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In-depth analysis: Supreme Court lifts ban on trading cryptocurrency in India

The Supreme Court of India has lifted the ban from the cryptocurrency Industry on the trading of virtual currency, cryptocurrency, and bitcoin.

Background of the case

Ban on Cryptocurrency trading by RBI:

On 6 April 2018, the RBI, India’s Central Bank issued a circular that had virtually banned cryptocurrency trading in India and directed all the RBI regulated entities to prohibit itself from providing any service concerning virtual currencies, including those of receipt or transfer of money in accounts relating to the purchase or sale of virtual currencies.

The central bank also gave the regulated entity three months to exit from its banking relationships with businesses or individuals dealing in virtual currency.

The ban aimed to “ring-fence” the country’s financial system from the private virtual currencies by making them illegal. This very circular was later challenged before the Supreme Court.

Legal Action by the Internet and Mobile Association of India (IMAI):

The legal action against the above mentioned Circular was initiated by the Internet and Mobile Association of India (IMAI), a nonprofit organization that works to expand and enhance India’s online and mobile value-added services sectors by representing various cryptocurrency exchanges.

The Supreme Court gave its final verdict in favor of the petitioners, through a comprehensive analysis of the moot points, as discussed in the next section.

The decision of the Supreme Court:

Following are the salient highlights of the judgment, which led the Court to lift the ban on cryptocurrency trading finally.

RBI is well within its power to deal with Virtual Currencies (VCs):

Petitioners argued that the RBI is not within its powers to deal with, regulate, or even ban VCs and VCEs. It was contended that VCs are not money or another legal tender, but only goods/commodities, falling outside the purview of the RBI Act, 1934, Banking Regulation Act, 1949, and the Payment and Settlement Systems Act, 2007.

The Court determined the issue at the following two levels:

  • Analyze the powers and functions of RBI.
  • Then to investigate what these virtual currencies are.

Analyzing the powers and functions of RBI :

The Court analyzed the statutory acts from which the RBI drew its power, which are the RBI Act, 1934, the Banking Regulation Act, 1949, and the Payment and Settlement Systems Act, 2007.

Under the RBI Act 1934, section 21, IMAI case at Par. 6.35, Empowers RBI to determine the policy concerning advances to be followed by banking companies.

The determination of policy may be in:

  • Public interest.
  • Interests of depositors.
  • Interests of the banking policy.

Under the Payment and Settlement Systems Act, section 17 at Par. 6.48. That empowers RBI to issue directions to a payment system or a system participant.

Which, in RBI’s opinion, is engaging in any activity that is likely to result in systemic risk being inadequately controlled or is likely to affect the payment system, the monetary policy or the credit policy of the country.

Section 18 Ibid. at Par. 6.49, of the Payment and Settlement Systems Act, 2007, further empowers RBI to issue directions to system providers or system participants or any other person generally.

To regulate the payment systems or in the interest of management or operation of any of the payment systems or public interest.

Legal qualification of Virtual currency (VCs) :

For the second part of the analysis, the Court went on to determine whether VCs are a form of money or commodity.

Here the RBI took the stance that VCs are not recognized as legal tender, but they seek to justify the impugned decisions on the ground that VCs are capable of being used as a medium of exchange.

The Court went into detail in analyzing how VCs were defined:

  • By regulators in different jurisdictions.
  • By the governments and other statutory authorities of various countries, through statutory instruments and non-statutory directives.
  • By courts of different jurisdictions.

After a prolonged analysis, the Court observed that the regulators and the governments of various countries hold the unanimous opinion that though virtual currencies have not acquired the status of a legal tender, they nevertheless constitute digital representations of value.

Thus VCs are capable of functioning as:

  • A medium of exchange
  • A unit of account
  • A store of value Ibid at Par. 6.59

The Court went on to analyze the definitions of currency under different acts, amongst which only FEMA had defined currency Ibid at Par. 6.67.

The word “currency” is defined in Section 2(h) of the Foreign Exchange Management Act, 1999 (hereinafter, ‘FEMA’) to include “all currency notes, postal notes, postal orders, money orders, cheques, drafts, traveler’s 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.”

