Decoding Cryptocurrency- Legal Status in India and Rest of the World

The state of Cryptocurrency has been in a constant conundrum in all the major countries since its advent in 2009. Cryptocurrency has been an amazing attempt to move the banking system into a more digitized format but simultaneously has been a threat to the old, secure and a centrally authorized system of banking. A lot of countries have legalised Cryptocurrency’s use but still haven’t put their whole faith into it. In India, RBI has made every attempt to stop its Spread with 2018 statement banning its use. But cryptocurrency’s fate reversed with The Supreme court judgement in 2020 by lifting the ban for its use. This article will give a deep analysis of cryptocurrencies and its handling in major countries especially in India.

Kshitij Pandey from Dr. Ram Manohar Lohiya National Law University, Lucknow

Cryptocurrency Introduction

Cryptocurrency is a digital or virtual currency designed to work as a medium of exchange wherein cryptography is used to store individual coin ownership in a computerized database. There were some theories related to cryptocurrencies in the 20th century like ‘How to Make a Mint’ the Cryptography of Anonymous Electronic Cash’ published by NSA in 1996. But formally it was introduced by Santoshi Nakamoto in 2009. He created ‘Bitcoin’, the first decentralised cryptocurrency. The cryptocurrency system is totally digitized means no hard notes or coins. It came to be as a revolutionary aspect of digitized transactions and performing other functions as it is fast, efficient and is systematic.

 A person can acquire bitcoins in 3 ways –

  1. By purchasing bitcoins in exchange for money
  2. By mining, mining is a process in which transactions for various form of cryptocurrency are verified and added to the blockchain database.
  3. By transacting with another Bitcoin user e.g.- selling any commodity in exchange for bitcoins

Features

  1. Its digital and not in the form of notes and coins.
  2. It is completely owned and regulated by private entities i.e.-The government has no control over cryptocurrencies and there are no regulations in place. Members of blockchain can transfer funds for each other directly without any interference from the government.
  3. There is no bank or any other centralised financial institution that is involved in recording or facilitating cryptocurrency transactions This eliminates the presence and need of middlemen. An elimination of these middlemen reduces transaction costs and increases the speed of sending and receiving currency.
  4. Cryptocurrencies offer anonymity to its users because transfers and transactions takes place cryptographically.

Misuse and Disadvantages

The main concern/disadvantage about cryptocurrencies are-

  1. Security– The system is not run by central authorities but rather its decentralized and also being privately owned. This means that there can’t be much check and balances to its misuse. A person in a middle of transaction can lose all of his money through malfunctions or hacking. Cryptocurrencies are prone to hacking. In 2019, hackers have successfully breached 11 major cryptocurrency exchanges and have stolen more than $283 million worth of cryptocurrency[1], according to blockchain analysis firm Chainalysis.  Bithumb, South Korea’s biggest cryptocurrency exchange, was hacked on June 2019 with $ 30 million in tokens stolen. Italian exchange BitGrail was hacked in February 2019, with $195 million in the token Nano was stolen[2].
  2. No legal backing– Cryptocurrencies don’t have a legal backing and are not considered legal assets.
  3. Misuse –  Due to lack of regulation, Cryptocurrencies have been used by criminals to evade taxes and launder money. It is also being used in online black markets like Silk roads and dark net markets. Cryptocurrencies are reported of being a security threat as terrorists can fund weapons through digitized transactions not being traceable due to lack of central control over it. Cryptocurrencies can also be used to evade economic sanctions like Russia, Iran, and Venezuela have successfully did so in the past. Russia also secretly supported Venezuela with the creation of El Petro, a national cryptocurrency initiated by the Venezuela government to obtain oil revenues by evading US sanctions.

 Cryptocurrency and their Legal Status In Different Countries  

Following the unprecedented growth in cryptocurrencies, the regulations too have been increasing to try and govern them. Many countries have different stance on them.

