Position as on: 19th May, 2021
The Supreme Court of India passed an important judgement on 4th March, 2020, in the matter of “Internet and Mobile Association of India v. Reserve Bank of India.” It set aside the Reserve Bank of India (“RBI”) circular “Statement on Developmental and Regulatory Policies” dated April 6, 2018 which prohibited its regulated entities from facilitating transactions relating to Virtual Currencies (“VCs”).
1. Background
The rise of VC trading in India, with over 1.5 crore crypto holding Indians, is tempered by the apprehension of banks to integrate and facilitate crypto-trade. All virtual currency transactions in India are arguably an exchange of commodities and find their completion when financial institutions facilitate their trade. The Indian Government’s projected policy is a blanket ban on VCs, a measure recommended by the RBI, after the Supreme Court set aside its indirect ban. In this political-legal environment, banks are concerned that facilitating virtual currency transactions would be at odds with the position of the regulating body and government. Previously, RBI has issued numerous press releases to users, investors and banks, cautioning them about the security related risks associated with the dealing in VCs (like Bitcoin and Ethereum), it then passed the 2018 Circular which prohibited entities regulated by it (such as banks, NBFCs) from dealing with or facilitating transactions for entities that dealt with VCs. This resulted in an indirect ban on VCs in the country, spelling doom for Crypto Start-ups. In July 2019, The Central Bank of India froze the account of an Indian Crypto Exchange, Koinex, citing the RBI circular. Subsequently, the Internet and Mobile Association of India (IAMAI) filed a writ petition, challenging the RBI Circular before the Supreme Court.
2. Judgement
The petitioners argued that the RBI did not have power to regulate VCs as they are not legal tender but are tradable commodities or goods, hence would not fall under the regulatory framework of the RBI Act, 1934 or the Banking Regulation Act, 1949. Additionally, services rendered by VCs did not qualify as ‘payment systems’ under the Payment of Settlement Systems Act, 2007. The petitioners also argued that there was no application of mind by the RBI and the impugned circular was in bad faith as it did not protect regulated entities or the public. Petitioners also contended that the impugned circular was disproportional and failed the test of reasonable restriction under Article 19(6) of the Constitution of India, the fundamental right to practise any profession, or to carry on any occupation, trade or business.
The Court held, since VCs were an accepted form of payment by some institutions, RBI has the requisite power to issue directions regarding such transactions. It further stated, “it is impossible to say that RBI does not have the power to frame policies and issue directions to banks who are system participants, with respect to transactions that will fall under the category of payment obligation or payment instruction, if not a payment system”.
The Court, however, agreed with the petitioners on the ground of reasonable restrictions and found the circular was a disproportionate restriction on the fundamental right under Article 19(6). The reasons inter-alia, was the inability of the RBI to show harm by VC Trading to its regulated entities. It noted that VC Trading is not banned under any law and no defects in their operation were reported by the regulatory body over a period of 5 years. The Supreme Court set aside the impugned circular, lifting the indirect ban on banks from facilitating virtual currency transactions, subject to existing due diligence norms.
3. Present Challenges
While the quashing of prohibition was a moment of relief for VC exchanges and start-ups, the sector has since been presented with further challenges. The RBI is allegedly advising lenders to cut ties with VC traders and Exchanges. Some banks have disabled virtual currency transactions on their payment systems and have blacklisted merchants buying or selling cryptocurrencies. This self-regulation comes with the National Payments Corporation of India (NPCI) refusing to ban virtual currency transactions and asking banks to decide for themselves.
In February this year, the Securities and Exchange Board of India had cautioned promoters of companies about the hindrance crypto-assets may pose, if they wanted to raise money through Initial Public Offerings. These advisories and self-regulation measures come in the face of a proposed Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 which will criminalize possession, issuance, mining, trading, and transferring of crypto-assets.
With the government reaffirming its stand on invalidating VCs as legal tender, Crypto Exchanges are calling for a healthy regulatory environment and the creation of a hybrid regulatory body under SEBI and RBI. The Financial Action Task Force (FATF), a global standard-setting body for anti-money laundering and combating the financing of terrorism, has also called for creation of such regulatory bodies. In a June 2019 Report titled ‘Guidance for a risk-based approach to Virtual Assets and Virtual Asset Service Providers’ it strongly recommended regulation of VC Exchanges and highlighted the harms a blanket prohibition may have on their money laundering and terrorist financing risks.
While the finance minister recently indicated that the government would adopt a calibrated approach in regulating cryptocurrency, a deviation from their projected policy so far, it has been reported that the central government may appoint a fresh panel of experts to study the same.
Despite the hurdles posed by the informal directions of the RBI and the proposed Bill banning private VCs, exchanges are hopeful that the penetration level of VCs in India now will persuade the government to take a more favorable view.
This post was authored by Abhinav Goyal & Aastha Kapoor.
The authors may be contacted at abhinav@sigmachambers.in.
DISCLAIMER. THIS CONTENT HAS BEEN PREPARED FOR INFORMATIONAL PURPOSES ALONE AND IS NOT A SUBSTITUTE FOR LEGAL ADVICE. PLEASE OBTAIN LEGAL ADVICE PRIOR TO ACTING ON OR RELYING ON THE CONTENTS OF THIS PAGE.