What next for virtual currency?
Supreme Court has set
aside an RBI ban on banks dealing with virtual currency holders. How do these
currencies work, how did the court rule on the RBI concerns, and what happens
after the ban is lifted?
On Wednesday, (04-03-2020) the Supreme
Court set aside a ban by the Reserve Bank of India (RBI) on banks and financial
institutions from dealing with virtual currency holders and exchanges.
The court held that the ban did not pass the “proportionality” test. The test of
proportionality of any action by the government, the court held, must pass the
test of Article 19(1)(g), which states that all citizens of the country will
have the right to practise any profession, or carry on any occupation or trade
and business.
In a circular in 2018, the RBI had banned
banks from dealing with virtual currency exchanges and individual holders on
the grounds that these currencies had no underlying fiat and that it was
necessary in the larger public interest to stop banks from providing any
services related to these.
What are
virtual currencies? Are they different from cryptocurrencies?
There is no globally accepted definition
of what exactly is virtual currency. Some agencies have called it a method of
exchange of value; others have labelled it a goods item, product or commodity.
In its judgment on Wednesday, the Supreme Court observed, “Every court which
attempted to fix the identity of virtual currencies, merely acted as the 4
blind men in the Anekantavada philosophy of Jainism, who attempt to describe an
elephant, but end up describing only one physical feature of the elephant.”
Satoshi Nakamoto, widely regarded as the
founder of the modern virtual currency bitcoin and the underlying technology
called blockchain, defined bitcoins as “a new electronic cash system that’s
fully peer-to-peer, with no trusted third party”. This essentially meant there
would be no central regulator for virtual currencies as they would be placed in
a globally visible ledger, accessible to all the users of the technology. All
users of such virtual currencies would be able to see and keep track of the
transactions taking place.
Virtual currency is the larger
umbrella term for all forms of non-fiat currency being traded online. Virtual
currencies are mostly created, distributed and accepted in local virtual
networks. Cryptocurrencies, on the other hand, have an extra layer of security,
in the form of encryption algorithms. Cryptographic methods are used to make
the currency as well as the network on which they are being traded, secure.
Most cryptocurrencies now operate on the blockchain or distributed ledger
technology, which allows everyone on the network to keep track of the
transactions occurring globally.
Are
cryptocurrencies dangerous?
The jury is out on that. Organisations
across the globe have called for caution while dealing with virtual currencies,
while also warning that a blanket ban of any sort could push the entire system
underground, which in turn would mean no regulation.
In June 2013, the RBI had for the first
time warned users, holders and traders of virtual currencies about the
potential financial, operational, legal and customer protection and
security-related risks that they were exposing themselves to. The following
year, the Financial Action Task Force came out with a report that highlighted
both legitimate uses and potential risks associated with virtual currencies. In
a different report, it again said use of such virtual currencies was growing
among terror financing groups.
Why did the
RBI ban virtual currencies?
Owing to the lack of any underlying fiat,
episodes of excessive volatility in their value, and their anonymous nature
which goes against global money-laundering rules, the RBI initially flagged its
concerns on trade and use of the currency. Risks and concerns about data
security and consumer protection on the one hand, and far-reaching potential
impact on the effectiveness of monetary policy itself on the other hand, also
had the RBI worried about virtual currencies.
In its arguments in the Supreme Court,
the RBI said it did not want these virtual currencies spreading like contagion,
and had therefore, in the larger public interest, asked banks not to deal with
people or exchanges dealing in these non-fiat currencies. The RBI argued that
owing to a “significant spurt in the valuation of many virtual currencies and
rapid growth in initial coin offerings”, virtual currencies were not safe for
use.
What did the
petitioners say?
The petitioners, who included virtual
currency exchanges operational in the country, told the Supreme Court that the
RBI action was outside its purview as the non-fiat currency was not a currency
as such. They also argued that the action was too harsh and there had been no
studies conducted either by the RBI or by the central government.
Arguing that the ban was solely on “moral
grounds”, the petitioners said the RBI should have adopted a wait-and-watch
approach, as taken by other regulators such as the Directorate of Enforcement
or the Securities and Exchange Board of India.
What did the
Supreme Court rule?
In its 180-page judgment on Wednesday,
the Supreme Court held that the RBI directive came up short on the five-prong
test to check proportionality — direct and immediate impact upon fundamental
rights; the larger public interest sought to be ensured; necessity to restrict
citizens’ freedom; inherent pernicious nature of the act prohibited or its
capacity or tendency to be harmful to the general public; the possibility of
achieving the same object by imposing a less drastic restraint.
The court did not agree, however, with
any other submission made by the petitioners. The petitioners had submitted
that the acceptance of Distributed Ledger Technology, or blockchain, and the
rejection of virtual currencies by the RBI as well as the government, is a
“contradiction” in terms.
Apart from domestic agencies, the RBI
could not be faulted for not adopting a “light-touch” approach as adopted by
other countries, the court said, adding that there could be no comparison with
other countries such as the US, the UK, Japan, or Singapore as they were
developed economies. “Therefore, we will not test the correctness of the
measure taken by RBI on the basis of the approach adopted by other countries,”
the court said.
What happens
now?
The Supreme Court’s judgment could lead
to the RBI rethinking its policies surrounding virtual currencies. It is
expected, said L Viswanathan, partner at Cyril Amarchand Mangaldas, that the
RBI will reconsider its approach to cryptocurrency and come up with a new,
calibrated framework or regulation that deals with the reality of these
technological advancements. Abhishek A Rastogi, Partner at Khaitan & Co,
said that the decision will help those investors who had used legitimate money
through banking channels.
Other
experts said that although the RBI’s reasons for prohibition could have been
right, it was never going to be successful as operations had predictably gone
underground. Salman Waris, founder of TechLegis, said the verdict removes the
arbitrariness of regulatory actions without disregarding the power of RBI to
regulate. “A reluctance on part of the regulator to regulate cannot be the
reason enough to stifle or kill a full industry,” Maco Mari said.
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