The increasingly widespread adoption of cryptocurrency and blockchain technology signals the onset of a new technological revolution. As a result, governments around the world are scrambling to understand and regulate cryptocurrencies and blockchain technology. Some countries like Singapore, Japan, and Switzerland have already enacted legislations promoting the use and adoption of cryptocurrencies and blockchain technology alike1. In contrast, India is yet to formally introduce any legislation governing the use and adoption of cryptocurrencies. However, the Reserve Bank of India has previously imposed a ban on the trading of cryptocurrencies2 (now lifted by the Supreme Court3), and the Indian government is in the process of publishing the draft Cryptocurrency and Regulation of Official Digital Currency Bill, 20214 which would, supposedly, prohibit the usage and trading of cryptocurrencies outright but permit and promote the use of the underlying blockchain technology.
Despite their name, the characteristics of cryptocurrencies are closer to an asset like gold rather than fiat money, owing to their popular adoption as a store of value. Cryptocurrency maximalists argue that it is an effective hedge against inflation, owing to its decentralised nature and limited supply. Incidentally, cryptocurrency, much like gold, is speculative in nature and derives its value from the market forces of supply and demand. Therefore, the similarities between cryptocurrencies and a physical asset like gold have given rise to a popular school of thought that views cryptocurrencies as an entirely new asset class. It follows then that, ideally, the law should not differentiate between the possessor/ owner of cryptocurrencies and the owners of any other conventional asset. However, at this juncture, the pertinent question to be answered is whether cryptocurrencies fall under the ambit of existing legislations that govern existing asset classes or if new legislations need to be enacted to classify and govern cryptocurrency as a new asset class.
But what are cryptocurrencies? Where do they derive their value from? Can they be regulated? If so, how? The answers to these questions will determine the nature of cryptocurrencies and serve as our basis for attempting to predict the legislative treatment cryptocurrencies may receive.
Cryptocurrency & Blockchain
Cryptocurrencies are a digital representation of value (i.e., virtual currencies) that use cryptography and specific mathematical algorithms to encrypt information that can only be deciphered by someone who possesses a secret digital key.5 They are also decentralized, meaning there is no central authority where records of transactions are maintained. Instead, transaction data is recorded and shared across multiple distributor networks, through independent computers. This technology is what is known as blockchain - a type of "distributed ledger technology" that can record and share data across multiple data stores (ledgers), each of which have the exact same data records and are collectively maintained and controlled by a distributed network of computer servers, which are called nodes.6 It is important to draw a distinction between cryptocurrencies and blockchain technology, especially in terms of the regulatory framework applicable to them. While cryptocurrencies employ blockchain technology, blockchain technology itself has numerous possible uses, independent of cryptocurrencies.
With the basic distinction between cryptocurrencies and blockchains established, we can now attempt to identify a suitable legal definition for cryptocurrencies based on the legal framework currently existing in India.
Can Cryptocurrencies be regulated as a Currency?
In India, and around the world, numerous businesses have begun accepting Bitcoin (the world's largest cryptocurrency by market capitalization) as a form of payment, despite the regulatory uncertainty surrounding the technology.7 Generally speaking, a "currency" is a medium for the exchange of value between two parties, i.e., goods and services on one hand and payment for said goods and services on the other. However, to ascertain whether cryptocurrencies qualify as legal tender or a valid payment system in India, we must look to the legislations enacted by the India in this respect. These are: (a) Reserve Bank of India Act, 1934 ("RBI Act"); (b) Foreign Exchange Management Act, 1999 ("FEMA"); (c) Coinage Act, 2011 ("Coinage Act"); and (d) Payments and Settlement Act, 2007 ("PSSA").
Section 2(h) of FEMA defines currency to include "currency notes, postal notes, postal orders, money orders, cheques, drafts, travellers' cheques, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments, as may be notified by the Reserve Bank". Further, "foreign currency" has been defined in Section 2(m) of FEMA to include any 'currency' other than Indian currency. Similarly, Section 26 of the RBI Act states that "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". As per Sections 24 and 25 of the RBI Act, the Central Government, after taking into account the recommendations of the RBI, has the power to specify the denomination, form and substance of such bank notes, with RBI being the sole issuer of such bank notes. Likewise, Section 6 of the Coinage Act affords the status of legal tender to only those coins which are (a) made of metal or a material approved by the government8; and (b) minted by an organisation and place authorised to do so by the Central Government, in the manner and dimensions prescribed by the Central Government.
