CRYPTOCURRENCY IN INDIA: THE PROHIBITION-REGULATION DILEMMA

by Aman Gugnani and Drishti Arora

Introduction

The Cryptocurrency Bill[1], the much-awaited legislative action to regulate the domain of cryptocurrency, was ultimately listed for discussion in the recent Winter Session of the Parliament. This particular bill is different from its predecessor, Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019 , as it omits the words “banning of” in the title. This is a key indicator that reaffirms the stand taken by the Government that the new bill allows, “certain exceptions to promote the underlying technology of cryptocurrency and its uses“. However, the description of the bill stays the same. The earlier bill had been strict regarding any activity involving cryptocurrency, be it mining, storing, selling or disposing, involving cryptocurrency. Similar provisions are still expected in the new legislation. Through this bill, the Government intends to introduce a Central Bank Digital Currency (CBDC) to reap the benefits of virtual currency, while simultaneously safeguarding customers from the risks associated with the volatility of these markets. Most Private Cryptocurrencies are expected to be banned, barring researching and experimentation. The present article, while elaborating the stands taken on both Central Bank Digital Currency and Private Cryptos, analyses the effect of their regulation. While appreciating the introduction and regulation of the former, this piece criticises the potential ban to be levied on the latter and makes a case for considering them as an intangible property.

RBI Circular of 2018 and SC Judgement 2020

Since 2013, the Reserve Bank of India (RBI) has published a series of public statements to warn the possible dangers of cryptocurrency use to the nation’s economy. On 28th February 2019, the Inter-Ministerial Committee issued a report advocating several restrictions on cryptocurrencies, including a total prohibition on private cryptocurrencies. The Crypto Token and Crypto Asset (Banning, Control, and Regulation) Bill, 2018 was also drafted by this panel.

The RBI released a circular in April 2018 prohibiting authorised financial firms from offering services to enterprises engaged in the conversion or trading of cryptocurrencies. This threw the Indian cryptocurrency trading industry into disarray. Various writ suits filed by crypto-trading organisations contested the legitimacy of the circular in the Supreme Court. The Hon’ble Supreme Court of India (SC) issued its final verdict of Internet and Mobile Association of India vs. Reserve Bank of India on 4th March 2020, which concerned cryptocurrencies and the RBI Circular. This judgement established the legality of cryptocurrency. The SC ruled that the RBI was within its powers to release the circular to achieve its legal goal of safeguarding the “interests of the public, depositor interests, and banking policy interests“. The SC held that “Anything that may constitute a risk to or have an effect on the financial market, despite the aforementioned activity not making it part of the credit facility or money system, can be controlled or forbidden by RBI“. The SC dismissed the claim that the RBI had used undue authority because the circular was published in the favour of banking policy, depositors and the public. Though the RBI was found to be within its authority to publish the circular, the absence of evidence of the “proportional damage” incurred by the RBI-controlled enterprises in engaging with cryptocurrency companies led to the circular being struck down. Although the RBI  found no problems with the running of these exchanges, the SC concluded that the circular isolated the financial system from cryptocurrency exchanges. Before publishing the circular, the RBI did not investigate the possibility of less intrusive alternatives, such as controlling bitcoin trade and cryptocurrency exchanges. Even though the SC verdict in 2020 brought temporary respite, there is no permanent regulation on the cryptocurrency market at this time.

Central Bank Digital Currency and Its Goals

Cash is a distinct commodity with four characteristics: (i) It is traded peer-to-peer, i.e., beyond the knowledge of the provider; (ii) It is global, as anyone can have it; (iii) It is anonymous; and (iv) It pays no dividend. Whereas, Central Bank Digital Currency (CBDC) is a peer-to-peer (P2P) substitute to currency that allows for modifications in three other characteristics: (i) It can be global or limited to a certain group of people. For example, Distributed Ledger Technology (DLT) can be accessible or closed, they can be limited to banks or financial institutions; (ii) It can be untraced/undiscovered like cash, or detectable like credit cards provided by banks. The first example correlates to the concept of token-based CBDCs, whereas the second belongs to the concept of account-based CBDCs; and (iii) It has the option of paying interest or not. The decoupling of cash and paper money allows for the inclusion of profit as a feature, whether in an account-based or a cash-based system.

