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Law School Articles

RBI's De Minimis Regulatory Safeguards: Inherent Enigma Surrounding Regulation of Cryptocurrencies

Ranbir Singh Thakur
18 July 2021 11:24 AM GMT
Proliferation of technology and emergence of digital payment services herald ushering of virtual currencies. Internet Technology has revolutionized the conventional conception of currency and financial transactions by begetting a phenomenon known as Bitcoin as the first form of cryptocurrency in the year 2009 by a developer having pseudonym Satoshi Nakamoto. Virtual currencies elude a comprehensive and a precise definition, grappled with semantic vagaries ranging from a property to means of payment etc. The primary objective pursued by Virtual Currencies was to be freed from the shackles of any central authority or financial intermediary and to bring a complete metamorphosis in the current Bretton woods monetary system hinging on an underlying asset. These autonomous virtual currencies were developed to make the central banks obsolete garnering worldwide attention due to its core elements namely low transaction cost as cryptocurrency transactions operate peer to peer to the exclusion of any financial institution, anonymity, immutability of transaction record stored in distributed ledger technology, transparency and security. In this academic exercise, I would accentuate upon the very ideation of regulation being antithetical to the rudimentary idea of decentralization behind the genesis of cryptocurrency. Moreover I would argue that RBI tailored regulatory endeavours seem otiose, owing to an ambiguous status of not being a legal tender attributed to it. Furthermore, I would delve with the inefficacious regulatory control exercised by the RBI in apropos of Virtual currencies as it misses the bullseye of the general practice of buying, selling & mining of such Virtual Currencies instead launching depredations on the Virtual Currency Exchange platforms to snap its interface with the fiat currency as well as the regular banking sector, which perhaps was RBI's ancillary target, albeit got hit in the process by RBI's de minimis regulations contained in a Circular issued in 2017. This scholarship would also explicate on the state of quandary RBI and the Indian government was barraged with, resulting in ring fencing the entities regulated by RBI by virtue of power vested in it by RBI Act 1934 as well as the Banking Regulation Act 1949 & the ultimate quashing of the impugned circular despite finding nothing wrong about the way these exchanges function thus not being inimical to the banking industry and the fact that VCs are not declared as unlawful as well as not banned in most of the foreign jurisdictions. Lastly, this scholarship would also expound on the concomitant risks of dealing in cryptoassets such as flouting of anti-money laundering laws as well as cross border funding of terrorist activities laws & elucidate as to why absolute interdiction of such cryptocurrencies would rather facilitate such malpractices instead of curbing it, that too in the absence of any robust mechanism to ensure smooth functioning of the cryptocurrency transactions.

Prolegomenon to the epoch of Decentralized currencies:

The emergence of Virtual Currencies saw dawn of the day soon after economy was in doldrums following a complete collapse done by financial crisis of 2008. The banking sectors were grappled with NPAs as lending practices of banks turned out to be a portent for them. Therefore, the trust reposed in the financial institutions by the depositors started waning and which engendered speculation that the genesis of cryptocurrency was to combat the very existence of behemoths namely central banks that became the cause of financial crisis of 2008. Thus, what lies at the core of Virtual Currencies is decentralization which cannot be taken away by any central bank in the world. The conception of currency has also underwent a sea of change as gold, coins and bullions were the only medium of exchange in ancient epoch but as the time rolled on, especially after 1934 they ceased to be used as a medium of exchange and thereafter the paper currency was in rife for carrying out financial transactions. The Bretton woods monetary system devised in the Bretton woods conference in 1944 established a system of payments predicated on the value of dollar, which defined all currencies in relation to the dollar. Therefore, the dollar became the standard to which every other currency was pegged to facilitate foreign exchange. But certainly, when Virtual currencies embarked on the international monetary system, it changed the entire landscape as these currencies purported to possess inherent value like gold, cash that were designed to enable purchases, sales and other financial transactions. Moreover, these currencies were bereft of any denomination, having its own unit of account leaving the purpose of foreign exchange otiose, that clearly means one could use these Virtual currencies anytime and anywhere in the world without resorting to currency exchange at the airport. This inherent value as well as same idiosyncrasies as that of real currency place it par with the fiat currency except that cryptocurrency is not accepted as legal tender as it is not backed by any central authority.

