Much like its value, the regulatory journey of bitcoin has had its ups and downs in India. With the recent jump in value, how will regulators react? Sourish Mohan Mitra reports
Trading in bitcoins has been breaking records. Its value climbed to an alltime high of US$42,000 recently before sliding to a 10-day low of US$31,977. But India got to see a darker side of the cryptocurrency with the recent news on the seizure of bitcoins worth ₹90 million (US$1.2 million) from a hacker in Bengauru. This was interesting against the backdrop of the bizarre bitcoin rally, and brought to memory another unsavoury incident, in March 2014, when investors lost millions as the world’s largest bitcoin exchange at the time, Japan-based Mt Gox, collapsed. Such activities in India are currently not regulated, leaving it quite open to operational curiosity.
Bitcoin, first released as open-source software in 2009, is the first decentralized cryptocurrency, and since its release others have emerged. The Financial Action Task Force (FATF), which is the global money laundering watchdog, in a 2014 report stated that cryptocurrency refers to a maths-based, decentralized convertible virtual currency that is protected by cryptography, i.e., it incorporates principles of cryptography to implement a distributed, decentralized, secure information economy.
Cryptocurrency relies on public and private keys to transfer value from one person (individual or entity) to another, and must be cryptographically signed each time it is transferred. The safety, integrity and balance of cryptocurrency ledgers is ensured by a network of mutually distrustful parties (in bitcoin, referred to as miners) who protect the network in exchange for the opportunity to obtain a randomly distributed fee. When implemented with decentralized control, each cryptocurrency works through distributed ledger technology, typically a blockchain, that serves as a public financial transaction database.
Let us take a step back and go through the regulatory journey of bitcoin in India, where it was viewed with suspicion by the authorities. We will also examine how the regulator fared, the involvement of the highest court in the land, and what lies ahead for bitcoin as a new law is being proposed for the official digital currency.
Catching the regulator’s eye
Immediately prior to the Japan debacle, the Reserve Bank of India (RBI) had warned of their usage via a press release dated 24 December 2013, stating that the creation, trading or use of virtual currencies (VCs), including bitcoins, as a medium for payment were not authorized by any central bank or monetary authority. No regulatory approvals, registrations or authorizations were stated to have been obtained by the entities concerned for carrying on such activities.
The RBI continued to issue similar advisories, and ultimately issued a statement on developmental and regulatory policies dated 5 April 2018, which, in paragraph 13, said that in view of the associated risks it has been decided that, with immediate effect, entities regulated by the RBI shall not deal with, or provide services to, any individual or business entities dealing with or settling VCs.
This restriction was elaborated on by an RBI circular on 6 April 2018, which mentioned that, with immediate effect, entities regulated by the RBI shall not deal in VCs, or provide services for facilitating any person or entity in dealing with or settling VCs. Such services included maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them, and the transfer/ receipt of money in accounts relating to the purchase/sale of VCs. A timeline of three months was provided to regulated entities that already provided such services to exit the relationship.
As trading in VCs was already a revenue generating activity, the above RBI statement and circular were challenged in the Supreme Court. In the following two years, the court heard arguments on the matter and pronounced its judgment on 4 March 2020, in the case of Internet and Mobile Association of India v Reserve Bank of India. The judgment provides a fascinating account of activities of various government institutions relating to VCs, clearly indicating a huge interest in this area. It also shows that most developments were against dealing in VCs, although in some situations the government seemed to oscillate towards regulation of the same.
To ban or not to ban?
The government constituted an inter-ministerial committee on 2 November 2017 – under the chairmanship of secretary of the Ministry of External Affairs, with the secretary of the Ministry of Electronics and Information Technology, chairman of Securities and Exchange Board of India, and deputy governor of the RBI as members – to study the issues related to VCs, and propose specific action to be taken in this matter.
Ironically, it appears that at about the same time as the RBI’s 2018 circular, the committee submitted its initial report (or a precursor to the report) along with a draft bill known as the Crypto Token and Crypto Asset (Banning, Control and Regulation) Bill, 2018. The committee, which initially recommended a specific legal framework including the 2018 draft bill, was of the opinion that a ban might be an extreme tool, and that the same objectives could be achieved through regulatory measures.