USA

Cryptocurrencies are not considered legal tenders in USA. While legal regulations vary from state to state and federal authorities also differ in defining the term ‘Cryptocurrency’. The exchange regulations are uncertain as various federal regulators claim jurisdiction. The Commodity Futures Trading Commission has regulated virtual currencies as commodities. The Securities and Exchange Commission requires registration of any virtual currency traded in the U.S. if, it is classified as a security. The regulatory structure also includes tax regulations and FINCEN transparency regulations between financial exchanges and the individuals and corporations with whom they conduct business. The Internal revenue service regards cryptocurrency as asset or property and requires for gains or losses upon an exchange of cryptocurrency to be calculated.

Due to its illegal handling, a lot of law suits have been filed against companies dealing with cryptocurrencies. Like in Commodities future trading commodity vs McDonell,[3] New York federal Court Ordered Defendant Patrick mcdonell to Pay to pay over $1.1 million in compensation to the Commodity Futures Trading Commission (CFTC) alleging fraud in connection with virtual currencies, especially Bitcoin. Another case is New York Office of the Attorney General v. Infinex[4], where New York state attorney alleged Infinex of committing fraud of $850 million fraud with their cryptocurrency ‘Tether’ which they said is lost while dealing with a Panama based company. However, The court ruled in favour of Infinex[5].

China

 Cryptocurrencies are not considered legal tenders in China. Cryptocurrency exchanges are considered illegal too. The People’s Bank of China (PBOC) prohibited financial institutions in handling Bitcoin transactions in 2013, and went further by banning ICOs and domestic cryptocurrency exchanges in 2017. However crypto-mining is legal in China.

China has made a reputation of having harsh cryptocurrency regulations. However, the atmosphere around China is changing. Shanghai’s Intermediary court held Bitcoin as legal assets that should be protected by law, while they ruled a case involving theft of cryptocurrency. The Shenzhen Futian  Court in Guangdong Province, ruled that Ethereum (cryptocurrency) is legal property with economic value while dealing with another theft case[6]. Various other courts are ruling in favour and considering cryptocurrencies as proper financial and legal assets. Some Government officials endorsed of having   Blockchain technology. China is looking to be a leader in the coming future with reports coming that China’s central bank is looking to create its own official digital currency.

South Korea

Cryptocurrencies were not considered legal tenders in South Korea but exchanges were legal. However, South Korea National assembly passed a bill that will provide framework for cryptocurrency and exchanges which makes cryptocurrencies fully legal and taxable in South Korea. The bill imposes anti-money laundering (AML) obligations on cryptocurrency exchanges, in compliance with the standards set by the Financial Action Task Force (FATF)[7]. They are also required to have a real name verification partnership with a Korean bank. Virtual asset operators such as cryptocurrency exchanges would have to report their operations to the Financial Intelligence Unit (FIU) under the Financial Services Commission after obtaining “real name-confirmed accounts” from commercial banks.

Switzerland

Cryptocurrencies are totally legal in Switzerland and has adopted suitable regulations. The Swiss Federal Tax Administration (SFTA) considers crypto / virtual currencies to be legal assets i.e. they are subject to the wealth tax, and must be declared on annual tax returns. Unlike other countries, Switzerland has provided an unrestricted and sustainable expanse for using cryptocurrencies Ex: – In 2016, the town of Zug, a prominent global cryptocurrency hub, introduced Bitcoin as a way of paying city fees. Swiz government has indicated many a times to promote cryptocurrencies.

UK

In UK, cryptocurrencies are not considered legal tenders and exchanges have registration requirements. The cryptocurrency exchanges have to be registered with Financial conduct authority (FCA). While there haven’t been much specific laws for cryptocurrency exchanges, they have to comply with Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs). Amendments to those regulations, which were approved in 2019 and came into force in January 2020, incorporate both the latest guidelines set forth via FATF [8]and the EU’s 5AMLD[9].