Legitimacy of VCs is mired in the genesis of such currencies that require users to carry out their transactions peer to peer without any due interference of any financial intermediary. Therefore, the birth of cryptocurrency makes the role of financial institutions redundant as users can now transact peer to peer with the help of Distributed ledger technology whereby all the users have an access to the secured information which is encrypted by hashes containing alphanumeric codes. The legal status of Virtual currencies is in limbo as it is fraught with enigma which could be best understood by the contrary stands taken by many countries. On the one hand, the governments and money market regulators throughout the world say that VCs have the capability of being used as real money but on the other hand they express their disinclination of countenancing it as a legal tender. These contrary stands beget a state of quandary which the national governments and money market regulators are grappled with. Decentralization is the cause of this enigma which goes to the roots of Virtual currencies and any attempt to sabotage this core element means expunging the existence of VCs. Perhaps, if these currencies imperil the financial system of any country then there may be a possibility of certain safeguards suggested by its central bank to be implemented as a preventive measure keeping into account the high volatility of crypto-assets and other vices like anonymity, irreversibility of transactions etc despite knowing that its legitimacy looms in limbo and also apprised of absence of any statute from which a central bank like RBI derives its potency to deal with a new form of currency that falls outside its periphery of regulation. The de minimis regulatory safeguards proposed by Indian Central Bank RBI to ring fence the regulated entities under the legislative scheme of RBI Act, 1934 as well as Banking Regulation Act, 1949 thus runs contrary to the core idiosyncrasy of decentralization of VCs albeit there is no cogent evident of actual harm caused to such regulated entities.

Abstruse Semantics & absurdity vis-à-vis Cryptocurrencies:

The discourse on deciphering an unambiguous definition of Cryptocurrencies seems to be fraught with radical subjectivism engendering divergence of views obscuring clarity in the legal classification of cryptocurrencies, which is very crucial in defining regulatory policies, ensuring legal certainty and rule of law in Cryptocurrency ecosystem. The New Palgrave Dictionary of Economics defines Cryptocurrency as a system of currency that uses cryptography to allow secure transfer and exchange of digital tokens in a distributed and decentralized manner.[1] The method of cryptography facilitates storing and transmitting data containing digital tokens in a particular form so that only those for whom it is intended can read and process it.

Few Definitions given by money market regulators: Financial Action Task Force, an intergovernmental organization of G-7 countries in its report defines Virtual Currency as a digital representation of value that can be digitally traded and functions as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction. It is neither issued nor guaranteed by any jurisdiction, and fulfils the above functions only by agreement within the community of users of the virtual currency.[2] The other definition that warrants mention is given by European Central Bank in 2012 which defines Virtual Currency as a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community.[3] The other intriguing definition that attempts to define Virtual Currencies as commodities is given by Canada Revenue Agency (CRA) which runs thus: "Virtual currency is digital asset that can be used to buy and sell goods or services. Cryptocurrency is a blockchain-based virtual currency. When cryptocurrency is used to pay for goods or services, the rules for barter transactions apply for income tax purposes. A barter transaction occurs when any two persons agree to exchange good or services and carry out that exchange without legal currency. Virtual currency can also be bought or sold like commodity."[4]

After bare perusal of all the definitions given by different market regulators it seems conspicuous that there lies discrepancy in the definitions of VCs engendering an aporetic situation whereby the regulators have discountenanced VCs to be recognized as legal tender, simultaneously also conceding to the factum that they are capable of performing some or most of the functions of real currency. Justice Breyer enlarged the umbrage of the definition of money in Wisconsin Central Ltd v. United States[5], wherein he relied on the definition given in the Oxford English Dictionary which included "property or possessions of any kind viewed as convertible into money" within the definition of money thereby rebutting the proposition posited by the majority which held that so long as VCs do not qualify as money either in the legal sense (not having a legal tender status) or in the social sense (not being widely accepted by a huge population as a medium of exchange), they cannot be termed or treated as currencies. Therefore this definition gave leeway to the national regulatory bodies and the central banks to treat VCs as money thereby expanding its regulatory clout to encapsulate VCs into its regulatory regime. The attribute of VCs or other financial instruments of being bereft to be characterized as a legal tender and qualifying as money, these two considerations are not mutually exclusive as it is manifested and illustrated in the definition of money contained in the Finance Act, 1994, interpolated by way of Finance Act, 2012 which defines 'money' to mean "legal tender, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveler cheque, money order, postal or electronic remittance or any other similar instrument, but shall not include any currency that is held for its numismatic value".[6] This definition arrogates significance, for it identifies many instruments other than legal tender, which could come within the definition of money, thus, as a sequitur connoting that legitimacy, of any financial instrument like for instance VCs is not necessitated in order to be categorized as money.

Judicial Precedents exploring the absurdity prevalent in the definition of VCs: Sherman Division Eastern District Court of Texas in SEC v. Trendon Shavers,[7] wherein the court opined in the following words which are extracted hereinbelow for ready reference:

"It is clear that bitcoin can be used as money. It can be used to purchase goods or services and as Shavers stated, used to pay for individual living expenses. The only limitation of bitcoin is that it is limited to those places that accept it as currency. However, it can also be exchanged for conventional currencies such as the US dollar, euro, yen and Yuan. Therefore, bitcoin is a currency or form of money…"

VCs as Payment Instrument/Medium of Exchange: Another judgment rendered by the Third District Court of Appeal, State of Florida, that further exacerbates the absurdity surrounding the definition of VCs, in State of Florida v. Michell Abner Espinoza[8], wherein the Court of Appeal dealt with the definition of a "payment instrument" which encompasses "a cheque, draft, warrant, money order, travelers' cheque, electronic instrument or other instrument, payment of money or monetary value, whether or not negotiable". The phrase "money services business" was defined in the statute to include any person who acts as a payment instrument seller. Since the expression monetary value means a medium of exchange, whether or not redeemable in currency, the court concluded that VCs are payment instruments and hence a person dealing with the same is in money services business. Though Bitcoin does not expressly fall within the definition of "currency" found in the statute, the court concluded that Bitcoin would certainly fall under the definition of a payment instrument. The Court of Appeal also observed that several restaurants in the Miami area accepted Bitcoins as a form of payment and hence Bitcoin functions as a medium of exchange.