Goals

CBDCs have 4 main goals: (i) To augment the efficiency of wholesale payment solutions; (ii) To substitute cash with a much more effective alternative; (iii) To keep improving the tools accessible for fiscal policy, particularly when dealing with the zero lower bound; and (iv) To decrease the occurrence and possibilities of financial meltdowns.

How do these goals align with the many possibilities available to CBDCs in comparison to cash?

DLT is a system that allows a decentralised digital database to run securely. The necessity for a central authority to maintain a check on manipulation is eliminated with distributed connections. Using encryption, DLT provides for the secure and accurate storing of any information. Using “keys” and cryptographic identities, the same can be obtained. Once the knowledge is saved, it forms an irreversible database that is subject to the platform’s rules. Real-time gross settlement (RTGS) refers to a financial transfer system that enables the exchange of cash and/or equities in real time. The RTGS system is an ongoing cycle of clearing payments on an individual order basis without aggregating debits and credits over a central bank’s books.

If the focus is to enhance the efficiency of wholesale payment systems, and you believe DLT will be more effective in the future than RTGS, you may develop CBDCs that are exclusively available to banks and other financial entities that engage in the system. The subsequent CBDC would be recognised because entrants would be known to the rest, constrained because it would not be accessible to the overall public and non-interest yielding because systems like these rely usually on nominal accounts, which are known to be associated by Central Bank and such institutions move funds in their cashflow framework. The Central Bank which is at the heart of conventional RTGS, would be just other participant in this arrangement, albeit this would preserve authority over certain aspects like admission and membership.

If the goal is to substitute cash with a much more effective method of payment, you would initiate a CBDC that is ubiquitous like cash, in the sense that everyone who has it can utilise it, anonymous in nature like cash and non-interest-bearing to mimic cash. But why would the government want to switch from physical currency to a virtual format? One reason is because issuing, circulating, and retiring tangible cash needs a pricey network, whereas digital currency dynamics are cheap. Also, physical currency degrades with time, it is unclean and hence, spreads infections. It also causes crimes like theft and fabrications, among other reasons. 

Open DLTs have a limitation and so a digital counterpart would be simpler, more productive and secure. Although DLTs are currently less efficient than RTGS, the gap between the two is not huge. As a result, a marginal improvement in DLTs could provide a credible substitute for RTGS. If the policymakers desire to improve economic instruments, particularly at the zero lower bound, they could implement a universal, anonymous and yield-bearing CBDC. It should be widespread because you want to reach the general public and eventually replace banknotes in people’s hands, yield-bearing because you want to seize this opportunity that electronic currency offers to bring positive and negative interest rates and anonymous because it is equivalent to cash, though it can be recognised separately.

If the goal of adopting CBDCs is to lessen or even eliminate the probability of a financial crisis and its destabilising effects, the mechanism should be universal, identifiable, and non-interest bearing. Although the prospect of incorporating both characteristics of identified and interest bearing is often an option, the idea is to open accounts for the community in the Central Bank, to be recognised, as in the case of bank deposits and to be non-interest bearing. As per the logic underlying this concept, financial services crises, are caused by fractional commercial banks, which means that fixed-value sight deposits are now under longer-term lending with a variable price and restricted fluidity. Banks are prone to banking crises because of this imbalance. The source of payments would be disentangled from the supply of finance if the Central Bank gave funds to the populace in the manner of CBDCs, and most banking crises would be avoidable according to Rogoff.

Pros and Cons Analysis of Central Bank Digital Currency

Central banks ought to be aware of the good and bad effects of digital fiat currency on economic stability and money supply. As a result, the evaluation of central bank digital currency benefits and drawbacks assumes that they are linked to central bank functions. Let us now examine the benefits and drawbacks of central bank digital currency in greater depth.