Other Countries

Countries like Algeria, Bolivia, Egypt, Iraq, Morocco, Nepal, Pakistan, and the United Arab Emirates have an Absolute ban on cryptocurrencies. While Bahrain, Bangladesh, Colombia, the Dominican Republic, Indonesia, Iran, Kuwait, Lesotho, Lithuania, Macau, Oman, Qatar, Saudi Arabia and Taiwan have partial bans which restrict and don’t acknowledge them as legal assets but can be exchanged with some firm regulations in place. Most countries are devising plans or solutions to use cryptocurrencies in a regulated and secure manner, while some countries have totally discarded the cryptocurrencies.

Legal Status In India

Cryptocurrencies had been ruled illegal effectively as tenders and exchanges until Supreme court judgement in 2020[10]. Since its onset in India, RBI and the Indian government made their intentions very clear of not allowing cryptocurrency to be used. In 2013, RBI issued a press release in which it stated that all transaction relating to virtual currency shall be prohibited in India. RBI mentioned the partial ban is to safeguard the interest of the people and curb illicit activities associated with the cryptocurrencies. Due to the volatile nature of all cryptocurrencies, RBI suggested that people avoid any type of usage and transaction in bitcoins or any other cryptocurrency.

Apart from the RBI and government, there were some individuals who were fighting the matter in court to permanently prohibit cryptocurrencies.   Petitioners  Siddhartha and Vijay Pal Dalmia[11] filed their civil petition in court. Their arguments were in favour of Ban/restrain etc. of cryptocurrencies. Their grounds were-

  1. Due to their unidentified nature, cryptocurrencies can be used for illegal activities like money laundering, funding terrorism, tax evasion etc.
  2. The use of cryptocurrencies could be in contravention to some laws ex-
  3. FEMA[12]– Section 2(h) which defines currency and crypto/virtual currencies do not fall within the definition given under section2(h). Section 2(i) defines currency notes which in short, can be hard coins and notes which are issued under RBI act,1934 and cryptocurrency does fall into this category[13]. Other sections which cryptocurrencies violate are Section 2(m),2(q),2(n).2(c) and 3.
  4. The Constitution of India, 1950 – Entry 36 and 46 of List I of the Seventh Schedule of the Constitution states that only the Central Government shall have the power to legislate in respect of currency, coinage, legal tender, foreign exchange and bills of exchange, cheques, promissory notes and other like instruments respectively[14]. This also includes cryptocurrencies
  5.  The Reserve Bank of India Act ,1934- Section 22 of the Reserve Bank of India Act, 1934 mandates that the RBI shall have the sole right to issue bank notes in India, and may issue currency notes of the Government of India supplied to it by the Central Government. However, Cryptocurrencies or Virtual Currencies do not qualify as currency or bank notes, as Cryptocurrencies or Virtual Currencies have not been issued by the RBI[15].
  6. Others are Securities Contracts (Regulation) Act, 1956 (“SCRA”); and The Sale of Goods Act, 1930; The Payment and Settlement Systems Act, 2007
  7. Cryptocurrencies give a subtle outlet which is not restricted or regulated.

Clubbed with the Dalmia Petition, another civil petition[16] was filed of the similar nature by Dwaiyapana  Bhowmick , which mainly aimed at issuing regulations regarding  cryptocurrencies and also forming a committee of well – known experts to look into the matter. His grounds were-

  • Lack of accountability and unregulated flow of cryptocurrencies which can be used for trading and other financial activities
  • Converting Bitcoins into foreign exchange which makes it vulnerable to cyber-attacks like ex- Ransomware wannacry 2017
  • Could result in disastrous financial implications if it remains unchecked

2018 RBI Ban

The Reserve Bank of India in April   2018, in its official statement [17] in para 13 directed banks to desist from dealing in transactions involving cryptocurrencies. They released the statement as to stop dealing with businesses involving virtual currencies. According to RBI Virtual Currencies (VCs), raise concerns of consumer protection, market integrity and money laundering, and among many other issues. This development came just two months after Finance ministry announced that the government does not consider cryptocurrencies as legal tender and will take all measures to eliminate payments using them. However, not complete crackdown measures or laws have been in place to stop the gush of cryptocurrency. The central government and RBI have acknowledged the Blockchain technology but are not putting in their faith into this system due to security reasons as it could endanger financial stability.