VCs as Property: The English High Court was faced with a conundrum vis-à-vis the proprietary status of Cryptocurrencies in AA v. Persons Unknown & others Re Bitcoin[9], which it answered in affirmative by relying on the essential ingredients of property delineated in a pronouncement rendered by the House of Lords in National Provincial Bank v. Ainsworth[10] namely, that it must be (i) definable; (ii) identifiable by third parties; (iii) capable in their nature of assumption by third parties; and (iv) capable of some degree of permanence. The court applied the aforesaid four criteria whilst also predicating its reasoning on UK Jurisdictional Taskforce of the Law Tech Delivery Panel's report titled "Legal Statement on the Status of Cryptoassets and Smart Contracts", to affirm its reasoning to declare that crypto assets constitute property under English law.

VCs as Non-Traditional Currency: The European Court of Justice tried to resolve the identity crisis of VCs in Skatteverket v. David Hedqvist[11], wherein the ECJ was asked to discern whether transactions to exchange a traditional currency for the 'Bitcoin' virtual currency or vice versa, which Mr. Hedqvist wished to perform through a company, were subject to value added tax or not. The ECJ adumbrated that Bitcoin and other Cryptocurrencies have a bidirectional flow i.e., they have a potential of being exchanged for fiat currency and vice-versa and has no purpose other than to be a means of payment. Therefore the ECJ ruled that the transactions in Bitcoin were entitled to exemption from payment of VAT as they fell under the category of transactions involving 'currency and bank notes and coins used as legal tender'. The court accordingly concluded that virtual currencies would fall squarely under the definition of non-traditional currencies and therefore the court postulated that Article 135(1)(e) EU Council VAT Directive 2006/112/EC will be applicable to non-traditional currencies i.e., to currencies other than those that are legal tender in one or more countries in so far as those currencies have been accepted by the parties to a transaction as an alternative to legal tender and have no purpose other than to be a means of payment.

Modus Operandi of Cryptocurrency Transactions: Mechanics of Blockchain Technology

Technological innovation has belittled the intermediary role played by banks and financial institutions by supplanting the physical cash transactions and quintessential method of storing data relating to transactional records as well as verifying the same. This technological innovation begat a digital transaction system which is called the Distributed Ledger technology (DLT) whereby all the independently verified transactions are published and arrayed onto a public ledger and also this ledger is broadcasted across all the computer nodes connected to the common database. Therefore, this technology eliminates the exclusivity vis-à-vis the transactional records and monopoly of the banking institutions over them, that they have enjoyed thus far, as it disseminates the transaction details to all the independent computer network users so that they can have an equal access to the transaction record to verify the validity of the transactions independently without any third party intermediary.

The transactional details of users transacting in crypto-assets stored on a public ledger are secured through blockchain technology as Cryptocurrencies are currently the most commonly used blockchain application. Blockchain is defined as "an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value."[12] Blockchain technology hinges on creating a trustless trust by operating peer to peer that would allow online payments to be directly sent from one person to the other without going through a financial institution also maintaining anonymity. Blockchain security predicates upon encryption technology through public and private keys. The public key acts as an anonymous user address on Blockchain corresponding to a Bank Account in physical cash transactions, while the private key acts as a PIN or password, which authorizes a transaction & permits only the owner to access their tokens (commonly in the form of cryptocurrency but can be in any form of data or other digital assets) grouped together in blocks.

Blockchain relies on three prime elements in order to function: decentralization, proof-of-work consensus, and practical immutability of transactional record.[13]Cumulatively, these three features provide a ubiquitous solution to any digital transaction that attempts to obliterate the need for an intermediary to legitimize the transaction as militated against the various modes of online payments like UPI, Google Pay, Phone pay etc wherein the digital payments are denominated in Indian Currency Rupees thereby vesting powers with the RBI to verify the validity of a transaction on such platforms. Blockchain accords a platform like public ledger to its users to independently verify the transactional records instead of relying on the third party intermediary to legitimize a transaction. Moreover the distributed ledger technology expunges the possibility of concentrating data at a single location by disseminating copies of transaction details to all the nodes connected to the common repository of transactional record. Therefore, multiplicity of copies of blockchain data disseminated on the public ledger makes it immune to tampering because if one would want to alter the transactional record then he has to alter all the copies that are floated across the common database. As mentioned in the foregoing paragraph, that blockchain technology creates a trustless trust, as it is writ large that a transaction in cryptocurrency is pseudonymous, by incentivizing network consensus to verify the validity of a transaction by the process called mining to ensure that only valid transactions are added to the ledger. The trustless trust that is created, is bolstered by the process of mining as when any transaction is executed and broadcasted over all the nodes then miners, who are independent users vie to solve complex mathematical problems to validate a newly added block containing transaction record for a reward in cryptocurrency, which underlies the concept of proof of work. Therefore, this very concept becomes the edifice of the trustless trust where the trust is reposed on the complexity and esoteric nature of the cryptographic computational problems rather than on any central financial third party intermediary. The process of mining takes high level of computing power to solve such abstruse mathematical puzzles in order to validate a transaction, which deters miners from verifying a fraudulent transaction.

