Now to Regulate Cryptocurrencies in India …

…by such sentences as ‘that thou art’, our own self or that which is untrue and composed of the five elements, is affirmed, but the sruti says ‘not this not that’ …
– Avadhuta Gita of Dattatreya

By quoting this conundrum of non-duality in its judgment, the Supreme Court (SC), in the Writ Petition #528 of 2018 (Internet and Mobile Association of India vs. the Reserve Bank of India), captured the essence of “that” to which no other definition applies. And “this” is how the SC has described the genesis of defining cryptocurrencies. 

In a well-conceived judgment quoting Satoshi Nakamoto and others, the SC  officially revoked RBI’s ‘ban’ on cryptocurrencies, which was the bane of virtual currency trading in India for almost two years.  

Ironically, while acknowledging that virtual currencies are meant to kill the demon of a central authority, the SC has held that the RBI has the requisite power to regulate or prohibit virtual currencies. Thus, supported by the argument that anything that could pose a threat to the financial system of India can be prohibited by the RBI, despite the activity not forming part of the credit or payment system, the SC ultimately upholds the central authority. The Payment and Settlement Systems Act, 2007 empowers the RBI to issue directions to banks that are system participants with regard to transactions categorized as payment obligations.  

RBI’s contention was that its April 6, 2018 circular, directing RBI-regulated entities to debar virtual currencies, aimed to: 

• Protect consumers 
• Prevent violation of money laundering laws
• Curb the menace of financing terrorism
• Safeguard the existing monetary/payment/credit system.  

The Inter-Ministerial Committee constituted on November 2, 2017, which introduced a new law, “Crypto-token and Crypto-Asset (Banning, Control and Regulation) Bill, 2018,” asserted that a banning is extreme and same objectives may be achieved through regulatory measures. But this opinion underwent a sea-change when the Committee presented its final report, recommending a complete ban on private cryptocurrencies through the proposed legislation – Banning of Cryptocurrency and Regulation of Official Digital Currency Act, 2019. The Bill recommended creation of a digital rupee as legal tender by the Central Government in consultation with the RBI, while continuing to recognize foreign digital currencies in India. 

The RBI circular, while not banning cryptocurrencies, terminated the lifeline of virtual currency trading and functioning of virtual currency exchanges by disconnecting them from the banking sector. Post the new SC judgment, cryptocurrencies are here to stay, for India to move forward and properly regulate these instruments.

Fast-paced, cutting edge innovations, such as virtual currencies, have created concomitant risks in data security and consumer protection. The Indian government needs to take stringent measures to protect consumers while not stifling innovation:

In India, the Central Board of Direct Taxes (CBDT) enters the investment domain only when the transaction is related to the sale and purchase of taxable goods and commodities. In its office memorandum of March 5, 2018, submitted to the Department of Economic Affairs, the CBDT had proposed legislative amendments and a ban on cryptocurrencies. Now that Indian cryptocurrency has new potential, the CBDT needs to re-examine the impact of online payment options and virtual currencies to determine whether or not it creates a taxable situation.  

Blockchain technology does not work without a token, and tokens need to be traded in and out of fiat/government-backed currencies. As the implication is a persistent chance to make a profit (in the respective fiat currency terms), the CBDT needs to clarify its stance to provide answers to crucial questions such as: Should crypto-to-crypto transactions be taxable in India? The CBDT also needs to delve into other possible taxable issues, such as earning a crypto-dividend.

Permission for the flow of fiat to crypto and vice-versa  via cryptocurrency exchanges would curtail non-compliance. However, such reform (post the SC decision) would require the RBI to allow crypto exchanges to access the banking sector.

As Indian banks are not drawn towards cryptocurrency exchanges they may be turning business away to other soil. The RBI needs to bring back this business by allaying the fear that funds could be used by criminals on the dark web or for money laundering. 

Initial Coin Offerings (ICOs)  enable companies to raise money by issuing digital tokens in exchange for cryptocurrency. However, the issuance of ICOs poses a clear risk as many companies raise money without any tangible products to back it. The GOI needs to delineate the parameters governing an ICO to keep abreast of the cryptocurrency wave. Such data is vital for informing investors and regulators on ICO rules such as who is governing the ICO, whether there is a refund mechanism on delivery failure, and who is in charge of governance issues. Before launching an ICO service, the Department of Economic Affairs needs to define whether an ICO is a derivative, or a contract for difference, or a collective investment scheme, or something totally different. 

The Securities and Exchange Board of India (SEBI) can step in only when transactions involve securities within Section 2(h) of the Securities Contracts (Regulation) Act, 1956. On July 23, 2018, SEBI informed the Department of Economic Affairs that it was not best suited to regulate crypto assets and tokens. SEBI may need to rethink this stance as it could benefit from becoming the regulator of cryptocurrency exchanges for ICOs. Under SEBI’s watchful eye, exchanges would be incentivized to conduct due diligence. 

From the investor’s perspective, anyone willing to invest should ideally qualify via a Know-Your-Customer and Anti-Money Laundering process. Each ICO investment should have a preamble that informs investors on the risks to their investment.  

Though the SC judgment has given a new interpretation to cryptocurrencies, distinguishing the ‘technology’ (Blockchain) from the ‘product’ (Bitcoin), India still lacks a clear grasp of the challenges in this new field. In June 2015, the Financial Action Task Force (FATF), an inter-governmental organization founded in 1989 under a G-7 initiative to develop policies to combat money laundering, offered a Guidance for a Risk Based Approach to Virtual Currencies. Its purpose: to instruct stakeholders on how virtual currency products and services function and impact regulatory regimes in respect of Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT). 

The Bank for International Settlements has sought concerted policy responses, warning that cryptocurrencies have become a combination of a bubble, a Ponzi scheme, and an environmental disaster. With the SC framing the ground rules for India, it is now left to the RBI, certain enforcement agencies, and relevant departments of the Government of India to create a viable home for virtual currencies in the country.

Authored by Sajai Singh, Partner, J. Sagar Associates (a law firm)