Due to a complete ban on dealings with cryptocurrencies: –

  • Investors incurred colossal losses in cryptocurrency trading and crypto-exchange business in near future looked bleak.
  • The Income Tax department gave around 5 thousand notices to Bitcoin and other cryptocurrency investors.
  • Many cryptocurrency businesses shut down especially ZebPay, India’s first cryptocurrency exchange.
  • RBI had instructed banks and financial institutions to stop accepting the digital currency as a mode of payment and stop investing in it.
  • The cryptocurrency market and its growth took a severe hit.

After the drastic step taken by the RBI to ban cryptocurrencies, some industry participants had filed petitions like Kali Digital Eco system, a company based in Ahmedabad filed a petition against RBI in Delhi High court back in 2019, challenging the constitutionality of the statement/circular.

2020 Supreme Court Judgement

The state of cryptocurrencies and their fate changed in India after giving a significant judgement in favour of cryptocurrency companies. In Internet and Mobile association of India vs Reserve Bank of India[18]. The petitioners Internet and Mobile association of India and other small companies with their counsel Mr. Ashim Sood and Mr. Nakul Dewan gave following arguments-

  • Crypto/Virtual currencies are not legal tenders or assets but tradable commodities not falling under RBI act 1934.
  • RBI has the Power to issue directions ‘in public interest’ under section 35(1)(a) of the banking regulation act, 1949 and under section 10(2) of the Payments and Settlements act, 2007 to issue guidelines for proper management of payment systems. But cryptocurrencies do not fall under this.
  • Cryptocurrencies also not fall under the credit system of our country which does not give a mandate to RBI to operate and regulate cryptocurrencies.
  • Many countries, multinational and national bodies have scanned cryptocurrencies but didn’t find anything pernicious about them. The government and RBI banning cryptocurrency seems illogical
  • RBI acknowledges Blockchain technology but not cryptocurrencies
  • The RBI circular violates article 19(1)(g) which states Right to freedom ‘To practice any profession, or to carry any occupation, trade or business’. The circular amounts to total prohibition of an activity not prohibited by law.

Another point of commotion was the Doctrine of Proportionality. Doctrine of proportionality means that any administrative action of restriction should be equal to the objective or purpose achieved and should not be arbitrary. According to the petitioners, The RBI circular was disproportionate and was an example of using their discretionary powers to totally restrict the use of cryptocurrencies which are not even unlawful. The purpose of ban did not seem to provide viable solutions but totally restricting or prohibiting the use of cryptocurrencies without any probable reasons.

The Supreme court supported the view of petitioners, citing many cases like one of them  Modern Dental college and research centre vs state of Madhya Pradesh[19], where Supreme court highlighted the tests for proportionality, that are-

  1. The action taken should be designated for a proper purpose
  2. The actions taken should be properly connected to the purpose
  3. There are no alternate invasive measures
  4. There is a relation between importance of achieving the aim and importance of limiting the rights

The Supreme court finally ruled in the favour of the petitioners citing insufficient evidence and ‘RBI has not come out with a stand that any of the entities regulated by it namely, the nationalized banks/scheduled commercial banks/co-operative 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’[20]. Thus the circular was struck down and the ban lifted.

Aftermath

Cryptocurrency companies and start-ups have been given a relief over their businesses crashing down. But this relief could be temporary or short lived as the RBI is planning to file an appeal or review against the judgement given by the Supreme court. The central government is also deliberating to introduce the bill ‘Banning of Cryptocurrency & Regulation of Official Digital Currency Bill 2020’ which can permanently prohibit cryptocurrencies and will term holding any kind of cryptocurrency as illegal and punishable by law.

