Jury out on fate of cryptos, NFTs

By Raghavan Ramabadran & Sai Prashanth, Lakshmikumaran & Sridharan in Chennai
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India stands on the cusp of a cryptocurrency boom even as a 2021 bill may scupper opportunities while also affecting prospects for non-fungible tokens, which are traded in cryptos. Raghavan Ramabadran and Sai Prashanth define the instruments and their predicament

In November 2021, the market capitalisation of the global crypto market crossed the USD3 trillion mark, surpassing the individual GDPs of the UK, France, India and Italy. India has slowly become a hub for cryptocurrency globally, with its crypto market expanding by 641% in the past year.

Similarly, non-fungible tokens (NFTs) are gaining traction with celebrities in India, with Bollywood actors, fashion designers and even cricketers entering the space. Bollywood superstar Amitabh Bachchan’s NFT collections of autographed posters and collectibles have received bids of close to USD1 million.

With the Indian market ripe with opportunities for cryptos and NFTs, it becomes imperative to understand them, and how they are regulated. This article provides a broad understanding on the two concepts and the ambiguities surrounding them.

All cryptos and NFTs are reliant on a blockchain network for their operation, so how does the underlying blockchain technology function?

BLOCKCHAIN TECHNOLOGY

A blockchain is a specialised database, essentially a digital ledger of transactions that is duplicated and distributed across a network of computing devices. A block is a bundle of information relating to transactions.

Raghavan Ramabadran, Executive partner, Lakshmikumaran & Sridharan
Raghavan Ramabadran
Executive Partner
Lakshmikumaran & Sridharan in Chennai

This bundle of information consists of transaction-related data and information called the hash value of the block, which also provides unique identification to the block. A blockchain network ensures asset security in such a manner that each block contains its own cryptographic signature, known as hash code or hash value, along with the hash of the block before it.

Information is first collated on the blocks and upon validation, and is added to the existing chain of blocks. For a block to be validated, more than 51% of the computers (called nodes) on which the ledger is maintained must confirm that the block is valid. This is called consensus protocol.

Each time a new transaction occurs on the network, a record of that transaction is added on the blockchain ledger of every participant’s computing device within the network. This database is decentralised in nature, since every transaction is stored on multiple devices within the network.

CRYPTOCURRENCY

A cryptocurrency is a digital asset present within a blockchain network that may be traded, utilised as a medium of exchange such as fiat currency, or used as a store of value. It is issued directly by the blockchain on which it runs, and that is why it is often referred to as a blockchain’s native currency. Examples of cryptos are Bitcoin, Ether, etc., and they are decentralised in nature, meaning they are not reliant on a central issuing authority.

Cryptocurrencies can be used as a currency to pay for goods or services, bought and sold like goods for profit, or invested in like savings to gain in value over time.

REGULATION OF CRYPTOS

From a legal perspective, how governments, central banks and regulators view and regulate cryptocurrencies plays an essential role in their development.

Sai-Prashanth
Sai Prashanth
Joint Partner
Lakshmikumaran & Sridharan in Chennai

Internationally, countries have embraced various frameworks to regulate cryptos. Canada and Switzerland regulate cryptocurrencies under their anti-money laundering legislation. Japan has gone a step further and accepted certain cryptos as a legal payment method. But on the other hand, countries such as China and Saudi Arabia have prohibited their use as a currency.

In India, there is no regulatory framework for cryptos to date, but the Reserve Bank of India (RBI) has always adopted a pragmatic approach since 2013. The RBI’s attempt in 2018 to ban banks and other financial institutions from facilitating cryptocurrency transactions was overturned by the Supreme Court in 2020.

During this period, a high-level inter-ministerial committee report in February 2019 recommended the enactment of a law to ban cryptos in India. Consequently, the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019, was introduced in the Lok Sabha (parliament). This bill did not materialise into law, much to the relief of the holders and traders of cryptos.

In January 2021, the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, was introduced into the Lok Sabha. The objective of the bill is to create an enabling framework for the official digital currency to be issued by the RBI, and to prohibit all private cryptos available in India. There is no clarity on what would be the scope and ambit of the phrase “private cryptocurrencies”. Reports suggest that India is likely to take a “middle path” on cryptos when the bill is tabled in the winter session of parliament.

TREATMENT AMBIGUITIES

Under the Indian law, cryptocurrency and its features invite different legal and tax implications. Presently, there are various regulatory gaps and implications that need to be considered in relation to cryptos.