CBDC, or Central Bank Digital Currency has become a possible alternative to digital money for central banks. CBDCs are being portrayed as a viable choice by internet firms such as Facebook, who have lately begun projects in the crypto asset market. However, it is critical to consider the advantages of central bank digital currencies to determine their worth.

The lower transaction costs are the most appealing feature of central bank digital currency. CBDCs can help with speedier institutional and retail payments while having lower transaction costs. It also puts a special emphasis on promoting economic growth in tandem with digital innovation. CBDCs have the potential to provide a secure digital currency jurisdiction while fostering a vibrant crypto industry. As a result, they have the potential to boost economic activity and to promote spillover effects in other technical sectors. CBDCs might be a much more cost-effective alternative to cash for storing value. CBDCs have a lower cost factor because they don’t have to pay for manufacturing, storing, shipment, or disposal. At the same time, CBDCs provide secure distribution options and alleviate concerns about fraud in the payment ecosystem.

Organisations might try to establish a trailblazer reputation by seizing chances with CBDC while it is still in its infancy. A corporation can pioneer definitions of monetary policy related CBDCs by exhibiting an active interest in CBDCs early on. As a result, firms operating on CBDC could serve a key role in developing the many CBDC-related standards. Liquidity is a key consideration for central bank digital currency pros, as it allows them to provide short-term liquidity support. Users can also take advantage of CBDC’s cash benefits on bank holidays. CBDCs can thus be beneficial in reducing the possibility of single institutions becoming implicated in globally-triggered chain reactions.

When you think of CBDCs, the word “financial inclusion” comes to your mind. Digital currencies issued by Central Banks could enable the bulk of unbanked consumers gain access to digital payments. CBDCs can assist customers in gaining access to contemporary digital payment tools at significantly reduced or no cost, even if they do not have a bank account. CBDCs are likely to improve competitiveness in the payment systems environment. They can also encourage private players to innovate by motivating them. Banks would battle for bank deposits tied to the assets that might be transferred to CBDC. The most significant advantage of CBDCs is that they do not require the use of intermediaries. As a result, CBDCs could play a key role in exponentially reducing the time for settlement and supporting real-time transactions. Finally, CBDCs could be used as a direct monetary policy instrument if they pay interest. As a result, it could help confer direct power over the government supply. Proponents of Central Bank digital currencies also claim to have increased privacy through their interface by offering higher level anonymity, in comparison to existing commercial bank card payments.

On the other hand, we must consider the disadvantages of CBDCs, the major drawbacks associated with CBDCs are as follows; It has a significant geographic limitation because they are only valid in the country that issued them. Central banks may become main competitors of payment service providers, resulting in revenue losses for banks. Additionally, new CBDC investment opportunities may diminish the demand for consumer deposits. As a result, CBDCs may be able to reduce bank lending to the wider market and economic growth. As crypto-based CBDCs are not linked to traditional currencies, they may experience greater price volatility. Commercial banks may face increased rivalry because of central bank digital money. The fact that CBDCs could be used as a substitute for bank deposits may encourage banks to raise deposit rates. Then, instead of deposit funding, it may be necessary to switch to wholesale funding.  Digital currencies issued by central banks can likely raise a system-wide bank run. Banks which would run based on such models could become more common in times of financial crisis, with no regard for time or vicinity.

A Crypt for Private Cryptos?

Private Cryptocurrencies, in all probability, are expected to be denied legal tender. The argument behind this is that it lacks the essential characteristics of a “currency”. The definition of currency has been provided in The Foreign Exchange Management Act, 1999

‘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.”

Keeping this definition in mind, private cryptocurrencies could have been put under “such other similar instruments“. The reasoning for such measure can be found in Inter-Ministerial Committee Report[2], which holds that they lack all the attributes of currency – currency being used here in an economic sense. Any currency is always accompanied by a fixed nominal value – which means face value on which it can be redeemed. Private Cryptocurrencies do not have any fixed nominal value and their value is highly based on market volatility – “which renders them incapable of being used as a medium of exchange or act as a store of value”. The value of cryptocurrencies is not attributed by the Central Bank and is left on the market forces of supply and demand. This is also the primary intention behind launching a central digital currency – so that it can be assigned a nominal value coming from a centralized authority. Not only this, but there are also several issues concentrated around the anonymity of transactions that could result into increased rates of crime.

