalized and termed as currencies? One might want to consider various factors such as the infancy of the whole system that houses both virtual and cryptocurrencies, lack of trust on part of the administration and ambiguity on part of the general population pertaining to the understanding of such currencies.
Timeline of Events
Understanding virtual currencies
The timeline starts from June 2013, when the Financial Action Task Force published New Payment Products and Services Guidance, a set of guidelines which were issued for risk-based online transactions. But this report did not establish comprehensively as to what a virtual currency was and what were its benefits and lacunas. So, a short-term project was initiated by the FATF to generate a risk matrix for such virtual currencies. At the very same time RBI also took cognizance of the proliferation these currencies, and in its Financial Stability Report expressed that since these currencies are owned by private individuals and are unregulated, they pose considerable regulatory and operational risks. On 27th of December 2013, the Enforcement Directorate conducted raids on two bitcoin trading firms in Ahmedabad, the second virtual currency-related raid globally, after the U.S.A., in October the same year. It then became clear that in the absence of a regulatory framework and a comprehensive understanding for such currencies their misuse was bound to outweigh their advantages. So, in June 2014, FATF came up with yet another report, one which focused on virtual currencies and their potential risks and advantages.
This report 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 same report by FATF also defined cryptocurrency as ‘a math-based, decentralised convertible virtual currency protected by cryptography by relying on public and private keys to transfer value from one person to another and signed cryptographically each time it is transferred.’
On the basis of another report, in June 2015, FATF advised nations to conduct their own assessments with regard to these virtual currencies and develop a risk profile for a specific type of currencies that pose a threat to their regulatory jurisdiction.
Difficulty in a comprehensive understanding
Around the same time, two narratives emerged pertaining to virtual currencies. The first, being that virtual currencies are the future of digital transactions and the second, being the polar opposite, that they will be a tool for criminals, terrorists and other similar outfits, that will attempt to evade the existing legal framework pertaining to anti-money laundering and countering the financing of terrorism (AML, CFT). The deep web and the dark web, both of which are abodes of online criminal activities, accept most payments via Bitcoins or other cryptocurrencies, as anonymity is a primary concern for both, the customer and the service provider due to the illegal nature of many services and products. It was common knowledge that the USPs for almost all cryptocurrencies were anonymity and lack of a regulatory framework which allowed them to transfer the said funds from anywhere globally, with little or no transactional costs. The anonymous nature of these currencies would make it more difficult than ever for authorities to track down suspicious or illegal activities. Adding on to an already long list of problems would be the issues for taxation. When virtual currencies are not recognised as legal tender, will the people who trade in the same and earn capital be liable to pay income tax for it? Most governments around the world struggled to comprehend whether these virtual currencies were advantageous to their trade or were they riddled with technologies that would make it impossible to track certain illicit transactions. This fact is what led a lot of countries like Algeria, Pakistan and Vietnam to place a blanket ban on any and all activities related to cryptocurrencies.
Discovery of the Blockchain technology
A very important part of all virtual currencies and cryptocurrencies is the Blockchain technology because almost all of them are different manifestations of the blockchain technology. Originally created for storing Bitcoin transactions, this technology is an ingenious invention. In layman’s terms, the blockchain technology creates a ‘block’ of information (which is a record of transactions in case of cryptocurrencies) that instead of being stored in a central data unit or with a central authority, is stored across all systems on a particular network or environment. Falsification of one single record would mean having to falsify all other millions of records stored on different systems, which is practically impossible, which is why the Blockchain technology is extremely secure. Satoshi Nakamoto (the creator of Bitcoin) also made public the reason for creating this technology. Writing on a peer to peer forum in 2009 he clarifies :
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.
With e-currency based on cryptographic proof, without the need to trust a third-party middleman, money can be secure and transactions effortless.”
After fretting over cryptocurrencies, many nations realised that there was a concealed advantage that came with them- the Blockchain technology. Though there were huge debates everywhere about the pros and cons of cryptocurrencies, what almost everyone agreed on was that the blockchain technology could be tapped beneficially for the rapid expansion of FinTech.
RBI finally decided to clarify its stance on virtual currencies and associated risks in the Financial Stability Report, December 2015, saying that the anonymous nature of such currencies and their volatile nature goes against the fundamental nature of AML laws. However, the central bank also acknowledged that many other central banks around the world were in process of creating their own blockchain-based infrastructure and digital currencies and that they must keep up with the advancements in the technological sphere.
Institute for Development and Research in Banking Technology (IDRBT), in January 2017 published a whitepaper titled “Applications of blockchain technology to banking and financial sector in India’’. One of the findings of the whitepaper was that while digital currencies have certain advantages like- very low transaction costs, better regulation and security, they are also subject to volatility and high risks.
Determining The Price Of Cryptocurrencies And Their Volatile Nature
The high-risk rating of virtual currencies is primarily because of two reasons. First, there being a complete absence of guarantors and any kind of consumer dispute resolution body. Second, the exchange market for these currencies being extremely volatile and subject to arbitrary fluctuations in prices. Apart from the basic factors of demand and supply, virtual currencies are not essentially revenue-generating by themselves, rather their exchange value depends on the participation of the community (security of the transactions by mining, usage of services and developers). The mains factors determining the price of virtual currency are utility, scarcity and perception.
