The cross-border transfer of cryptocurrencies/ virtual digital assets (VDA) plays a pivotal role in their functioning as digital assets which are predominantly traded on online platforms that enable their conversion into various currencies, including traditional fiat currencies. This dynamic gives rise to critical legal issues within the framework of India's foreign exchange regulations, specifically under the purview of the Foreign Exchange Management Act, 1999 (FEMA). Additionally, it raises concerns about uncertainties regarding enforceability of contractual obligations embedded in smart contracts with respect to the Indian Contact Act, 1872 (Contract Act). The regulation of cross-border cryptocurrency transactions takes on a heightened significance due to the growing consensus that such transactions are on the rise globally.
Cryptocurrencies can be conceptually understood as public currencies lacking the recognition and assurance of sovereign guarantees. This characteristic empowers them to mitigate the risk of a systemic payment failure during times of crisis, circumventing scenarios where a centralized entity like a bank might be unable to honour its payment obligations. A notable instance illustrating this advantage is the recent banking crisis in United States. Unlike traditional currencies, cryptocurrency's inherent design prevents unilateral revocations of this nature.1 It is imperative to emphasize that an outright prohibition of cryptocurrencies, as opposed to a regulatory approach, could result in missed opportunities for India to leverage the economic and technological advantages of this global digital asset class. It is noteworthy that the applicability of FEMA and its corresponding regulations on cross-border cryptocurrency transactions remains uncertain. Even if a comprehensive ban were to be imposed on cryptocurrency usage within India, immediate challenges would arise concerning the disposition of existing cryptocurrency holdings within the country. In essence, a ban or uncertainties in applicability of FEMA could potentially hinder or restrict Indian entities from engaging in domestic and cross-border cryptocurrency transactions.2 This necessitates an understanding of arguments on utilization and regulation of cryptocurrencies and the need for a nuanced approach to harness the potential benefits while addressing associated risks.
The global legal framework for use of blockchain or cryptocurrency in market transactions has not grown as fast as the blockchain technology itself. On the contrary, some countries are still unsure about the definition of cryptocurrencies, while others are formulating blockchain-related legislation without being clear about applicability of such laws in different circumstances. This situation exposes a mere fraction of the overarching challenge, the absence of a unanimous international consensus concerning cryptocurrencies, asset tokenization, and smart contracts. This paucity presents a significant conundrum for the field of private international law. Indeterminate legal status of digital assets and smart contracts in various jurisdictions prompts a fundamental predicament. The problem becomes obvious when domestic legal systems are yet to conclusively establish the legal categorizations of digital assets. Hence, it becomes imperative to scrutinize the legality of 'consideration' within smart contracts frequently denominated in decentralized (Defi) and centralized financial products and services offered in the industry, while also examining the legal standing of these smart contracts themselves.
THE CRYPTO ADVANTAGE: SPEED, COST AND SECURITY
Blockchain-enabled cross-border payments has revolutionized the way money or value is transferred between parties in different countries. Unlike traditional methods that involve multiple intermediaries, delays, and high fees, cross-border cryptocurrency payments streamline the process. Imagine you are in the UK and want to send money to a friend in Dubai. The process begins by using an 'on-ramp' service to convert your fiat currency into cryptocurrency using methods like credit cards or bank transfers. This cryptocurrency is then securely stored in a digital wallet of your choice (custodian or non-custodian). Once you have your friend's wallet address, you can easily send the desired amount of cryptocurrency. Your friend can then convert this cryptocurrency into their local fiat currency, completing the transaction through an off-ramp platform and/or peer-to-peer transaction directly.
Contrast this with traditional cross-border transfers, which often involve selecting a transfer service, providing recipient details, waiting for processing, potential currency conversion, and enduring delays before the recipient gains access to the funds. The conventional methods are burdened by a complex network of banks and SWIFT messaging system. Transactions can take days to finalize, incurring an average fee of around 6.5% - 8 % per transaction3. Additionally, adhering to the rules of centralized authorities like banks leads to inefficiencies, such as restricted payment timings. Whereas, blockchain-based cross-border payments offer instant processing within seconds, a substantial reduction of 40–80% in transaction costs, and robust security with full traceability of payment-related information4. This innovative approach bypasses the need for multiple intermediaries, slashing processing times and expenses while maintaining a high level of security and transparency.