Besides the afore-stated, the Inter-Ministerial committee report outlines several other issues – which seem to have formed the primary motivation as to why private cryptocurrencies are being banned. The law-makers strongly believe that the anonymity of the transactions, if allowed, will result in a direct assault the rigorous efforts of the government to prevent crime. It isn’t just about procuring narcotics, weapons or other banned substances by paying for these products in cryptocurrency, rather it also allows for services such as hire-for-kill a seamless way to do businesses. Popular examples of the same is Silk Road, the infamous dark net website, which, like its successors thereof, allows for exchanging drugs via paying for them in cryptocurrency. Moreover, cryptocurrency is a safe haven for terrorist groups. A 2014 report by Financial Action Task Force[3] stated that decentralized nature and anonymity – which private cryptocurrencies exclusively provide – makes the job of law enforcement authorities to track illegal activities difficult. Besides these concerns, there is a threat of money laundering and an increased potential to invest money in the black markets.

Even if these illegal activities are countered by the claim  that anything has the potential of being misused and this shouldn’t be a decisive factor for deciding whether anything should be outlawed, there are economic risks as well. For one stance, as highlighted above as well, there is no fixed price and value highly depends on market fluctuation, as has been explained above. Another argument is that the cryptocurrency has been designed in such a way that it makes transactions irreversible – which means once a fraud has been done, there is no way that it could be remedied. Then the issue of power consumption has often been cited. Mining cryptocurrency especially required high electricity consumption and computation power since it anyway works on a distributed network. Another major issue is the incapability of taxation, since the transactions are anonymous and it is almost equally difficult to determine possession, it will be severely difficult for the government to determine how much tax can be levied.

After this brief rundown of the reasons highlighted in Inter-Ministerial Committee Report on Virtual Currencies, an examination of the proposed action against cryptocurrencies is necessary. The problematic issue here is that although there are several arguments regarding banning of private cryptocurrencies, many which are in tandem with established economic principles, still there is no definition nor any evaluation criteria allotted within the legislation to determine if any currency falls within the set of private cryptocurrencies. Even if this is overlooked, the issue again stands whether adopting this ‘orthodox’ position on use of private cryptocurrencies will be useful. Simply put, banning private cryptocurrencies may not result in the desired outcome, but could open a Pandora’s Box of problems.

A ban only establishes that the currencies are not regulated and have not been provided legal tender – which ultimately may give rise to an even wider array of problems that legislators are concerned to eradicate. The estimated value of cryptocurrencies in India far exceeds the expectations of legislators, which makes it that more difficult for the legislators to ban the cryptocurrencies in one stroke. Any step taken will have a significant impact on the crypto market and leaving investors to downward spiralling fluctuations, which is how the market will behave if there is an outright ban, will be like striking one’s leg with an axe. The offences are taken as deterrent, but the reception depends a lot on how private stakeholders react to it. Holding that these cryptocurrencies have no value only looks at the value in legal terms. In real world, where the technology is far exceeding the hands of regulations, it is only a matter of time they become even more difficult to trace. Regulation, on the other hand, allows for law to enter these spheres effectively by retaining the benefits of the efficient technology and simultaneously act as a deterrent for ‘illegal’ use. The position should be to accept them as digital assets, rather than completely banning in hope of eradicating private cryptocurrencies.

The question now stands how and to what extent the domain should be regulated. Let us try to draw on the concerns put forth and previously stipulated. A fixed nominal value can be interpreted as a promise by the Central Government to pay the person possessing such currency that value. Any investor while investing in cryptocurrency will know the inherent risks associated with it and it would be an obvious concern. There is not a compulsion that a fixed nominal value must be assigned – which means that an investor would not be able to redeem any “fixed” value of currency from the Government and fluctuating value will only be reduced to a concern for the investor.