However, the Court relied on the VCs definition under the FATF Report 2014 Ibid at Par. 6.63, RBI has taken a stand in paragraph 24 of its counter-affidavit that VCs do not fit into the definition of the expression “currency” under Section 2(h) of FEMA, even though FATF, in its report on June 2014 on “Virtual Currencies.”

The Key Definitions and Potential AML/CFT Risks” defines virtual currency to mean “a digital representation of value that can be digitally traded and functions as:

  • A medium of exchange
  • A unit of account
  • A store of value, but it does not have legal tender status.

Which provides that the VCs are a virtual currency without a legal tender status. Also, the Court said that it is not necessary for the RBI’s role and power to come into play only if something has acquired the status of a legal tender.

Apart from the domestic definitions, the Court analyzed the judicial interpretations from various jurisdictions.

Here multiple courts in different jurisdictions have identified virtual currencies to belong to different categories ranging from property to commodity to non-traditional currency to payment instrument to money to funds.

As per the Court, such varying definitions might have put RBI in a dilemma Ibid at Par. 6.86.

Nothing prevents RBI from adopting a short circuit by notifying VCs under the category of “other similar instruments,” indicated in Section 2(h) of FEMA, 1999, which defines ‘currency’ to mean “all currency notes, postal notes, postal orders, money orders, cheques, drafts, travelers’ 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.”

The Court ruled that VCs are capable of being used as a medium of exchange. They are akin to promissory notes, cheques, bills of exchange, etc. which are also not precisely currencies but operate as valid discharge (or creation) of debt only between 2 persons or peer-to-peer.

Therefore, it is not possible to accept the contention of the petitioners that VCs are just goods/commodities and can never be regarded as real money.

After concluding that VCs are currencies, the Court held that the RBI is well within its power to regulate the Ibid at Par. 6.90. But as pointed out elsewhere, RBI is the sole repository of power for the management of the currency, under Section 3 of the RBI Act.

RBI is also vested with the sole right to issue banknotes under Section 22(1), and to issue currency notes supplied to the Government of India and has an important role to play in evolving the monetary policy of the country.

By participation in the Monetary Policy Committee, which is empowered to determine the policy rate required to achieve the inflation target, in terms of the consumer price index.

Therefore, anything that may pose a threat to or have an impact on the financial system of the country, can be regulated or prohibited by RBI, despite the said activity not forming part of the credit system or payment system.

The expression “management of the currency” appearing in Section 3(1) need not necessarily be confined to the management of what is recognized in law to be a currency, but would also include what is capable of faking or playing the role of a currency.

Consequently, it is not possible to accept the contention of the petitioners that they are carrying on an activity over which RBI has no control statutorily.

Impugned Circular does not prohibit trading in VCs:

The Court observed that the impugned Circular does not entirely prohibit the use of or trading in VCs but merely directs the RBI regulated entities not to provide banking services to those engaged in the trading or facilitating the trading in VCs.

RBI is well within its power to do so Ibid at Par. 6.94, Section 36(1)(a) of the Banking Regulation Act, 1949 very clearly empowers RBI to caution or prohibit banking companies against entering into certain types of transactions or classes of transactions.

The prohibition does not affect the VCs trading directly as it is against banking companies, concerning a class of transactions.

Ban adversely affects VC Exchanges:

Any restriction to the freedom guaranteed under Article 19(1)(g) should pass the test of reasonableness in terms of Article 19(6).

With such an aim, the Court distinguished between three categories of people involved in cryptocurrency trade who are hobbyists, traders in VCs, and VC Exchanges, based on the existence of profit motives.

The first category, which is the hobbyists cannot claim any fundamental right as they are not covered under any profession, occupation, trade, or business under Article 19(1)(g).

The second category comprising the traders who have made purchase and sale of VCs can perfectly challenge under Art. 19(1)(g) as they are involved in occupation or trade.

These are citizens who have taken up the trade of buying and selling virtual currencies:

  • Either from trading in crypto-to-crypto pairs.
  • In using the currencies stored in their wallets, to make payments for the purchase of goods and services to those who are prepared to accept them, within India or abroad.