In the matter of Internet and Mobile Association of India v. Reserve Bank of India5, it was argued, that global trade in virtual currencies across borders, combined with a lack of accountability, poses potential risks to the regulated payments system overseen by the Reserve Bank of India (RBI). However, the traditional definition of money from 18796 is becoming outdated in today's context, considering technological advancements and changing perceptions of currency. Breyer, J., while giving a dissenting opinion in Wisconsin Central Ltd. v. United States7, highlighted the evolving nature of money, noting historical shifts from cowrie shells to gold coins. He also acknowledged the ambiguity in defining money, suggesting a need for a broader interpretation. The Oxford English dictionary already includes the idea of property convertible into money within the definition of 'money'. India faces security threats from cross-border terror financing and money laundering and the laws have been enacted to combat these issues. The government cannot allow anything that facilitates illicit activities, including anonymous cross-border fund transfers. Virtual currencies have been associated with illegal purchases, necessitating stringent measures. The RBI's circular dated 06.04.20188 tried to address these concerns by preventing the banking system and regulated entities from facilitating virtual currency trades. The additional measures are crucial due to the significant engagement of millions of Indian users in daily virtual currency transactions. Measures like these are designed to protect the financial system from potential risks linked to virtual currencies acting as fortified checks and balances. In this case the Hon'ble Court held that the RBI's statement and circular on virtual currencies are not ultra vires the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949. However, the court held that the RBI's circular on virtual currencies is not proportionate, as the RBI failed to show any damage suffered by its regulated entities. Therefore, the court set aside the RBI's statement and circular on virtual currencies.
It is imperative that India takes a regulatory stand on digital assets, failing to regulate cryptocurrency in India would result in forfeiting a distinctive opportunity for altering the country's socio-economic and political spheres for betterment. At the same time, totally banning cryptocurrencies wouldn't really solve the main problem, which is stopping illegal activities that happen across borders. For instance, consider a recent case presented before the Karnataka High Court in a matter of Aayush Ajit v. Inspector of Customs9 where the accused procured illicit substances from the Netherlands using cryptocurrency. Criminals would likely persist in utilizing cryptocurrency for transactions, as their primary concern is the sense of anonymity10 it provides, rather than its legal status. While transactions through alternative payment methods might become more traceable, an equally effective approach could involve mandatory disclosures under the FEMA pertaining to cryptocurrency transactions. Therefore, it becomes essential to establish well-structured regulations that can effectively counteract these cross-border criminal activities. Such regulations should address the issue of traceability and foster a secure environment, simultaneously allowing legitimate users to harness the advantages of cryptocurrencies.
SITUATING CRYPTOCURRENCIES WITHIN THE FEMA FRAMEWORK
In response to an RTI request, the RBI has provided clarity regarding the classification of cryptocurrency within the framework of FEMA. The RBI's stance is that cryptocurrency does not fit the definition of 'currency' as outlined in Section 2(h) of FEMA11, and there has been no official notification by the RBI designating it as such. Consequently, RBI does not categorize cryptocurrencies as 'currency' under FEMA. Instead, the characteristics of cryptocurrencies align more closely with those of goods under FEMA, allowing for potential classification based on their functional value and market demand. Cryptocurrencies possess unique attributes. Although intangible, they are produced, marketed, and stored on physical servers. They offer the capacity for various actions, such as buying, selling, transmitting, transferring, delivering, storing, and ownership. This multifaceted nature positions them within the sphere of goods, according to the FEMA's perspective.