Permanence and immutability of record is another endogenous feature of blockchain technology and cryptography. Once the transaction is verified by miners, then the transaction details of a user is packaged in a block and each block has a unique identifier or hash function denoted in an alphanumeric code bearing semblance to the previous block on the blockchain, which is then linked to the preceding blocks to form an infinite chain of transactions. The semblance of these unique identifiers (hashes) or alphanumeric codes is a testament to the legitimacy of every newly added transaction as every code would contain a reference to the previous block so that each block is linked to every previous transaction.[14] So, therefore if a hacker attempts to alter or add a new block to the ledger then its alphanumeric identity may not match the code or hash of the previous block, making it immune as well as nearly impossible or impractical to tamper with the blockchain as then an intruder has to alter the hashes of all the preceding blocks, which perhaps would be a daunting task. Even if any node connected to the public ledger wants to verify an invalid transaction, such as transferring coins that a user doesn't actually possess, then the user would have to control more than 50% of the total computer processing power in the network. Thus, this blockchain technology leverages the trust of the users assuring them that they have accurate untampered records that are not susceptible to any influence of any central authority or intruders and ensuring the permanence, transparency and immutability of record of transactions disseminated to all the nodes connected to the public ledger.

Issues & Challenges of the Cryptocurrency Ecosystem: Factors deterring widespread use of Cryptocurrencies

The virtual currency's ecosystem has evolved into a parallel transparent, easily accessible and secure payment mechanism enfeebling the potency and monopoly over the issuance of fiat currency of the central authority. But the growth of VCs has endangered not only the exalted status of central banks in their respective jurisdictions but also engendered concomitant risks. Certain factors that might deter widespread use of virtual currencies are as follows:

  • Bereft of the status of legal tender: the core element of decentralization spurred up to be an endogenous feature of VCs that makes the transactions in VCs devoid of any legal sanctity. Moreover the discrepancies persisting in the definitions of VCs given by various money regulators and sovereign jurisdictions have created a quagmire of ambiguity engendering distrust among the ardent players in the cryptocurrency ecosystem as to the non-accountability to any central authority and indemnity in case of loss of VCs equivalent of million dollars contained in the digital custodian wallets or stored in blockchain, owing to the contingencies and risks concomitant with the technological innovation.
  • Devoid of enjoying fiat currency's externalities: Money has a peculiar idiosyncrasy of qualifying as money in legal sense as well as in social sense. Any currency's externalities hinges upon it being used as money in social sense meaning thereby that it is used as a common means of payment by large segment of population. Therefore VCs externalities currently are nowhere near the externalities enjoyed by fiat currency.
  • Anonymity facilitating nefarious activities: Since virtual currencies including cryptocurrencies operate peer to peer without any financial intermediary therefore they are susceptible for being used for nefarious and illicit activities in many jurisdictions due to its anonymous nature as one is oblivious to the identity information of counterparties in such peer to peer anonymous/pseudonymous transaction. The inevitable corollary that flows from such anonymity is unintentional breach of anti-money laundering laws (AML) and combating the financing of terrorism (CFT) laws as parties may easily siphon their financial assets hiding, either to evade taxes or to finance terrorist organizations behind the veil of anonymity.
  • Inapplicability of KYC norms: The KYC norms formulated by RBI were assimilated into our banking culture after adoption of Basel-II norms, therefore these norms are followed in letter and spirit when it comes to fiat currency. Banks are required to monitor their customer's transactions and are obliged to recurrently update their identity under the KYC norms beset by RBI. However, such norms are misnomer for virtual currencies as it is an affront to the core rudiments, like decentralization and anonymity of virtual currency.
  • Irreversibility of transaction recorded on Public ledger: Users transacting in cryptocurrency have their transaction details stored in blocks on public ledger premised on Distributed ledger technology. Once a transaction in cryptocurrency or for that matter in any VC is confirmed and validated by miners by solving cryptographic hash functions and consequently added as a block to the chain of transactions, then such transaction recorded on public ledger cannot be withdrawn and therefore becomes irreversible as militated against physical cash transactions, whose legitimacy is verified by central authority and therefore amenable to revocation at the instance of the financial intermediary.
  • Price Volatility: Bitcoin which embarked on the virtual trading platforms as the first form of cryptocurrency in 2009 underwent a whirlwind change in prices from niche to nadir through all these years since then. This volatility in VCs value, heralds close affinity to it being a commodity rather than a medium of exchange as it doesn't seem to possess any store of value. Moreover, the precipitous variations in its prices suggest the market for virtual currency currently being driven by speculative investors, not by a growing demand for VCs due to frequent transactions by traditional merchants and consumers.
  • Ceiling cap discouraging the use of VCs as currency: Admittedly, the central banks enjoy monopoly over the issuance of bank notes as well as on formulation of monetary policies of nation states and additionally are also entrusted with a very imperative role of maintaining inflationary index which is in contradistinction to imposition of ceiling cap vis-à-vis the supply of VCs on the trading platforms. The virtual currency ecosystem is hinged on even distribution of virtual currency's supply by CPU power throughout the network rather than localizing power in the hands of the central authority. Therefore, unlike the conventional currency where Central Banks have no embargo in unlimited printing of money, thereby causing debasement of all savings and holdings, virtual currencies intrinsic mechanisms like for instance Bitcoin software, have rules to ensure that the process of creating new coins would stop after 21 million are out in the world. Furthermore, this limited supply of VCs floating in the market has potential ramification on market forces of demand and supply as for limited supply of VCs in the market, demand for VCs would surge causing its price to steadily increase. The sequitur of that increase is that the price of goods and services in a particular virtual currency would steadily plummet causing deflation incentivizing people to hoard assets in cryptocurrency rather than spend them, thereby not only reducing the number of transactions in cryptocurrency eventually making it an unsuccessful medium of exchange in juxtaposition to fiat currency but also retarding the economic growth and hampering the financial stability of the country. Hence, centralized inflationary control would perhaps be a sound alternative rather than having recourse to capping the supply as exhibited by virtual currency ecosystem, inflicting deleterious consequences on the financial growth of a sovereign jurisdiction.

