Cryptocurrency, and its underlying technology, Distributed Ledger Technology ("DLT") are arguably two of the most polarizing financial developments of the last decade. Their growth and adoption have also run parallel to multiple regulatory challenges across jurisdictions. The Reserve Bank of India ("RBI") issued a circular on April 6, 2018, banning entities dealing in Virtual Currencies from accessing the banking system. The Internet and Mobile Association of India (IAMAI) and other affected stakeholders filed PILs before the Supreme Court and across High Courts, challenging the basis of the Circular. The long pending hearings in the consolidated PIL concluded on the 28th of January, 2020, and the SC has reserved judgment on the matter.
The RBI, and the Finance Ministry, through press releases and speeches, had between 2013 and 2017, cautioned users about virtual currencies not being legal tender in India with sovereign guarantee. The term virtual currency ("VCs") includes Bitcoin, Ripple, Ethereum, Litecoin and close to 2000 other cryptocurrencies in use across the world.
The RBI, on April 6, 2018, issued a circular prohibiting entities regulated by it from dealing in VCs, and providing services to any person or entity dealing in VCs ("Circular").
The implications of this Circular were immense for start-ups around India who had begun operating cryptocurrency exchanges, but could no longer access financial services offered by banks. These services included:
· maintaining accounts,
· trading, settling, clearing,
· giving loans against virtual tokens, or
· transfer or receipt of money relating to the purchase of sale of such VCs.
Following the Circular, as mentioned above, multiple PILs were filed in High Courts and in the Supreme Court of India, contending that the Circular violated the right of equality, and the right to carry on any occupation, trade and business.
RBI v. Crypto:
In this section, we briefly summarize the arguments reported to have been made by both sides in the hearings.
The RBI issued the Circular under Section 35A of the Banking Regulation Act, which pertains to the RBI's powers to issue directions to banks in public interest. In the arguments made by the IAMAI,
· it contended that the Circular was ultra vires the RBI's authority, as it could only regulate 'banking companies' and other financial intermediaries in public interest, not entities such as crypto exchanges.
· It further argued that any reasonable restriction on an entity's rights under Article 19(1)(g) must be placed by legislative authority, and not by way of an executive direction, which the Circular amounted to.
· Finally, it contended that by banning VCs, the RBI was merely losing sight of violations, and not curbing them, as intended. The IAMAI cited the example of the USA, whose solution to detect crime has been to instruct crypto exchanges to maintain transaction data. With the present Circular, IAMAI argued, the RBI does not prevent trading, use as a means of payment or bar transfer of VCs abroad; it merely impacted businesses operating as exchanges.
The RBI in its response argued that VCs were highly volatile, and could pose potential threats and risks to the banking system. It defended the Circular stating that it had statutory powers to issue such directions. However, the RBI crucially stated that it has not prohibited VCs in India, thereby confirming that cryptocurrency itself is neither banned by the RBI nor by any legislation passed by the Government, thus leaving it open to regulation regardless of the validity of the Circular in question.
Under Section 26 of the RBI Act, the concept of 'legal tender' is expressed as follows: "every bank note shall be legal tender at any place in India in payment or on account for the amount expressed therein, and shall be guaranteed by the Central Government". Thus, fiat currency in circulation in India has a sovereign guarantee expressly made by the Central Government. At present, no country in the world has accorded virtual currencies the status of legal tender.
Certain countries such as Russia, Canada and Switzerland, allow for VCs to be traded for goods and services, i.e. as a mode of payment. These countries regulate VC transactions under a range of laws. Switzerland, for instance, only permits VC transactions that comply with AML laws. Canada taxes VC transactions in accordance with the nature of such transactions. Finland and Germany regulate the trade of VCs in the same manner as commodities. Certain others such as China have banned their use altogether. While there may be no jurisdictions whose set regulatory template can be emulated in the Indian context, different countries provide for reporting requirements, KYC norms, use case limitations and other conditions that VCs and exchanges must meet in order to be traded within such country.
The RBI states that the basis for the ban is to ringfence the banking system from any possible negative effects from cryptocurrency exchanges. However, the move has not served to address the following concerns.
Missed Opportunity for KYC/AML: The ban has not served to affect peer-to-peer trading of cryptocurrency within India, and may do little to prevent the RBI's concern of VCs being used for money laundering or to fund terrorism. On the contrary, as the IAMAI representation stated, if entities such as crypto exchanges were brought within a regulatory framework, they could carry out KYC/AML checks of its users, which would assist in identifying high value transactions.
Lack of Regulatory Oversight: The RBI currently regulates payment intermediaries operating within India, by way of the Payment and Settlements Act, 2007. By placing a de facto ban on the operations of cryptocurrency exchanges in the country, the RBI ignores the identical liquidity and credit risk they pose to consumers and market participants as other payment intermediaries do.
Consumer Vulnerability unaddressed: The regulator is justified in being cautious of a financial innovation whose impact is yet to be observed and studied. The immutability of a VC transaction is one of its oft-cited hallmarks. This calls into question the ability to deal with a disputed transaction. The jurisdiction of a regulator is unclear in a system where the final point of a transaction is inherently difficult to identify. The above are legitimate concerns about the medium that the RBI, and other experts, have expressed. However, a ban of, or as with the impugned Circular, a refusal to engage with, a technology that is gaining traction with or without regulatory approval, will only increase consumer vulnerability.
Regardless of whether the Supreme Court upholds the Circular or strikes it down in the ongoing case, the RBI will have to assess the risks and benefits of VCs, and work in cohesion with other regulators such as the SEBI and the CBDT in determining how best to regulate cryptocurrency to ensure consumer and financial system protection. Further, given the regulatory vacuum on the use of cryptocurrency itself, it is also a subject which Parliament may legislate upon in the near future.
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