An additional aspect of the discourse pertains to the classification of cryptocurrency as "foreign currency" or "foreign exchange". For instance, under Section 2(m) of FEMA12, "foreign currency" is defined as any currency apart from the Indian currency. It brings us to question, whether cryptocurrency could be deemed a form of foreign currency. This perspective gains traction while considering instances where cryptocurrency assumes financial obligations, potentially aligning with the concept of foreign currency within the FEMA framework. Furthermore, the Supreme Court has opined that if cryptocurrency functions as a medium of exchange, its lack of legal tender status does not preclude RBI from regulating it13. Advocates of this viewpoint also present an argument that if a foreign nation endorses cryptocurrency as a legal tender, it could automatically fall within the definition of "foreign currency" in India.14
However, this perspective encounters practical challenges. To date, except El Salvador and the Central African Republic (CAR)15, no jurisdiction has officially recognized cryptocurrency as a legal tender. Moreover, given the established principle that cryptocurrency cannot be classified as "currency" without an RBI notification, the question of regulating it as a subset of "foreign currency" loses significance. In a similar sense, since cryptocurrency cannot constitute "foreign currency," it should also fall outside the scope of "foreign exchange" under Section 2(n) of FEMA.16 In essence, RBI's clarification regarding cryptocurrency's classification within FEMA elucidates its distinct position from traditional currency and foreign exchange.
In the realm of cross-border cryptocurrency transactions, we can broadly categorize them into two main groups. The first category pertains to the buying or selling of cryptocurrency from sources outside India. In simpler terms, this involves using regular currency (fiat money) to acquire cryptocurrency from foreign sources or selling cryptocurrency held within India to receive foreign currency. The second category involves utilizing cryptocurrency as a form of currency itself – using it for international payments, making investments, and more.
When focusing on the first category of transactions, there isn't a direct prohibition in FEMA against purchasing or selling cryptocurrency using fiat money, as long as these transactions occur through authorized channels like banks. These transactions can be equated to standard trade transactions involving the exchange of goods for money. However, it's crucial to ensure that appropriate declarations are made when selling cryptocurrency under the Foreign Exchange Management (Export of Goods and Services) Regulations, 2015 (Export Regulation).17 While these regulations don't explicitly outline procedures for disclosing cryptocurrency, the general rules for disclosing exports may apply depending on the nature of transaction. The complexities become more apparent when cryptocurrency is employed as a substitute for traditional currency. As mentioned earlier, it's not suitable to classify or treat cryptocurrency as legal tender or standard currency. Consequently, it's necessary to delve into the pertinent rules and regulations that govern these types of transactions.
In the context of payments for exports and imports, the Foreign Exchange Management (Manner of Receipt and Payment) Regulations of 2016 ('Receipt and Payment Regulation') specify that such transactions must occur using appropriate foreign exchange or currency. This effectively means that cryptocurrency cannot be used for these transactions, as it does not qualify as foreign exchange or currency.
The argument that under Regulation 5(2)(b) of the Receipt and Payment Regulation18, cryptocurrency could be used as payment for imported goods if the exporting country recognizes cryptocurrency as a valid form of payment,19 assumes "cryptocurrency" to be included in the definition of "currency" as per FEMA. However, it is yet to be seen whether currency will be interpreted as per Indian laws or as per the laws of country of export to include or exclude cryptocurrency within its definition.
Also, if Indian residents participate in cryptocurrency transactions outside of India to make payments for goods and services from non-residents, these transactions will be subject to the Receipt and Payment Regulation or any other directions issued by the RBI.20 This regulation requires that the full value of exports and imports must be received through authorized banking channels. Consequently, a scenario where cross-border trade using cryptocurrency occurs without involving traditional fiat currency and authorized banking channels could be in violation of the Receipt and Payment Regulation. Therefore, the notion that cryptocurrency could be used for payments to the exporting countries, based solely on their recognition, lacks a solid foundation.
Another scenario involving cross-border transactions is in relation with remittances directed to non residents according to RBI's liberalised remittance scheme21, which allows a resident Indian to remit up to USD 250,000 via approved channels per financial year for any permitted current22 or capital23 account transactions or a combination of both as per the regulations prescribed under the Foreign Exchange Management (Current Account Transactions) Rules, 2000, as amended from time to time, and the FEMA or the rules or regulations framed thereunder. Arguably, within this framework, there exists a theoretical avenue for effecting these remittances through cryptocurrency. However, a notable caveat emerges which is the absence of formally authorised person24 or dealer for facilitating such transfers through cryptocurrency. As it stands, the lack of authorized persons or dealers to securely facilitate cryptocurrency transactions has created a palpable gap in this domain. The RBI could potentially authorise select cryptocurrency exchanges, publicly or privately held, or even a combination of both, as authorized person under FEMA to facilitate these cross-border payments using cryptocurrencies. RBI has the power to confer official recognition upon VDA as a valid and accepted mode of payment in consonance with the legislative directions and this should be aimed at fostering and amplifying cross-border transactions utilizing VDA as a conduit.