Triviality of RBI's de-minimis ostensible regulatory control on Virtual currencies exercised by ring fencing the regulated entities: A sop or a befuddled approach?

The disquisition on the incipient stage of virtual currency ecosystem and its technological brilliance, in terms of bringing about a complete metamorphosis in the payment system by introducing an alternative to fiat currency, culminates into an inescapable conundrum of regulatory mechanism for cryptocurrencies as to whether such mechanism is antithetical to the ethos of cryptocurrency and even if such regulation is warranted, then how such regulatory mechanism should curb the vices associated with cryptocurrency transactions sans distorting the rudiments of virtual currencies on which this system thrives today. The panacea to this conundrum can either be in affirmative or negative and therefore there cannot be any middle path as preferred by the Reserve Bank of India by issuing a circular in 2018, cautioning users, holders and traders of VCs in apropos of various risks associated with virtual currency transactions and exhorting them to avoid participating in them. Perhaps, a peculiar fact that crops up for consideration is that the depredations that were launched through the circular was only for virtual currency exchanges by interdicting only the interface of virtual currency with fiat currency and hence such a regulatory control is de-minimis or negligible as it deals with only the convertibility aspect of transactional ecosystem of cryptocurrencies leaving the other possible means by which cryptocurrency transactions could be effectuated. Thus, the interdiction of VCs by ring fencing the regulated entities by severing the ties between the virtual currency exchanges and financial institutions depicts central government's as well as RBI's befuddled approach in tackling the pitfalls of VCs, furthermore the act of interdiction, aimed only at VCEs leaving other possible modus operandi of transactions in VCs like mining and storing VCs in digital custodian wallets rather than on blockchain, relegates as nothing more than a sop in the name of regulation.

RBI as a central bank draws its majority of powers to streamline the banking culture from Reserve Bank of India Act 1934 & Banking Regulation Act 1949. The Reserve Bank of India was established as a statutory body under the Reserve Bank of India Act 1934. The genesis of the need for regulatory regime was reflected in the RBI's Financial Stability Report released in 2016 which accentuated the risks and concerns about data security and consumer protection on one hand and its deleterious ramifications on the efficacy of monetary policy on the other hand, of the fast paced innovations such as virtual currencies. The objects as enshrined in the preamble of the RBI Act as well as in the scheme of statutory provisions, entrust following functions to the Central Bank:

  • Regulating the issue of Bank notes & manage money supply and interest rates;
  • Keeping of reserves with a view to securing monetary stability in the country;
  • Operating the currency and credit system of the country to its advantage;
  • Taking over the management of the currency from the Central Government and of carrying on the business of banking in accordance with provisions of the RBI Act.[15]
  • To hold & carry out money, remittance, exchange and banking transactions in India on behalf of the Central Government.[16]

