“When digital transformation is done right, it’s like a caterpillar turning into a butterfly, but when done wrong, all you have is a really fast caterpillar.” — George Westerman
The aforementioned quote illustrates that unless implemented correctly, digital transformation can end up being a façade. The digital currency ecosystem in India is passing through a phase where growth of the digital currency market is happening amidst regulatory uncertainty. The growth of virtual currency (“VCs”) sector is the last decade marked the beginning of a new digital economy. It would not be wrong to state that in this digital age, we had started visualizing a new VC ecosystem.
In the last decade we noticed growth in the VC sector worldwide. However in India, since inception, the VC sector has been battling the regulator with intrinsic value of VC as a legal tender often being questioned. It has often been argued that, VC lack the very basic attributes of legal tender and that VC may pave way for criminal activities including money laundering, since as opposed to other non-cash payment methods, VC offers greater anonymity. The RBI and government since the growth of the VC market in India have been making efforts to highlight the security, operational and the consumer protection risks associated with the VC ecosystem.
By way of circular dated April 6, 2018, RBI prohibited the entities regulated by it from dealing in virtual currencies and from providing services for facilitating any person or entity in dealing with VCs. Regulated entities which were already providing such services were directed to exit the relationship within 3 months from the date of the circular. Way back in November 2017, an Inter-Ministerial Committee (“IMC”) was constituted by the government to analyse the implications of VCs, which submitted its report in February 2019. The IMC in its report had observed that cryptocurrencies (a specific type of VC) do not offer any advantage as a currency and proposed the ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’ (Crypto Bill) with an intent to prohibit the usage of cryptocurrencies as legal tender and to criminalize activities connected with cryptocurrencies. At the same time, the draft Bill contemplated (i) the creation of a digital rupee as a legal tender, by the central government in consultation with RBI and (ii) the recognition of any official foreign digital currency, as foreign currency in India. Even though the IMC report did recognize the need to regulate the VC sector considering several factors, including the degree of pseudonymity associated with VC transactions, the inability of the current regime to deal with the risks associated with VC industry, RBI and the central government are yet to clear the air on VC.
The VC sector had almost come to a standstill after the aforementioned circular of RBI dated April 6, 2018, which prohibited the entities regulated by it from dealing in VCs. It lead to many VC exchanges shutting down in India or shifting overseas. It created an uproar in the VC sector which lead to the circular being challenged by way of several writ petitions. The matter was finally heard by the apex court in the matter of Internet and Mobile Association of India vs. Reserve Bank of India. The Supreme Court was of the view that till date,
RBI has not come out with a stand that any of the entities regulated by it namely, the nationalized banks/scheduled commercial banks/cooperative banks/NBFCs has suffered any loss or adverse effect directly or indirectly, on account of the interface that the VC exchanges had with any of them. Citing another decision by the hon’ble court, the apex court stated that there must have been at least some empirical data about the degree of harm suffered by the regulated entities (after establishing that they were harmed). In light of the aforementioned reasoning, the apex court set aside the impugned RBI circular dated April 6, 2018.
There have been reports suggesting that RBI intends to file a review petition against Supreme Court’s judgement, setting aside April 6, 2018 circular of RBI. However, there have also been reports suggesting that recently, RBI in response to an RTI, has clarified that there is no prohibition on banks in providing accounts to traders dealing with virtual currencies. However, we are yet to see if RBI comes up with a revised circular in light of the apex court judgement. Amidst lack of clarity from the regulator, the Indian VC market has been swiftly growing with several cryptocurrency exchanges reporting upsurge in users, trading volume and new cryptocurrency exchanges opening in India.
Despite the fact that the April 6, 2018 circular has been set aside by the apex court, the biggest battle for the VC sector continues to be absence of a clear legal framework considering that the Crypto Bill is pending in the parliament. Amidst this lack of clarity from the RBI and government, banks had continued to show their distrust towards VC and many banks had denied their services to crypto currency sector players. RBI’s response to the RTI may act as a beacon of light and may pave way for banks serving cryptocurrency players without hurdle.
Absence of clarity from RBI may also be a hurdle in attracting foreign investors in the Indian VC market considering that even the foreign direct investment regime does not regulate or restrict VCs. The confusion prevails not just on the regulatory front but also on the taxation of VC transactions. VC players are seeking clarification as to how they will be taxed under the GST regime. The apex court has also been of the view that the RBI Act, 1934, the Banking Regulation Act, 1949 and the Payment and Settlement Systems Act, 2007 cumulatively do recognize vide powers of RBI to regulate inter alia financial system of the country. Hence, the apex court has in a way recognized RBI’s authority to regulate the VC sector.
Though the apex court has paved way for the Indian VC sector to boom by overturning the blanket ban on cryptocurrency imposed by RBI, new investors will show interest in the Indian crypto market only if the government and RBI act together, shedding off all their inhibitions regarding issues involving VCs and come up with clear regulatory framework governing digital currency. The persisting regulatory uncertainty may be the biggest hurdle for the Indian crypto market renaissance after the apex court judgement and majority of the investors would prefer waiting until there is more regulatory clarity on VCs. Akshay Pathak is an Associate at Cyril Amarchand Mangaldas, Delhi office. His practice area includes domestic and cross-border M&A transactions, and general corporate matters including restructurings.