VALIDITY OF CRYPTO AS CONSIDERATION IN SMART CONTRACTS
In general, when it comes to smart contracts involving cryptocurrency payments, the principles of contract law and the terms of the contract itself would apply. The contract should clearly specify the terms of payment, including the type of cryptocurrency, the amount, and any conditions or timelines for payment. Additionally, it is important to consider any applicable laws and regulations related to cryptocurrencies and cross-border transactions in the relevant jurisdictions. These laws can vary significantly and may impact the enforceability and legality of the contract.
Section 10 of the Contract Act, lays down the fundamental criteria that transform an agreement into a legally binding contract in India, at its core, Section 10 outlines four crucial elements that must be fulfilled for an agreement to be considered a contract. An agreement which is made by the "free consent" of "competent parties" for a "lawful consideration" with a "lawful object" is a valid contract. Smart contracts encompass all the aforementioned fundamental aspects, yet a challenge emerges concerning the concept of consideration. Every contract requires a lawful consideration, in the terms of smart contracts, it is commonly expressed through digital assets or cryptocurrency like Bitcoin, Ethereum, and Litecoin. In India, the primary legal framework for contracts is the Contract Act. Pursuant to Section 10 of the Contract Act, consideration must be lawful, and Section 23 outlines the criteria for its legality. It stipulates that consideration is lawful if it adheres to the following: a) it is not prohibited by law; b) does not contravene any legal provisions; (c) is devoid of any fraudulent intent; (d) does not entail or suggest harm, and is not morally reprehensible or in conflict with public policy.
Hence, for a contract to be legally binding, the consideration it entails must satisfy the aforementioned criteria. The term 'law' as interpreted by the Supreme Court refers exclusively to established and effective statutes, excluding proposed bills in Parliament. To confer enforceability upon a smart contracts, the consideration involved, viz. cryptocurrency, must adhere to the requisites outlined in Section 23.
When we analyse these provisions, we can find that cryptocurrency indeed meets all the prerequisites necessary for a valid consideration. Firstly, there exists no prevailing legislation in India that deems cryptocurrency unlawful. Secondly, cryptocurrency does not contravene any existing legal provisions. Thirdly, rather than being harmful, it proves advantageous to both the public and the state due to its noteworthy attributes such as user autonomy, decentralization, accessibility, and encryption. These attributes contribute to enhanced efficiency, security, and the facilitation of unimpeded trade and technological exchange. Lastly, cryptocurrency does not bear any taint of immorality, fraudulence, or violation of public policy, assuming that it is not being used for any illicit or illegal purposes. Consequently, cryptocurrency fulfils all the fundamental criteria of a legitimate consideration. Hence, it can be said that smart contracts find legal validation and enforceability under the framework of Indian law.
The stance of numerous developed nations has leaned favourably towards cryptocurrency, leading to the establishment of supportive legal frameworks. In the United States, contract law encompasses State common law, judicial precedents, and codified principles known as the 'Restatement of Contracts.' While consideration remains an important element for contracts, specific requirements for such consideration are not delineated, unlike in Indian law. The legality of smart contracts is fully acknowledged and recognized by various states25 in United States including Arizona26 and Tennessee27. Similarly, the United Kingdom defines consideration as something of value, and the law commission has explicitly affirmed the compatibility of smart contracts within the UK legal system.28 Hence, both the US and UK legal systems recognize the legality and full enforceability of smart contracts rooted with cryptocurrencies and decentralized finance.
In the case of B2C2 Ltd. v. Quoine Pte Ltd29, the Singapore International Commercial Court noted that while cryptocurrencies may not possess the status of legal tender, they exhibit a fundamental characteristic of intangible property, representing a discernible entity of value. This indicates that even though cryptocurrencies may not be officially recognized as legal tender, their utilization as a consideration in business transactions effectively aligns with the purpose underlying the concept of consideration within contracts.