The Court here held that impugned circulars neither prohibited nor indirectly paralyzed them as these forms can still find their way to or through the market, despite being prevented from accessing the banking services.

The Court gave the decision in favor of the third category, who are involved in the business of online exchanges that provide certain services such as the facility of buying and selling of virtual currencies, the storing or securing of virtual currencies in what are known as wallets and the conversion of virtual currencies into fiat currencies and vice versa.

These VC exchanges do not appear to have found out any other means of survival (at least as of now) if they are disconnected from the banking channels, unlike VC traders.

VC exchanges through the online platforms are severely affected by the Circular since the commission that they earn by facilitating the trade is required to be converted into a fiat currency, which is not possible in the absence of any banking channels.

Thus the exercise of such a power by RBI, over the entities regulated by it, has caused collateral damage to some establishments like the petitioners, who do not come within reach of RBI’s net.

Concluding the impugned Circular infringes Art. 19(1)(g) For the VC exchanges, the Court went on to analyze the test of proportionality against the circular.

On the question of proportionality, the Court relied upon the four-pronged test Ibid at Par. 6.157 summed up in the opinion of the majority in Modern Dental College and Research Centre v. State of Madhya Pradesh (2016) 7 SCC 353

The four tests:

  • Measure is designated for a proper purpose.
  • Measures are rationally connected to the fulfillment of the purpose.
  • There are no alternative less invasive measures.
  • There is a proper relation between the importance of achieving the aim and the importance of limiting the right.

Concerning these four tests, the Court held that the measures taken by the RBI failed to meet the third test as there were less intrusive measures available, which were considered as an alternative.

RBI did not consider the availability of alternatives before issuing the impugned circular.

The Court found:

  • RBI has not so far found, in the past 5 years or more, the activities of VC exchanges to have impacted adversely the way the entities regulated by RBI function.
  • The consistent stand was taken by RBI up to and including in their reply dated 04-09-2019 is that RBI has not prohibited VCs in the country.
  • The Inter-Ministerial Committee constituted on 02-11-2017, which initially recommended a specific legal framework, including the introduction of a new law namely, Crypto-token Regulation Bill 2018, believed that a ban might be an extreme tool and that the same objectives can be achieved through regulatory measures.

Earlier, the European Union Parliament Ibid at Par. 6.163. The discussion in paragraph 5.7 of the July 2018 Report also addressed the issue in the parliament.

To address whether it is best to introduce an outright ban on some aspects linked to some cryptocurrencies, or to make the ultimate recommendation not to go for a total ban on the interaction between cryptocurrency business and the formal financial sector as a whole.

Although the VCs are not banned, 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.

In conclusion, the Court held that the measure failed to meet the proportionality test as RBI was unable to show at least some semblance of any damage suffered by its regulated entities through VC exchange.

Implications:

The judgment is going to be a game-changer for India’s crypto ecosystem, which has already witnessed a considerable growth potential over the past years.

A study released by Crebaco Global Inc. stated that Indian crypto exchanges such as UNocoin, ZebPay and others recorded $5.6 billion as a total trading volume in 2019.

Additionally, trade-related activities from the Indian IP industry on Binance between January – December 2018 were at 7.9% — a number that clearly shows a booming interest among Indian people when it comes to cryptocurrencies.

The study then proceeded to highlight that crypto and blockchain technology has been able to create a massive increase in the number of jobs.

For instance, Crebaco’s data suggested in 2019 that around 6,150 individuals got employment as blockchain content writers and coders within India’s local fintech market.

Currently, India has a record number of mobile subscribers with around 1.2 billion, while 582 million people have bank accounts. Thus the ban lift can be seen as a huge opportunity to use digital currencies for financial inclusion.

With this judgment, decks are cleared for a regulatory regime of cryptocurrency in India instead of a complete ban.

In a separate bunch of petitions, the Supreme Court is also examining the issues related to the regulation of cryptocurrency. The judgment on Wednesday will have an impact on the pending case too.

Thus the judgment will bring in health regulations for cryptocurrency trading in India as the judge’s panel has understood the enormous potential that blockchain and crypto possess and how these technologies can transform the economic and digital landscape of the nation in the coming few years.

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