In India, payment systems relating to electronic funds are regulated by the PSSA, which unlike legislations in other jurisdictions, does not define the terms "digital currency" or "virtual currency" despite the now normalised use of "in-game currency" in video games which facilitate in-game purchases by users. In 2002, however, the RBI issued a report9 which defined electronic money as "an electronic store of monetary value on a technical device used for making payments to undertakings other than the issuer without necessarily involving bank accounts in the transaction but acting as a prepaid bearer instrument". While the aforesaid definition is wide enough to seemingly apply to cryptocurrencies, Section 2(i) of the PSSA defines a payment system as "a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange". If we apply the aforesaid definition to a simple cryptocurrency transaction, where the two parties involved in the exchange of value are the payer and beneficiary, and the mining of blocks to validate the transaction between these two parties, this effectively serves as a clearing mechanism which triggers the settlement upon which the funds in question are then transferred from one party to another. If the Central Government were to adopt a similar view and a desire to regulate cryptocurrencies as electronic money, it would have consequential implications for such currencies in terms of the PSSA including inter alia requiring them to register themselves with the RBI, incorporation of an entity in India and compliance with various anti-money laundering and "know-your-customer" regulations, which, presently, are not mandatorily applicable to cryptocurrencies.
Taking the above into account, it is clear that for a 'currency' to be considered a valid payment system and/or legal tender in India, it must receive the assent of the Central Government and RBI, something which cryptocurrencies currently lack. This does not mean that using and trading in cryptocurrencies are ipso-facto illegal or prohibited in India; rather, it means that cryptocurrencies like Bitcoin will continue to exist outside of the purview of the Indian banking system and RBI's mandate until they are guaranteed by the Central Government or a notification is issued bringing them under the purview of the regulators.
Can Cryptocurrencies be Regulated as a Security?
The advent of cryptocurrency exchanges in India, and around the world, validates the view held by many that cryptocurrencies are actually a form of investment. However, in classifying cryptocurrencies as an investment, it is important to determine whether cryptocurrencies and crypto exchanges can be brought under the purview of the Securities and Exchange Board of India ("SEBI"). This is where Initial Coin Offerings (or "ICOs") come in, a relatively recent phenomenon adopted by players in the blockchain space.
ICOs serve as a fundraising mechanism where digital tokens (i.e., coins) are issued by an entity (usually a body corporate) in exchange for fiat currency, or cryptocurrencies such as bitcoin or ether10, which once issued can be traded on cryptocurrency exchanges. These digital tokens often represent a utility (known as utility tokens) and can be used by the recipient to access products and services within the blockchain ecosystem designed and implemented by the issuer. More recently, the types of tokens being issued by these blockchain companies has increased manifold, with the emergence of 'security tokens' being one such development. Security tokens are on-chain instruments serving a similar purpose for blockchain projects and/or digital assets that traditional securities serve for companies, for instance: (a) recording an ownership interest; or (b) serving as evidence of a debt; (c) offering a right to a share of earnings; (d) a right in property distribution, or other similar legal rights.11
But what constitutes a security under Indian laws? Can ICOs be regulated in the same way that initial public offerings ("IPOs") are? In this regard, section 2(h) of the Securities Contract (Regulation) Act 1956 ("SCRA") may be referred, which provides for an inclusive definition of securities:
"i. shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
ib. units or any other instrument issued by any collective investment scheme to the investors in such schemes;
ic. security receipt as defined in clause (zg) of section 2 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
id. units or any other such instrument issued to the investors under any mutual fund scheme;
ie. any certificate or instrument (by whatever name called), issued to an investor by any issuer being a special purpose distinct entity which possesses any debt or receivable, including mortgage debt, assigned to such entity, and acknowledging beneficial interest of such investor in such debt or receivable including mortgage debt, as the case may be;
ii. Government securities; and
iv. rights or interests in securities"
The Supreme Court has previously held12 that "marketable securities of a like nature" means that the securities should be freely transferrable and/or capable of being sold. Therefore, while tokens or coins may not fall within the definition of "shares, bonds, stocks, scripts, or debentures", they may still be classified as a security and fall within the jurisdiction of SEBI if the tokens are issued by a body corporate / incorporated company and are "capable of being sold". Further, a body corporate, as defined under the Companies Act, 2013 includes a company incorporated outside India13.