In the matter of M/S N.N. Global Mercantile Private Limited V. M/S Indo Unique Flame Ltd30, Hon'ble Justice Hrishikesh Roy quoted Hon'ble Chief Justice D.Y. Chandrachud's observation at a conference31 which said, "Technology and artificial intelligence are integrated into commercial transactions. One such example of integration of technology and contracts is a smart contract, where the terms and conditions of the contract are encoded. A breach in the terms of the contract would automatically enforce the contract." The statement falling from Hon'ble Chief Justice of India shows the acceptance of smart contracts as enforceable contracts in India if it satisfies the necessities of Contract Act.
Cryptocurrency inherently holds substantial value and is anticipated to appreciate further in the future, thereby meeting the criteria of valid consideration. Consequently, this alteration ensures that the enforceability of smart contracts and the rights of involved parties remain insulated from the uncertain fate of cryptocurrencies. In essence, by embracing this approach, smart contracts can retain their autonomy and viability, detached from the fluctuations and regulatory fate of cryptocurrencies.
In an era of increasing globalization, the demand for seamless cross-border transactions has become more pronounced, prompting the exploration of innovative solutions. Cryptocurrencies emerge as a compelling solution in this landscape. While traditional banks may attempt to reduce transaction fees to compete with crypto-based systems, the unparalleled immutability and security offered by blockchain technology give cryptocurrencies a distinct advantage.
The foundational objectives of the FEMA, as outlined in its preamble, emphasize the facilitation and promotion of foreign trade. Opting for an outright ban on cryptocurrencies, rather than embracing a regulatory approach, would seemingly run counter to FEMA's objectives. Though this article has not explicitly delved into the legal viability of a potential ban, its implications on India's foreign trade capabilities are undeniable. The regulatory authority vested in the RBI under FEMA appears sufficient for overseeing cross-border cryptocurrency transactions. This oversight could involve categorizing and normatively acknowledging cryptocurrencies as "goods." Interestingly, while the legislature might contemplate crafting a new regulatory framework to govern both domestic and cross-border cryptocurrency transactions, the RBI could effectively establish pertinent guidelines under FEMA without necessitating formal legislative adjustments.
In the scenario of a comprehensive cryptocurrency ban, a critical concern would arise regarding the rights of existing cryptocurrency holders. A blanket prohibition without prior establishment of a regulatory framework within FEMA could effectively block any avenues for these holders to exit their investments. By embracing innovation, adapting legal frameworks, and addressing risks, India can harness cryptocurrency's potential benefits while ensuring financial ecosystem security.
1. Meenal Garg, "A Regulatory Approach to Cross-Border Transactions through Cryptocurrency in India." SCC Blog, November 23, 2021. https://www.scconline.com/blog/post/2021/11/23/cryptocurrency-3/ last visited on 30.10.2023.
2. Jaideep Reddy, The Case for Regulating Crypto-Assets: A Constitutional Perspective, 15 Indian Journal of Law and Technology 379, 413-14 (2020)
3. Biswajit Banerjee, Digital Currencies and Cross-Border Policy Cooperation and Coordination, G20 Digest Vol. 2, Special Issue, pp 23-34, October, ©2020, Research and Information System for Developing Countries (RIS) https://www.ris.org.in/sites/default/files/2021-09/Biswajit%20Banerjee_2.pdf last visited on 28.10.2023
4. "Blockchain for Cross Border Payments." ScienceSoft footer icon. Accessed October 14, 2023. https://www.scnsoft.com/blockchain/cross-border-payments last visited on 28.10.2023.
5. 2020 SCC ONLINE SC 275
6. Definition of 'money' as given by F.A. Walker in his book 'Money in its relation to Trade and Industry', published in 1879 to the effect that "money is that which passes freely from hand to hand throughout the community in final discharge of debts and full payment for commodities, being accepted equally without reference to the character or the credit of the person who offers it and without the intention of the person who receives it to consume it or apply it to any other use than in turn to tender it to others in discharge of debts or payment for commodities."