Utility: Since virtual currencies do not hold any value of their own (understandably because they are not attached to any assets) their value is directly proportional to their utility in their respective ecosystems. For example, in the Ethereum ecosystem, to execute contracts in the blockchain one needs Ether (a kind of cryptocurrency).
Scarcity: Having only a limited amount of a virtual currency in circulation will increase its value in the long run. Since the number is finite, the value almost always, will be increasing. The best example of this is Bitcoin. The total number of Bitcoins is fixed at 21 million.
Perception: A virtual currency is only as good as people deem it to be. Since most virtual currencies are manifestations of the Blockchain technology in different forms, their projected value is determined by respective white paper objectives, the number of users, software etc.
For the purpose of an example, let us assume that you contract a service provider for a particular product or a service and agree to pay him 1 Bitcoin for the same. Now while your service/good is being provided to you the value of a Bitcoin increases by 4 times (yes that is possible and probable). From a legal point of view, on a global scale, this would open up the Pandora’s Box of contractual and jurisdictional disputes and adding on top that would the absence of any kind of authority for either enforcement of the said agreement or resolution of disputes arising from the said agreement.
Hence, in April 2017 the Government of India decided to constitute an inter-disciplinary panel which would constitute members from various financial committees, government departments and regulatory organisations. This panel was tasked with studying the existing legal framework of other countries with respect to virtual currencies, and give its recommendations on dealing with the same. In the report submitted by the panel it recommended to place a blanket ban on all activities related to cryptocurrencies, and enact a law making the same an offense punishable by law. Around the same time an inter-ministerial committee was constituted by the government to draft a law for the ban of such virtual currencies. As a precursor to their report, the committee prepared a draft titled “Crypto Token and Crypto Asset (Banning, Control and Regulation) Bill, 2018”, but before any steps towards enacting such a law could take place, RBI had already banned virtual currencies via its 6-4-2018 circular. Simultaneously, technological ventures, who had invested a substantial amount in these currencies, also started filing petitions. What followed was a two-year-long period where all activities related to virtual currencies were prohibited. However, the Hon’ble Supreme Court emerged as a saviour for these trading firms and individual. Applying the four-pronged proportionality test to the said circular, the apex court found it to be unreasonable to place a blanket ban on virtual currencies. However, it did declare that the virtual currencies can be regulated on account of the power they possess to influence the economic system.
Why does India need cryptocurrencies?
Bank robbery is an initiative of amateurs. True professionals establish a bank.
— Bertolt Brecht.
Recently Yes Bank and PMC Bank both drowned financially, leaving the people who had deposited their hard-earned money, stranded and unable to liquidate their assets. Now it is important to note that while the value of a cryptocurrency fluctuates very rapidly, at no point can such currencies be placed under a moratorium, like these banks by the whims and fancies of bureaucrats. There can be no restrictions on their liquidation, whatsoever. Moreover, even if their values dip drastically momentarily, in the long run these currencies will turn out to be a profitable investment, as is exhibited best by Bitcoin.
Another advantage of such currencies would be minimal transaction costs, hence eliminating the need for middlemen in financial transactions. This would also help in drastically reducing the deep-rooted and rampant problem of corruption in the country by eliminating the various levels of administration that funds have to pass through, by directly transferring the said funds with the help of the Blockchain technology, with minimal transaction costs.
The Way Forward
The apex court lifting the ban on virtual currencies was a welcome decision by a majority of the tech giants in the country. Many international crypto trading platforms like Binance and WazirX are now planning to invest and expand into India. But as it has been already established earlier that while virtual currencies come with a lot of freedom and inclusivity, the flip side can be equally deteriorating. So while allowing the trade of virtual currency is a bona fide move on part of the judiciary, what is desperately needed is a well-drafted framework of laws that allow for the proliferation of bona fide activities related to cryptocurrencies, while simultaneously curbing the mala fide ones so as to sufficiently suffocate all AML and CFT operations. It is important however to note that strict regulations and restrictions might actually have the contrary effect as compared to what is desired. Stricter laws could force the operators of such currencies to shift underground, essentially making it impossible for the authorities to trace them. In the absence of any laws pertaining to these currencies, status quo mandates that all the financial authorities (SEBI, RBI, Income Tax Department etc.) will regulate such currencies in their respective fields.
Is the RBI going to file a review petition in the apex court against the judgement? Well, even if it does so, the grounds for the same are going to be extremely narrow considering how it has been established in the 88-page long judgement that even though these currencies have to be regulated through economic policy i.e. legislation since they also have the power to affect the monetary system, they are within the regulatory jurisdiction of the RBI, to some extent. Is the IMAI judgement a momentary relief? This is something that remains to be seen as the government had already drafted multiple laws which proposed to ban all activities related to cryptocurrencies. A favourable option for both the regulators and consumers would be to use this period of time as an experimental one, and to verify that, in what ways are these currencies affecting the economic system of our country. Accordingly, the authorities should come up with the required laws and regulations, that would eliminate all the negative aspects and loopholes related to the trade and mining of these currencies.
ABOUT THE AUTHOR
Utkarsh Dubey is a first-year law student at National Law University, Jodhpur. His interests lie in the fields of Political Science, International Affairs, Cyber Law and Criminal Law.