There is also a plausible case to be made for ICOs and cryptocurrencies to be interpreted as an "investment contract" or "collective investment schemes". In Paramount Bio-Tech Industries v. Union of India14, the division bench of Allahabad HC utilised the Howey Test to gauge whether an instrument was a "collective investment scheme" ("CIS"). The Howey Test, established by the U.S. Supreme Court15 to determine the existence of an investment contract, prescribes four conditions which must be satisfied for an existing arrangement to be interpreted as an investment scheme: (a) an investment of money; (b) in a common enterprise; (c) with the expectation of profit; and (d) to come significantly from the efforts of others. The statutory definition of collective investment schemes given under Section 11AA of the Securities and Exchange Board of India Act, 1992 ("SEBI Act") takes inspiration from the principles established in the Howey Test. As per Section 11AA, a CIS is one which involves contributions, or payments made by the investors with a view to receive profits, income, produce or property, which are then pooled and utilized solely for the purposes of the scheme or arrangement. It is also essential that the investment forming part of the scheme is managed on behalf of the investors and that such investors do not have day-to-day control over the management of the scheme or arrangement. While some would debate if funds raised by an ICO are being utilised and pooled solely for the purpose of the scheme or arrangement, there is undoubtedly contributions being made by investors towards one scheme or arrangement with expectation of profits and/or property, over which they do not have day-to-day control or management. In any event, the Central Government may even consider amending the definition of a CIS to address the differences between a traditional CIS and an ICO and thereby eliminate any ambiguities or gaps which are likely to arise, should an unamended definition of CIS be applied to ICOs or cryptocurrencies.
Are Cryptocurrencies Goods or Property?
The 'transfer of property' is defined as "an act by which a living person conveys property, in present or in future, to one or more other living persons, or to himself [or to himself] and one or more other living persons; and "to transfer property" is to perform such act." 16
Transactions involving cryptocurrencies could fall within this definition as they satisfy the main ingredients required to qualify as a transfer:
- any living person (which includes companies, association and body of individuals) which in a cryptocurrency transaction would mean the owner of such tokens; and
- in present or future, determines that such owner transfers cryptocurrency; and
- to one or more living person which would mean the receiver of the cryptocurrency in the transaction.
One may understand and analyse cryptocurrency as a property by understanding some of the theories of property. The bundle theory of property classifies property as an amalgamation of tangible and intangible rights associated with it. This essentially includes all the rights that are associated with such a property. As of today, since cryptocurrency is not backed or recognised by the RBI or the Government, it will not be classified as an asset under this theory as no legal rights are vested with an individual owning cryptocurrency. The exclusion theory classifies property based on the right to exclude. This means that the owner of the property has the exclusive right to dispose the same and exclude others of the rights enjoyed by the owner. In the context of cryptocurrency, owners have the exclusive right to dispose the property and thus it may qualify as a property under this theory.
Cryptocurrencies may even be classified as a 'good'. Section 2(7) of the Sale of Goods Act, 1930 ("SGA") reads "goods means every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale". Cryptocurrency may fall under the meaning of movable property under this provision. However, under this classification, cryptocurrency cannot be used as consideration (excluding the instance when transferring it in terms of monetary value). The rationale for the same is provided under Section 2(10) of the SGA, which explicitly states that 'price' would mean the money consideration for a sale of good. This means that the SGA classification of cryptocurrencies as a "good" is mutually exclusive from it being used as a currency/ price for purchase of a good or service, i.e., classifying cryptocurrencies as a good would disqualify the use of cryptocurrency as consideration under a contract for provision of goods or services. Therefore, it unlikely that cryptocurrency will be treated as a good.
Before legislating, analysing and comparing the characteristics of cryptocurrencies to currency, security, property or goods, it would be more pragmatic to recognise its diverse nature and refrain from trying to shoehorn it into an existing asset class. Since, 'asset' is a broad term covering a lot of items of value, the understanding of its basic features and comparing the same to cryptocurrencies would provide a more suitable and comprehensive legislation which would recognise the development and establishment of a new asset class.
For example, 'Capital Asset' as defined under Section 2(14) of the Income Tax Act, 1961, would include cryptocurrency like other speculative assets such as jewellery and paintings. The speculative nature of cryptocurrency is also an important reason for the Indian Government's stance on contemplating banning it. The Government's view is that the tremendous increase in value of certain cryptocurrencies is a bubble that could lead to the public, especially retail investors, losing a substantial portion of their monies. Despite the highly speculative nature of cryptocurrency, it can be regarded as an asset due to the similarities in its utility, basic functioning, and characteristics with other assets. Some of the characteristics cryptocurrencies share with physical assets (including currency, security, goods and property) are:
- Transferability: Cryptocurrency, just like gold or land can be transferred to another owner in exchange for something else.
- Medium of Exchange: One should be able use an asset to facilitate the sale, purchase or trade of goods. Though this utility of a cryptocurrency has not reached the adoption levels of fiat money, in the not-so-distant future it may well be used as any other currency/money issued by governments across the globe. Currently, most cryptocurrencies are used simply to trade other cryptocurrencies, with only Bitcoin and Ethereum being afforded the privilege of being exchangeable for fiat money or to purchase goods and services.
- Extrinsic Value: The value of a cryptocurrency is determined by demand and supply. For example, the price of cryptocurrency can be related to price of a property or land, both are limited in supply and the price increases based on demand. The value of property too, many a times, is affected by the speculation of investors.