In addition to the following functions entrusted to the Central Bank, Section 45JA enumerates the power of RBI to regulate the financial system of the country to its advantage which is disparate from the powers of the RBI to operate the currency and credit system of the country to its advantage as envisaged in the preamble of the RBI Act. The peculiar idiosyncrasy engrafted in Section 45JA is that it empowers RBI, both to determine the policy and to give directions to all Non-banking financial companies vis-à-vis certain matters. The concerns sought to be addressed by Section 45JA(1) are public interest, financial system of the country, interests of the depositors and interests of NBFCs. Therefore, anything that may pose a threat to or is conceived to be inimical to the financial system of the country, can be regulated or prohibited by RBI. Moreover, Section 45L addresses yet another concern namely, the regulation of the credit system of the country to its advantage which stands in contradistinction to the power to operate the credit system. Whilst exercising the power to issue directions conferred under Section 45L(1)(b), it is incumbent upon the RBI to have due regard to the objects for which central bank as RBI has been established, its statutory responsibilities and the impact the businesses of such financial institutions, which are regulated as well as monitored by the RBI, is likely to have on trends in the money and capital markets.[17] Therefore, a profound and a holistic perusal of the statutory provisions of the RBI Act, 1934 would lead to an indefatigable inference that the operation/regulation of the credit/financial system of the country to its advantage is a common thread that runs through the statutory scheme of the RBI Act and connects all other provisions which confer powers upon RBI to determine policy as well as to issue directions.

The Reserve bank of India also draws its powers from the Banking Regulation Act, 1949, which are conspicuously manifested in the Statement of Objects and Reasons for the Banking Regulation Act, 1949, one of the prime features of which is to widen the powers of RBI so as to enable it to come to the aid of the banking companies in times of emergency. RBI is empowered to determine the policy in relation to advances to be followed by the Banking companies. The determination of policy may be predicated upon some pertinent factors namely, the public interest, interests of depositors or interests of the banking policy.[18] Furthermore, all the banking companies registered under the Banking Regulation Act are bound to follow the policy formulated by the RBI. Moreover, Section 35A of the Banking Regulation Act empowers RBI to issue directions to banking companies, which are binding on the banking companies and the NBFCs. The directions issued under the aforesaid section may be issued in public interest, in the interest of banking policy, to prevent the affairs of the banking company from being conducted in a manner prejudicial to the interests of the depositors or of the banking company itself and lastly to secure the proper management of the banking company. Section 36(1)(a) enlarges the powers of the Reserve bank of India by bestowing it with the powers to caution or interdict banking companies against entering into any particular transaction or class of transactions.

The brobdingnagian repository of powers wielded by a central behemoth like RBI galvanized it to cause depredations on the virtual currency's ecosystem by issuing a circular in 2018 to ring fence the regulated entities as a pre-emptive action against the possible harm that may be inflicted on the financial system of India. The Constitutional validity of the aforesaid circular, interdicting the banking companies to accord any services to the persons or exchanges involved in cryptocurrency transactions was challenged, as being ultra vires in the case titled Internet and Mobile Association of India v. Reserve Bank of India[19], wherein the SC categorically quashed the circular on the grounds of proportionality simultaneously upholding the ban imposed by the RBI on virtual currency exchange platforms. The disquisition on the conundrum of regulatory powers of RBI over VCs transactions is reduced to ascertaining as well as delineating the various other modus operandi through which persons or entities engage or deal with cryptocurrency transactions.

The ban imposed by impugned circular aimed at only the liaison or intermediary platforms namely, the virtual currency exchanges (VCEs) through which cryptocurrency transactions interact with the market, but there are various other modes through which cryptocurrency transactions can be consummated sans any VC exchange platforms. Another viable mode of generating and dealing with cryptocurrency is through the process of mining, whereby a reward is earned in VC in consideration for miners' services for legitimizing transactions stored in blocks on public ledger by solving abstruse mathematical computational problems. Furthermore, a person or entity may also engage, deal or transact in cryptocurrency by storing it in digital custodian wallets. As virtual currencies cannot be stored anywhere as being bereft of corporeality, therefore what can actually be stored are the private keys, which can be used to access the public address and transaction signatures. The private and public keys of those who own virtual currencies are stored in a software program called a digital custodian wallet. Moreover, these keys may be stored in different kinds of wallets, depending upon the logistics available to store them, namely paper wallets, mobile wallets, web wallets, desktop wallets, and hardware wallets. Interestingly, these wallets can be accessed from anywhere in the world and therefore, have great mobility. The easy accessibility as well as great mobility lay impetus on its usage to consummate transactions in VCs, allowing a person to use the cryptocurrency stored in the wallet for buying and selling provided the counterparty accepts or remits transactions in cryptocurrencies. Thus, upon foreclosing the disquisition on the different modes through which VCs interact with the populace, it seems conspicuous that what actually got hit by the impugned circular was merely one channel, namely virtual currency exchanges, providing platform for its users to facilitate the activity of convertibility whereby users transact in VCs after getting them exchanged for fiat currency or vice-versa leaving other viable modes, still through which persons or entities can transact in VCs merrily.