Similarly, legal tender, in practicality, bounds people to accept a particular currency as a mode of payment. Denying private cryptocurrencies legal tender ultimately results in giving an option to people to deny if they wish to exchange their goods or services with cryptocurrency. This can also be allowed. The point is cryptocurrency does not need to be regulated as a form of currency – but rather be considered. This might sound like the field is not being regulated at all, but there is a way where governments can keep just enough control in their hands while allowing public to reap the benefits of the new technology.

It is not denied that crypto assets are designed in a way that create practical obstacles for legal intervention, but it simultaneously does not mean that they could be kept outside of the realm of law.[4] Examining the nature of cryptos, they are, inevitably, coming under intangible personal property. Allowing them to be considered cryptos as a property not only gives investors rights to ownership and possession, but also helps in taxation requirements. Taxes can be directly levied on miners and like in any market; it will introduce a chain reaction of miners recovering their taxes from customers and so on. Similarly, another possibility is to tax the owners of cryptocurrency for possession of the intangible property – an approach taken by the UK Government. Furthermore, they can be used as a mode of payment – something akin to barter transactions. Not denying them legal tender and still permitting them to be used as a mode of payment does not expose the public to volatility of the markets, while allowing them to reap its benefits based on mutual trust and agreement. The stance has also been taken, quite recently, in the Ruscoe v. Cryptopia Ltd (In Liquidation)[5].

Conclusion

The Winter Session 2021 of the Indian Parliament saw an increased hype around the field, when the legislation was introduced. However, the Session failed to deliberate and conclude upon the Cryptocurrency Bill, however it being converted into a legislation is a distinct possibility.  It is speculated that the reason for not discussing on the bill includes factors such as determining how other countries may react to it, to allow a coherent scheme for investors to back their investments from cryptocurrency, to rethink the stance on private cryptos due to a huge market in India, etc.

Whatever may be the reason, the fact remains that India is still not clear about their stance on cryptocurrency. From the steps taken in the recent years, it seems to be that the government would still adopt a reserved and orthodox position on the matter. Although it is not denied that a Central Digitized Currency is needed for smoother finance as well as allowing the people to reap its benefits, it cannot be denied that a frenzy for private cryptos within investors is not going to die down soon. Private Cryptos, seeing the concerns regarding an increase in crimes and panic amongst legal enforcement institutions, can very well be denied legal tender, but completely banning them from a country whose 7.30% of the population owns cryptocurrency and finishes at the top rank for highest number of crypto owners[6] is no minor feat and if allowed, can result in a turmoil amongst investors. It’s high time the lawmakers pursue better options which allow us to reap the benefits of the innovative technology while simultaneously allowing us to levy a check on illicit activities which follow. The recommendation to consider private cryptos as property allows us the same, as highlighted in the case above to be a definitive solution to the current problems. It is not feasible nor viable for private cryptos to be instantly banned in a country – the ramifications could be catastrophic.


[1] The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021.

[2] Report of the Committee to Propose Specific Actions to be taken in relation to Virtual Currencies, Committee in Virtual Currencies, Department of Economic Affairs, Ministry of Finance, 28th February 2019

[3] Virtual Currencies: Key Definitions and Potential AML/CFT Risks, Financial Action Task Force, June 2014

[4] See Legal Statement on Cryptoassets and Smart Contracts, UK Jurisdiction Taskforce, The LawTech Delivery Panel, November 2019, Available at: https://35z8e83m1ih83drye280o9d1-wpengine.netdna-ssl.com/wp-content/uploads/2019/11/6.6056_JO_Cryptocurrencies_Statement_FINAL_WEB_111119-1.pdf

[5] [2020] NZHC 728.

[6] The Countries with Highest Crypto Awareness Scores, Crypto Countries: The Countries with the Most Interest in Cryptocurrency, Broker Chooser, Available at: https://brokerchooser.com/education/crypto/crypto-countries.


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