Subsequently, the committee did a complete U-turn, and proposed the ban in its report dated 28 February 2019, which contained the draft of the Banning of Cryptocurrency and Regulation of Official Digital CurrencyBill, 2019.
Globally, there are concerns that VCs can be used for unlawful, terrorist or anti-money laundering activities.
Some experts have also claimed that it is akin to a financial bubble. Accordingly, it needs to be evaluated whether banning VCs will address this concern and eliminate the risk, or in doing so, will unnecessarily affect the livelihoods of stakeholders who could be legitimately running the business. It looks like we are at a crossroads with cryptocurrencies.
In this respect, the Supreme Court high-lighted an important aspect: That the RBI has so far not found, in the past five years or more, the activities of VC exchanges to have adversely impacted the way entities are regulated by the RBI function. The Supreme Court, while setting aside the RBI circular, held that: “The position as on date is that VCs are not banned, but the trading in VCs and the functioning of VC exchanges are sent to comatose by the impugned circular by disconnecting their lifeline namely, the interface with the regular banking sector.
“What is worse is that this has been done:
(1) despite the RBI not finding anything wrong about the way in which these exchanges function; and
(2) despite the fact that VCs are not banned. As we have pointed out earlier, the concern of the RBI is, and it ought to be, about the entities regulated by it. To date, the RBI has not come out with a stand that any of the entities regulated by it namely, the nationalized banks/scheduled commercial banks/cooperative banks/non-bank financial companies have suffered any loss or ad- verse effect, directly or indirectly, on account of the interface that the VC exchanges had with any of them.”
Seeing promise in blockchain
Another dichotomy that emerged in the government statements is support for blockchain, which is the technology behind VCs. This was mentioned in the committee report, as well as in the government’s 2018-19 budget speech, which said: “The government will explore the use of blockchain technology proactively for ushering in a digital economy.”
Perhaps it would be easier to promote blockchain technology by giving some legitimacy and recognition to its usage. There is a hint of this in the same budget speech, which mentioned: “The government does not consider cryptocurrencies legal tender or coin, and will take all measures to eliminate use of these crypto assets in financing illegitimate activities, or as part of the payment system.”
It would perhaps be a huge boost to the government’s Digital India Programme – under which Apiary, a centre of excellence in blockchain technology, was launched in 2020 – if the government could come out with suitable financially-protected provisions that could adequately regulate VCs, and promote blockchain at the same time. This would be tantamount to the proverbial killing of two birds with one stone.
The 2018 draft bill definitely merits a revisit in view of the Supreme Court judgment, which observes that the 2018 draft bill contained a proposal:
(1) to prohibit persons dealing with activities related to crypto tokens from falsely posing these products as not being securities, or investment schemes, or offering investment schemes, due to gaps in the existing regulatory framework; and
(2) to regulate VC exchanges and brokers where sale and purchase may be permitted.
The key aspects of the 2018 draft bill, found in paragraph 13 of the “note-precursor to report”, shows that the committee was fine with the idea of allowing the sale and purchase of digital crypto assets at recognized exchanges. The increase in value of cryptocurrencies, together with its blockchain technology, could be a moot point for Indian regulators to step in as the government gears up to introduce The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (2021 bill) in the Budget session of the Lok Sabha.
The committee report has also proposed that the government may establish a standing committee to revisit the issues addressed in the report, as and when required. The government seems to have accepted these recommendations as the objective for the 2021 bill is to create a facilitative framework for an official digital currency to be issued by the RBI.
The 2021 bill also seeks to prohibit all private cryptocurrencies in India, although it allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses. Despite the current direction taken, there have been significant developments in the past two years, since the committee report was published, that need to be accounted for by the government in deciding the future of cryptocurrencies. A holistic view should be adopted by the parliament when it finalizes the framework for cryptocurrencies including reconsidering the proposal to ban private currencies.
Sourish Mohan Mitra is an India-qualified lawyer currently working with the in-house team of a global technology research and advisory firm in New Delhi. The views expressed are personal. The author can be reached at firstname.lastname@example.org or Twitter: @sourish247.