The actual or the primary target which still eludes regulation is the trade in VCs, which is yet not prohibited by Indian law except trading in them through VCEs and other platforms which facilitates convertibility of VCs into fiat currency. Therefore, the impugned circular does not per se interdict the purchase or sale of VCs. The raison d'etre of hitting at the primary target is to ensure consumer protection, prevention of unintentional breaches of anti-money laundering laws, curbing the menace of financing of terrorism and safeguarding of the existing monetary/payment/credit system from being capitulating to the perils of VCs. The genesis of resorting to a tortuous route to assail the VCs ecosystem is premised on the absence and inability of proceeding to confront and target directly as targeting directly is not within the domain of RBI, as also acknowledged by the RBI. Hence, the impugned circular issued by RBI launched a tortuous attack to ring fence the regulated entities by invoking its powers contained in the RBI Act, 1934 as well as the Banking Regulation Act, 1949. Therefore, in the process of ring fencing the regulated entities by severing the umbilical cord that VC has with fiat currency thereby paralyzing the VC platforms and Exchanges by restricting the access to the Banking services eventually making the convertibility aspect (the bidirectional flow) of the VCs defunct, has perhaps hit the ancillary target. Thus, the corollary that is engendered from the aforesaid proposition is that the impugned circular issued by the RBI has hit the VC Exchanges and not the actual trading of VCs, which it actually purports to monitor and regulate.

The Apex Court, whilst adjudicating upon the Internet and Mobile Association of India's[20] case adumbrated that RBI did not have any cogent material placed before it prior to issuing a circular to interdict the VCs interface with the regular banking sector. Therefore, the SC also clarified that the RBI's decision to interdict VCs transactions through VCEs was perhaps a corollary of non-application of mind. The ban imposed by the circular that ensued into paralyzing the VCEs by ring fencing the regulated entities was effectuated despite not only the RBI but also the Supreme Court unable to find anything wrong about the way in which these VCEs function and despite the knowing that VCs are not declared as unlawful and thus not banned in many countries. Ban imposed by any executive decision is considered to be an extreme step of administrative action and the ban imposed by the RBI circular is one which may be considered as an intrusive measure when less intrusive alternatives were available and yet neglected. The proportionality and legality of a complete prohibition or a ban are factors which are tested on the touchstone of actual harm test evolved by the Constitutional courts whilst exercising its powers of judicial review. However, the RBI failed to prove the 'actual harm' suffered by any of its regulated entities on account of the provision of banking services to the online platforms running VC Exchanges which fortified the relief claimed by the petitioners to quash the impugned circular imposing ban, suffused with infirmities of being disproportional as well as bad in law. Ban was therefore not warranted and could be termed as preposterous as reflected by impetuousness and impulsiveness exhibited by RBI which thus connotes RBI's as well as the central government's underlying quandary and insecurity which resulted from its adoption of volte-face attitude in coming up with two draft bills namely the Crypto Token Regulation Bill in 2018 & the Banning of Cryptocurrency and Regulation of Official Digital Currency Act in 2019 propagating two contrary stands taken by an Inter-ministerial Committee in its report in a brief span of 1 year. The former accorded a great leeway in allowing users to buy and sell crypto-assets but only on a recognized virtual currency exchange whereas the latter recommended the imposition of a complete ban.

The action of imposing a ban whilst seeking to assail its primary target to address the growing concomitant risks of unintentional breaches of anti-money laundering laws and countering financing of terrorist activities directives, instead prompt the miscreants to carry such nefarious activities surreptitiously so that they can be away from the gaze of the law enforcement agencies. Therefore, the ban in my view as rightly held by the SC wasn't a viable panacea to the conundrum of formulating a regulatory scheme for the parallel economy of cryptocurrencies.

Conclusion: Yearning for potent & comprehensive Regulatory Safeguards for Cryptocurrencies Ecosystem.

The legitimacy of Cryptocurrency ecosystem looms in limbo and uncertainty around the globe as manifested by the manner in which it has been dealt with, by either resorting to foiled or dodgy attempts made by the European Union and many other sovereign jurisdictions in tackling the concomitant perils, which users transacting in crypto-assets may expose themselves to. As virtual currency ecosystem is hinged on unfettered decentralization and anonymity which are its inextricable features and therefore sine qua non for any transaction to be termed as a cryptocurrency transaction, therefore tweaking the same features for the purpose of regulation would tantamount to belittling the VC ecosystem. Perhaps, it's like fitting a square peg into a round hole when it comes to fitting cryptocurrencies into the traditional legal framework governing fiat currency. The discourse on regulation of virtual currencies is suffused with core technical deficiencies like decentralization and anonymity, which engenders inherent semantic ambiguity in definitions of VCs rendered by various money market regulators and financial institutions across the world. The money market regulators and International bodies also realize the need to bring uniformity and coherence in the definitions of VCs before regulating it, so that it may facilitate in framing a regulatory mechanism to streamline the technical deficiencies, further to also mitigate the risks associated with it in tandem with sustaining the sine qua non features of VCs ecosystem. Moreover, International financial institutions and regulators are apprised of the gradual growth of the parallel economy, begat by VCs and thus apprehend the possible supplanting of fiat currency by VCs in future. Therefore, to thwart the building of a parallel economy of VCs as feared by many critics, many central banks across various jurisdictions have begun to frame rules to curb the vices associated with the transactions in cryptocurrency.

