In a landmark judgement, the Supreme Court of India (SC) has quashed the circular issued by the Reserve Bank of India (RBI) on 6 April 2018 (Circular) that prohibited banks and financial institutions from dealing in, and providing services for facilitating dealing in, virtual currencies (Cryptocurrencies) such as Bitcoin. A three-judge bench of the SC held the Circular to be a disproportionate regulatory action, in a decision that suggests that Cryptocurrencies should be subject to considered regulation, and not blanket prohibition, under Indian law.
Key arguments before the SC
The principal arguments of the petitioners were as follows:
- The RBI has no jurisdiction to act in this manner, as Cryptocurrencies are neither 'currency' nor a 'payment system', which are regulated by the RBI. Merely because Cryptocurrencies can be used in a manner akin to money, does not change the essential legal characteristic of Cryptocurrencies, which resemble tradable digital goods or commodities more than they resemble a form of currency and are, thus, outside the RBI's usual scope of regulation.
- The Circular amounted to an arbitrary, unfair, and unconstitutional restriction on a legitimate business activity. In the absence of a 'legislative' ban on Cryptocurrencies that declares them res extra commercium, the use of, and trade in, Cryptocurrencies is a legitimate business activity.
- The Circular effectively placed a complete ban on the use of Cryptocurrencies, and such a ban was unreasonable, disproportionate, and based on an erroneous understanding that it was impossible to regulate Cryptocurrencies.
In response, the RBI's principal arguments were as follows:
- Cryptocurrencies were capable of being used for illegal purposes (on account of the digital anonymity that blockchain technology affords).
- Widespread use of Cryptocurrencies would fundamentally undermine India's credit system and monetary stability.
- The RBI had the right to regulate banking activity (which is what the Circular pertained to) as it saw fit.
- In any case, the RBI has the authority to make broad-based decisions on the economic policy of the country, and the SC has traditionally shown deference to RBI's authority.
The SC ruled that while Cryptocurrencies do not constitute legal tender (either in India or in any other jurisdiction that the SC had analysed), they can function as either a medium of exchange, a unit of account, or a store of value (or some combination thereof). The RBI has the statutory authority to notify certain instruments as currencies, and (as the SC observed) it has not chosen to exercise this power with respect to Cryptocurrencies. In fact, the RBI has specifically argued in the past that Cryptocurrencies do not fall under the statutory definition of 'currency'. Nonetheless, the SC concluded that the manner in which Cryptocurrencies are often used in India – as consideration for goods or services provided, or as a facilitator of payment between parties – constitutes an activity that falls within the RBI's regulatory purview.
Having concluded that the RBI did indeed have the power to regulate Cryptocurrencies in India, the SC proceeded to evaluate the Circular on its merits. While the SC rejected the argument that there had been no application of mind in the RBI's directives and that it did not find the Circular to be a colourable exercise of power, the SC did ultimately conclude that the Circular was a disproportionate regulatory measure.
The SC noted that the RBI is primarily responsible for the financial institutions that it is required to regulate, and that it had argued about the potential harms that Cryptocurrencies could cause to those institutions. However, the SC held that the RBI had failed to actually demonstrate the damage that the use of Cryptocurrencies had caused to such regulated entities – given that the RBI had not identified any specific adverse impacts of Cryptocurrencies on banking and financial institutions in India, and had specifically argued (both in previous regulatory guidance and during the course of arguments in the present case) that Cryptocurrencies were not actually banned under Indian law.
As a result, in prohibiting regulated entities from dealing with a sector that was not subject to a statutory ban, and which had not demonstrably harmed such regulated entities, the RBI was held to have acted disproportionately, and the Circular was set aside.
This decision is an important development for the Cryptocurrency sector in India. In the short term, it removes regulatory restrictions on banks from providing services to participants in the sector and makes Cryptocurrency activities viable in India again. Early media reports indicate that several operators of prominent Cryptocurrency exchanges, many of whom had ceased Indian operations or moved to jurisdictions such as Singapore, are already contemplating a move back to India. While it remains to be seen whether they do indeed return to Indian shores, considering that the RBI and the Indian government remain sceptical of Cryptocurrencies, this is still a highly encouraging development for activity in this sector.
Beyond the short-term market effects of this decision, the SC has also laid down a marker for regulatory action on Cryptocurrencies in India, which has typically been a slow-moving and muddled affair. The full decision contains extensive analysis of the regulatory treatment of Cryptocurrencies in various jurisdictions and evaluates how different countries seek to classify Cryptocurrencies and how such classifications (as securities, digital assets, payment instruments, etc) might be interpreted under existing Indian law. In particular, the SC's finding that Cryptocurrencies resembled existing currency systems enough to fall within the RBI's purview, could prove to be crucial in determining how the RBI and the government frame regulations around cryptocurrencies in future.
Further, while the judgement does not itself hold that Cryptocurrencies cannot be banned altogether, its analysis of Cryptocurrency legislations in other jurisdictions suggests that an Indian regulatory framework for Cryptocurrencies is viable, and that an outright ban may be uncalled for. In this regard, several public interest litigation matters have been filed seeking the implementation of regulatory measures for Cryptocurrencies; these remain pending before the SC, and the SC's decisions in those cases will shed light on the manner in which India's Cryptocurrency regulations are likely to develop. News reports also indicate that the RBI is also likely to seek a review of the SC's decision in this case, so the matter appears to be far from resolved.
For now, there remains some uncertainty about the future of the Cryptocurrency industry in India, also in the context of the Banning of Cryptocurrency & Regulating of Official Digital Currency Bill, 2019 (Bill), which proposes the ban of private Cryptocurrencies and the criminalisation of their use. The Bill has not yet been brought to the Indian Parliament for a vote, however, and is thus subject to revision. Further, the Bill proposes the creation of a 'digital rupee' that the central government and the RBI would have a monopoly over, so the government's general position on Cryptocurrencies is clearly not as unfavourable as it once was. Whether this will extend to an acceptance of decentralised, non-government Cryptocurrencies – and whether private players will be permitted to participate in an Indian Cryptocurrency market that has significant scope for growth – remains to be seen, and we expect to see significant developments in this space in the coming months.
There is no doubt that this is a path-breaking judgement, as it takes a progressive stance on how to deal with disruptive tech developments. There is a clear message to the regulators – banning disruptive tech is not the solution (bans seldom work), embracing and regulating it is the only way (well thought-through regulations almost always work). Framing and implementing comprehensive and effective regulations on Cryptocurrencies is one of the most challenging regulatory problems of recent times (with regulators across the world struggling with it). In India, it will require concerted effort by authorities like the RBI, the Securities and Exchange Board of India, the Ministry of Finance, etc to achieve this. We hope they will rise to the occasion, and the SC judgement will trigger Indian regulators' thought leadership in this space as well as other techno-legal matters in the times to come.
Khaitan & Co represented one of the petitioners in the matter.
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