However, if Cryptocurrencies get to live, it can have a massive impact on the Indian economy and the credit and banking system. Here are some advantages-

Cryptocurrencies can help in creating employment opportunities– Indian economy has been facing the unemployment crisis for a long time with more unskilled educated people and less jobs. With the opening of major blockchain companies and start-ups, can give create multiple employment or job roles in India such as entrepreneurs, cryptanalysts, crypto economists, mining hardware manufacturers, hardware wallet traders, content creators, developers, crypto legal experts, crypto tax experts, and accountants.

Cryptocurrencies can help boost the economy. With employment generation, comes more income. With various countries like China, which provide unsustainable environment for blockchain companies to grow with hard regulations and government interferences, India can become a hub for blockchain enthusiasts to open more of blockchain companies. With cheap labour and low cost mining, India can become a very lucrative destination for cryptocurrency companies and investors. With increased FDI and investment, The GDP of the country will enhance supporting 5 trillion economy plan by 2023.

Cryptocurrency can help reduce corruption. With increased Digi-payments, there can be less instances of bribes and scams. The financial records will be more easily accessible and there can be no need to denominate the currency again.

Cryptocurrencies will be more suited to consumers than cash notes and coins. With its digitised nature, transactions can be more easy and efficient.

Conclusion

Cryptocurrencies state looks to remain uncertain. Various countries are working to provide ingenious solutions like China looking towards starting their own Digi-currency. While some countries are just engrossed in legal and regulation battles with cryptocurrency companies. No doubt that cryptocurrencies can for sure change the working of our economies both in a bad or good way. But considering its implications, people have yet to still put faith in it’s working.

Indian government and RBI are shaken to their core if the Supreme court judgement gets to stay permanently. Both have been trying to to debase the SC ruling by re appeal and preparing a draft of the bill for permanently prohibiting cryptocurrency. It seems illogical that Indian government on one hand acknowledge the advancement in technology but on other hand don’t want to even consider the idea of blockchain technology. If the government decides to permanently prohibit cryptocurrencies than it would be a big missed opportunity to become a hub of blockchains. Which in turn could solve most of the underlying problems in our economy like unemployment, low investment, low FDI, corruption etc. The government could work upon allowing blockchains but putting some restrictions or laws in place to vitiate its misuse to a greater extent. Whatever the decision might be, it could impact people of India for good.


[1] https://www.zdnet.com/article/2019-saw-more-cryptocurrency-hacks-than-any-other-year/

[2] https://www.investopedia.com/news/largest-cryptocurrency-hacks-so-far-year/

[3] Commodity Futures Trading Commodities v. McDonnell, 18-CV-361 (E.D.N.Y. Mar. 6, 2018)

[4] James v. IFINEX Inc., INDEX NO. 450545/2019 (N.Y. Sup. Ct. 2019)

[5] https://casetext.com/case/james-v-ifinex-inc-1

[6] https://news.bitcoin.com/chinese-court-ethereum-legal/

[7] VIRTUAL ASSETS AND VIRTUAL ASSET SERVICE PROVIDERS (FATF, 2019)

[8] https://complyadvantage.com/blog/cryptocurrency-regulations-around-world/

[9] European Parliament Report on Cryptocurrencies and Blockchain – Legal context and implications for financial crime, money laundering and tax evasion

[10] Internet and Mobile Association of India v Reserve Bank of India (2020 SCC Online SC 275)

[11] (2017 SCC online SC 1799)

[12] The Foreign Exchange Management Act, 1999 (FEMA)

[13] http://www.femaindia.in/femaact/section-2-definitions##showsection

[14] The constitution of India,1950, Bare act (2018)

[15] https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIAM_230609.pdf

[16] (2017 SCC Online SC 1071)

[17] Statement on Developmental and Regulatory Policies

[18]  Internet and Mobile Association of India v Reserve Bank of India (2020 SCC Online SC 275)

[19] (2016) 7 SCC 353

[20] https://economictimes.indiatimes.com/markets/stocks/news/sc-allows-trade-in-cryptocurrency-quashes-rbi-curb-on-use/articleshow/74470078.cms?from=mdr


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