- Exclusive Ownership: Property under the exclusion theory is the owner's right to exclude others from the usage or enjoyment of the exclusive rights he possesses over it. Just like other traditional assets, cryptocurrency owners possess absolute rights over it (barring the exception of the State's exercise of eminent domain over property, but as it stands it is difficult to say whether the State would be able to exercise such a right over an individual's cryptocurrencies, like it can, for example, with land).
If one is skeptical about the multi-faceted nature of cryptocurrencies and their viability as a commodity or asset, the recent sale of a tokenized artwork for $69 million17 will make them reconsider. The digital art piece is the first of its kind to come up for auction, owing to its classification as a non-fungible token ("NFT"), which, simply put, means that unlike cryptocurrencies which are fungible, i.e. any Bitcoin is equivalent in value to any other Bitcoin, just like a dollar is equivalent to any other dollar, non-fungible tokens are unique and differentiated from one another, and capable of being bought and sold just like any other token18. This relatively new concept of issuing NFTs for art revolutionizes ownership of art and other collectibles, as they are brought 'on chain' and therefore are certifiable and indisputable as proof of ownership. Going forward, such phenomena may be common and NFTs holding value may even be used as collateral to obtain a loan. The use case for NFTs may be unlimited as the value for the same may be backed by any item, good or asset (in the instant scenario, the digital artwork). Recent developments in the blockchain space have also given rise to entirely new categories of cryptocurrencies: governance tokens, platform tokens, stablecoins, utility tokens, security tokens, and transactional tokens, each of which serve completely different functions, offering their holders different rights and entitlements, both in the blockchain ecosystem and the real world.
Cryptocurrencies & the 'Currency' Debate
All of the above further validates the view that "cryptocurrency" is a buzzword, reflective of a host of misconceptions held by society; attributable to a lack of clarity and awareness on the underlying technology and its capabilities. This technology is multi-faceted and can be utilised as a currency, security, or asset. Thus, it is imperative that the Indian Government resists the urge to legislate cryptocurrencies using a broad-brush approach. Instead, one would hope for a fundamentalistic approach from the Government, wherein it engages with the industry stakeholders and attempts to understand the implications of each use case before taking a stance either for or against the widespread adoption of cryptocurrencies. There is a real risk that misclassifying the technology or implementing prohibitive legislation would restrict the promotion and development of blockchain technology in India.
Without a doubt, stakeholders in the industry and the public in general are anxiously awaiting the Indian Government's proposed legislation on cryptocurrency in India. Given India's population and potential to be one of the largest crypto-markets, whatever decision the Government takes will have a massive impact on the entire cryptocurrency community at large and will decide the course, development, rights and reliefs associated with this revolutionary technology in India. The upcoming cryptocurrency bill will clearly indicate whether India will take a step forward, by recognising and affording legal recognition to cryptocurrencies and blockchain technology or fall behind allowing other nations to get a head start in the game changing potential of blockchain technology. A balance must be struck between regulating the more negative aspects of cryptocurrencies like the possibility of money-laundering, and lack of governance; and nurturing the technological innovation cryptocurrencies will unquestionably bring about.
1. https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf (Department of Economic Affairs, Ministry of Finance, New Delhi India "Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies", 2019)
2. Prohibition on dealing in Virtual Currencies (VCs), Circular No. RBI/2017-18/154.
3. Internet and Mobile Association of India v. Reserve Bank of India Writ Petition (Civil) No.528 of 2018.
5. World Bank Group (H. Natarajan, S. Krause and H. Gradstein), "Distributed Ledger Technology (DLT) and blockchain", 2017, FinTech note, no. 1. Washington, D.C., http://documents.worldbank.org/curated/en/177911513714062215/pdf/122140-WP-PUBLIC-Distributed-Ledger-Technology-and-Blockchain-Fintech-Notes.pdf s
8. Section 2 (a) of the Coinage Act, 2011
9. RBI's Report of the Working Group on Electronic Money dated July 11, 2002
10.https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf (Department of Economic Affairs, Ministry of Finance, New Delhi India "Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies", 2019)
12. Bhagwati Developers Pvt. Ltd. v. Peerless General Finance (Civil Appeal No.7445 of 2004) reiterated in Sahara India Real Estate Corporation Limited v. Securities and Exchange Board of India (Civil Appeal No. 9813 OF 2011).
13. Section 2 (11) of the Companies Act, 2013
14. (2004) 2 CompLJ 446 All
15. SEC v. W. J. Howey Co., 328 U.S. 293 (1946)
16. Section 5 of the Transfer of Property Act, 1882
18. Chevet, Sylve, Blockchain Technology and Non-Fungible Tokens: Reshaping Value Chains in Creative Industries (May 10, 2018).
Originally published Jun 11, 2021
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