An important question that needs to be addressed is whether cryptos can have the sanctity of a currency/legal tender issued by the government, as per existing laws. Multiple laws deal with regulation of currencies, including the Reserve Bank of India Act, 1934; Foreign Exchange Management Act, 1999; and Coinage Act, 2011.

Each of these deals with definitions such as currency, currency note, coin, etc., from the perspective of the objective of the respective acts. On an examination of the existing definitions, cryptocurrency may not fall under the purview of the term “currency” under these acts. While there is no clarity on this, it can safely be presumed that cryptos are not legal tender, based on the past actions of the RBI.

Another question that remains unanswered is whether cryptos qualify as goods/movable property. The answer to this question is pivotal to understanding the implications under several laws, as well as customs procedures and the Goods and Service Tax (GST). Representatives from crypto exchanges in India have approached the Central Board of Indirect Taxes and Customs’ Authority for Advance Ruling, seeking clarity on whether Bitcoin would be characterised as a “good” or a “service” for determination of tax rates under the GST.

Since no decision has been taken on whether to impose a GST on cryptos, the authority could not determine the nature of Bitcoin and demystify the issue. Similarly, only if a crypto qualifies as goods can it be subject to customs duty in the event of a cross-border transaction.

There are ambiguities from an income tax perspective as well. The classification of earnings from cryptos as business income or capital gains may depend on the nature of each investor, frequency of such transaction, income, etc. If a crypto is treated as ‘goods’, it may also attract the TDS (tax deducted at source) provisions under the Income Tax Act, 1961. Also, when a non-resident trades in an Indian crypto exchange and earns income, it remains to be seen if such income would be taxable in India, since the situs (place of origin) of the asset (cryptocurrency) becomes a determinative factor.

NFTS

An NFT is a type of crypto token. In economics, a non-fungible item is one that has unique properties and cannot be exchanged with something else. While both NFTs and cryptos are based on blockchain, the difference boils down to its fungibility, meaning the inherent capability of a commodity to be substituted. While cryptos are fungible, each NFT is unique and incapable of being substituted with another. NFTs can represent real estate, art, music, sports highlights, etc. NFTs are one-of-a-kind assets in the digital world that can be bought and sold like any other piece of property, but they have no tangible form of their own. These are digital tokens that can be thought of as certificates of ownership for virtual or physical assets, and can be bought or sold just like regular artwork. The ownership of NFTs is stored on the blockchain ledger. These records cannot be forged, since the ledger is maintained by thousands of computers around the globe.

REGULATING NFTS

An NFT’s treatment in law largely depends on the underlying asset. An NFT representing a work of art would be treated differently from one representing ownership of a video clip relating to sports.

NFTs are only traded in cryptos, and in India all platforms that have launched trading in NFTs to date are crypto exchanges. So, all uncertainties revolving around the legality of cryptos equally applies to the legality of NFTs.

There is also no clarity on whether NFTs are “contracts”, as per the Indian Contract Act, 1872, or whether they qualify as derivatives, as per the Securities Contract (Regulation) Act, 1956. If NFTs qualify as the latter, there is an embargo to exchange, trade, sell and buy.

While buying NFTs from abroad, issues can arise under the Foreign Exchange Management Act (FEMA). Questions arise over whether cross-border transfers of NFTs involve an export or import of an “intangible asset”. If yes, FEMA states that the transaction has to have a corresponding remittance of fiat currency done through authorised banking channels.

There may also be issues arising from the angle of IP laws. NFTs are digital collectibles with restricted rights, and generally do not transfer copyright ownership to a holder unless contractually agreed. An NFT holder can utilise the copyrighted material if a licence to do so is obtained from the copyright owner. At most, an NFT holder can display a purchased work in a limited capacity, or transfer the NFT by way of sale. The NFT holder cannot produce additional copies of the work.

CONCLUSION

The future in India is expected to revolve around digital assets such as cryptos and crypto tokens. India has the highest number of crypto owners in the world, at 100 million persons. The onus is now with the government on how to tackle the “crypto boom”.

The courts have emphasised that an outright ban is seldom the solution to perceived problems, and must only be a last resort. As things stand, all stakeholders will have to cautiously plan their next moves, while keeping a close eye on developments of the 2021 bill during the winter session of the parliament.

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