India: All's Well For Cryptocurrency In India?

The Supreme Court, in a recent decision¹ has held the Reserve Bank of India's ("RBI") circular dated

April 06, 2018 ("Circular"), which prohibited entities regulated by RBI from dealing with virtual currency, as disproportionate and has accordingly revoked the said prohibition.

In December 2013, RBI issued a press release highlighting the risks associated with virtual currencies and cautioned users, holders and traders of virtual currencies about potential financial, operational, legal, customer protection and security risks. This was followed by two press releases on a similar premise in 2017.

Taking this one step ahead, in April 2018, RBI notified the Circular that dealt with virtual currencies and prohibited regulated entities from dealing with the same. As per the Circular, all entities regulated by RBI were prohibited from:

(i) dealing with virtual currencies; and

(ii) providing services² to facilitate any person or entity in dealing with or settling virtual currencies.

In short, while the RBI did not ban virtual currencies per se, it only prohibited regulated entities from rendering services to entities/persons dealing with virtual currencies. The Circular also provided for a 3 (three) month period from the date of issuance of the Circular within which, all regulated entities were directed to put an end to all forms of engagement with entities dealing in virtual currency.

By blocking the channel between fiat currency and virtual currency, the Circular paralyzed the growth of cryptocurrency in India. The Circular resulted in an immediate decline in wide range of virtual currency-based activities in India. In fact, several prominent and growing companies in this space began to shift their base to other countries such as Singapore and Estonia.

The Internet and Mobile Accessories of India ("Petitioner") challenged this Circular before the Supreme Court seeking a direction to the RBI to not restrict or restrain banks and financial institutions, from providing banking services to those engaged in the transaction of crypto assets. In parallel, there were multiple writ petitions filed before various High Courts on the same matter. Due to multiplicity of cases emanating from the Circular, the Supreme Court allowed the RBI to transfer all those cases from various High Courts to the Supreme Court. The Supreme Court further directed that no other High Court will entertain writ petitions in relation to the impugned Circular.

The Petitioner's prime contention in this matter was that the RBI has no power to prohibit the activity of trading in virtual currencies through virtual exchanges as it is not an activity which the RBI is mandated to regulate.

Assuming the RBI had the power to regulate such an activity, it was contended that the RBI had not exercised prudence and the ban failed the test of proportionality.

It was also pointed out that there are very few countries which have put an absolute ban on dealing with virtual currencies. Further, the Petitioner highlighted the fact that that even in India other than the RBI, none of the other regulatory bodies such as the Enforcement Directorate and Securities and Exchange Board of India, shared the same view as RBI.

It was also contended that the ban went against the Petitioner's fundamental right to carry on trade or business. Lastly, it was submitted that banning such activities should be a legislative function and should not arise out of an executive action.

RBI defended the Circular stating that the object of introducing this prohibition was to ensure (i) consumer protection; (ii) prevention of violation of money laundering laws; (iii) curbing financing of terrorism; and (iv) safeguarding existing monetary/payment/credit system from being polluted. These claims were refuted, and it was stated that best practices have been adopted, such as (i) avoidance of cash transactions; (ii) enhanced know your customer norms; and (iii) confining their services only to persons within India to resolve RBI's concerns.

Supreme Court's Findings and Decision

The submission that virtual currencies may not be regulated by RBI was rejected by the Supreme Court. Given some institutions accept virtual currencies as valid payments for purchase of goods and services, the Supreme Court held that the activities carried on by users and traders of virtual currencies falls within RBI's purview.

The contention that prohibition in trading of virtual currency should be by way of a legislation and not an executive action was rejected by the Supreme Court. Relying on judicial precedents, the Supreme Court held that what articles and goods should be allowed to be produced, possessed, sold and consumed is to be left to the judgment of the legislative and executive wisdom. Additionally, the Supreme Court rejected the contention that the Circular prohibited use or trading in virtual currencies and pointed out that it only directed the entities regulated by RBI not to provide banking services to those engaged in trading or facilitating the trading in virtual currencies.

The Supreme Court was of the view that any restriction to the freedom guaranteed under Article 19 (1)(g) of the Constitution of India, should pass the test of reasonableness. The court observed that virtual currency exchanges did not have any other means of survival if they were disconnected from banking channels. Therefore, while there was no direct ban on the business conducted by virtual currency exchange entities, the action of prohibiting regulated entities from dealing with these entities, indirectly violated the Petitioner's fundamental right. Further, the court took into account the Petitioner's reliance on the four-pronged test to determine whether RBI' action was proportionate. The elements of the four pronged test include (i) whether measures were designated for a proper purpose; (ii) that the measures are rationally connected to fulfilment of such purpose; (iii) that there are no alternative less invasive measures; and (iv) that there is a proper relationship between importance of achieving the aim and the importance of limiting the right. The Supreme Court noted that the RBI failed to present any empirical evidence demonstrating that the business of the Petitioner caused any harm to the regulated entities and concluded that the RBI's action was disproportionate.

For the reasons above, the court set aside the Circular on the grounds of proportionality.

Conclusion

The judgment demonstrates the forward-looking attitude of the apex court and positively evokes praise. While this judgment is certainly a start, there are various challenges that the virtual currency industry may have to face. The first challenge may be on account of the RBI filing for a review of this judgment for further scrutiny. The law in relation to virtual currency is still not frozen and may undergo drastic changes in the near future. The judgment merely held the Circular disproportionate and did not rule on the legitimacy of virtual currencies. Virtual currencies may very well be banned if the Parliament passes a law on this subject prohibiting dealing in virtual currencies. The 'Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019', a bill on this subject matter prescribes usage of virtual currencies and provides for disproportionate penalties such as imprisonment of up to 10 years for activities such as mining, holding and selling of cryptocurrencies. Players in the virtual currency industry are in a wait and watch mode. The coming months would be instrumental for such players. It would be interesting to see if the legislature's approach is whether to effectively regulate virtual currencies, or simply ban it.

Footnotes