But Indian Central Bank (RBI) took an extreme step by imposing a ban, which was an impulsive as well as an early step against newly innovated virtual currencies, which is yet to flourish and become an equivalent of fiat currency. Whilst admitting that RBI lacks statutory powers to regulate VCs ecosystem, Supreme Court accentuated the befuddled approach of RBI as manifested in its absurd actions, by issuing a circular which does not seek to ban the VCs but only purport to severe its interface with the fiat currency coupled with the underlying quandary Central Government is grappled with, as reflected in its inaction to enact a comprehensive legislation, despite inter-ministerial committee coming up with several proposals including two draft bills which advocated exactly opposite positions. RBI acknowledged and admitted the inability of assailing the primary target of trading of VCs for want of statutory powers, therefore it adopted an elusive regulatory mechanism to target only the VCEs, which was merely one of the channels through which transactions in cryptocurrency was consummated dodging the conundrum of regulating miners and the blockchain which are thus the edifice of decentralized cryptocurrency, to mitigate its concomitant risks. Therefore the ban, in my view was merely a sop in the name of regulation as it was really naïve and dodgy trying to canvas a regulatory cover only on VCEs just because it interacts with fiat currency, thereby galvanizing the RBI into ring fencing the regulated entities to safeguard the monetary system against the possible harm that may be inflicted by providing banking services to such intermediaries, whose role in the ecosystem is merely secondary. Considering that many countries whilst not accepting VCs as a legal tender have also not yet banned cryptocurrencies, in the wake of it, ban would certainly impact India's burgeoning image of being a center of technological innovation. Henceforth, a potent and a comprehensive regulatory framework is yearned for VCs ecosystem, to mitigate the unintentional breaches of Anti-money laundering laws and Countering of financing of terrorist activities directives sans tweaking the edifice upon which the VCs ecosystem survives.


  • Articles:
  • Alan Lloyd Paris & Srinivasa Manikant Upadhyayula, "Bitcoin: Currency of the future or money laundering vehicle?" (2017).
  • Elizabeth S. Ross, "Nobody Puts Blockchain In A Corner: The Disruptive Role of Blockchain Technology In The Financial Services Industry And Current Regulatory Issues", (2017).
  • Marc Pilkington, "Blockchain Technology: Principles and Applications", Research Handbook on Digital Transformations, (2015).
  • Dr. Asress Adimi Gikay, "Regulating Decentralized Cryptocurrencies Under Payment Services Law: Lessons From European Union Law", Journal of law, Technology & the Internet, Vol.9, (2018).
  • Reports:
  • Guidance for a Risk-Based Approach – Virtual Currencies, Financial Action Task Force Report, (2015).
  • Virtual Currency Schemes, European Central Bank Report, (2012)
  • Guide for Cryptocurrency users and tax professionals, (2019)

[1] Eli Dourado and Jerry Brito, Cryptocurrency, THE NEW PALGRAVE DICTIONARY OF ECON. (2014).

[2] Guidance for a Risk-Based Approach – Virtual Currencies, FATF, page 26 (June 2015)

[3] Virtual Currency Schemes, European Central Bank Report, page 13 (October 2012)

[4] Guide for Cryptocurrency users and tax professionals (Last modified on 27 June 2019)

[5] 585 US ___ 2018, 138 S. Ct. 2067 (2018)

[6] Clause (33) of Section 65B of the Finance Act, 1994

[7] Case No. 4: 13-Cv-416 (August 6, 2013)

[8] 264 So. 3d 1055 (2019)

[9] [2019] EWHC 3556 (Comm)

[10] [1965] 1 AC 1175 at 1248

[11] Case C-264/14 dated 22-10-2015

[12] Alan Lloyd Paris & Srinivasa Manikant Upadhyayula, "Bitcoin: Currency of the future or money laundering vehicle?" (2017).

[13] Elizabeth S. Ross, "Nobody Puts Blockchain In A Corner: The Disruptive Role of Blockchain Technology In The Financial Services Industry And Current Regulatory Issues", 25 CATH. U.J.L. & TECH. 353, 360-61 (2017).

[14] Marc Pilkington, "Blockchain Technology: Principles and Applications", RESEARCH HANDBOOK ON DIGITAL TRANSFORMATIONS, 3 (Sept. 24, 2015).

[15] Section 3(1) of the RBI Act, 1934

[16] Section 21 of the RBI Act, 1934

[17] Section 45L(3) of the RBI Act, 1934.

[18] Section 21 of the Banking Regulation Act, 1949.

[19] Writ Petition (Civil) No.528 & 373 of 2018.

[20] Ibid.

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