7. 138 S. Ct. 2067 (2018)
9. 2020 SCC ONLINE KAR 1940
10. Andy Greenberg, Tracers in the Dark: The Global Hunt for the Crime Lords of Cryptocurrency, Doubleday (November 15, 2022)
11. Section 2 (h) of FEMA - "currency" includes all 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
12. Section 2 (h) of FEMA - "foreign currency" means any currency other than Indian currency
13. 2020 SCC ONLINE SC 275
14. Hatim Hussain, Reinventing Regulation: The Curious Case of Taxation of Cryptocurrencies in India, 10 NUJS Law Review 792, 802 (2017)
15. https://icrier.org/pdf/IPCIDE-Policy_Brief_2.pdf last visited on 24.10.2023
16. "foreign exchange" means foreign currency and includes,—
- deposits, credits and balances payable in any foreign currency,
- drafts, travellers cheques, letters of credit or bills of exchange, expressed or drawn in Indian currency but payable in any foreign currency,
- drafts, travellers cheques, letters of credit or bills of exchange drawn by banks, institutions or persons outside India, but payable in Indian currency
17. Foreign Exchange Management (Export of Goods and Services) Regulations, 2015 Part. II S. 3(i).
18. Regulation 5 (2) In respect of import into India –
- Where the goods are shipped from a member country of the Asian Clearing Union (other than Nepal and Bhutan) but the supplier is resident of a country other than a member country of the Asian Clearing Union, payment may be made in a manner specified for countries in Group B of Regulation 5;
- In all other cases, payment shall be made in a currency appropriate to the country of shipment of goods;
- Any other mode of payment in accordance with the directions issued by the Reserve Bank of India to authorized dealers from time to time.
19. India's Discomfort with Blockchain Based Currency: A Vacuum on the Legality of Bitcoins by Amit K. Kashyap & Akanksha Goyal
20. Master Directions on Export of Goods and Services FED Master Direction No. 16/2015-16 Dated 1 st January 2016
22. Section 2 (j) of FEMA - (j) "current account transaction" means a transaction other than a capital account transaction and without prejudice to the generality of the foregoing such transaction includes,—
- payments due in connection with foreign trade, other current business, services, and short-term banking and credit facilities in the ordinary course of business,
- payments due as interest on loans and as net income from investments,
- remittances for living expenses of parents, spouse and children residing abroad, and
- expenses in connection with foreign travel, education and medical care of parents, spouse and children;
23. Section 2 (e) of FEMA - (e) "capital account transaction" means a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or assets or liabilities in India of persons resident outside India, and includes transactions referred to in sub-section (3) of section 6
24. Section 2 (c) of FEMA - (c) "authorised person" means an authorised dealer, money changer, offshore banking unit or any other person for the time being authorised under sub-section (1) of section 10 to deal in foreign exchange or foreign securities
25. Illinois, 205 Ill. Comp. Stat. 730/5, 730/10 (2020); Iowa, Iowa Code Ann. § 554E.3 (2022); North Dakota, N.D. Cent. Code § 9-16-19 (2019); Arkansas, Ark. Code Ann. § 25-32-122 (2019); Idaho, Idaho Code § 28-5303 (2022); Kentucky, Ky. Rev. Stat. Ann. § 42.747 (West 2020); Nevada, Nev. Rev. Stat. §§ 719.045, 719.090, & 719.145 (2021)
26. Uniform Electronic Transaction Act (UETA) Ariz. Rev. Stat. Ann. § 44-7061 (2017)
27. Tenn. Code Ann. §§ 47-10-201–202 (2018)
28. Smart legal contracts Advice to Government, Law Commission, CP 563, Law Com No 401, Nov, 2021 last visited on 28.10.2023 at https://s3-eu-west-2.amazonaws.com/cloud-platform-e218f50a4812967ba1215eaecede923f/uploads/sites/30/2021/11/Smart-legal-contracts-accessible.pdf
29. "Cryptoassets, Cryptoliabilities: Bitcoin and Insolvency." South Square. Last visited on 16.10.2023 at https://southsquare.com/articles/cryptoassets-cryptoliabilities-bitcoin-and-insolvency/ .
30. 2023 SCC ONLINE SC 495
31. 6 Dr D.Y. Chandrachud, International Conference: Arbitration in the Era of Globalization (4th Edn., Dubai, 19-3-2022).
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