Cryptocurrency v/s Law in India

Recently there has been news about the arrest of 1100 people associated with a money laundering case in china.[1] They used cryptocurrency to launder the money acquired through illegal activities. This is just one example; cryptocurrency has more or less dominated the news for some time now. There had been news of individuals becoming millionaires within weeks.[2] People around the world are excited about this new form of currency and are eager to learn about it. Big business magnates like Elon Musk are regularly tweeting about their favorite cryptocurrency. Online hacker group called ‘Anonymous’ have also entered by releasing video, openly threatening Elon Musk for his irresponsible tweets that dramatically impacts the crypto market.[3] Nowadays netizens are showing their support online for one and sometimes shading on another cryptocurrency. However, there is no doubt that people are enthusiastic about cryptocurrencies. In this article we will understand what cryptocurrency is and what has been its journey in India.

Understanding Crypto

The most basic definition of cryptocurrency (also called crypto) is that it is a digital currency that uses cryptography to secure the transactions.[4] The motive behind cryptography is that there should be no counterfeiting or double spending. It is different from fiat money (Conventional Money) as it is generally decentralized. Before the cryptocurrency as we know it today, there were few attempts to make a digital currency which would use cryptography and would use a decentralized ledger system. A phenomenon came to the world of finance in the form of a person named Satoshi Nakamoto, when he published his paper titled “Bitcoin – A Peer to Peer Electronic Cash System” in the year 2008.  He appeared out of nowhere in 2008 and disappeared just as abruptly three years later, after establishing the world’s first cryptocurrency ‘BITCOIN’.  Bitcoin has a limited supply to make sure the steady appreciation of value. It was initially designed to function as a mode of exchange on the internet where anonymity of its users remains intact. Since that time many more cryptocurrencies have been developed which are collectively called ‘Altcoins’. As of January 2021 there are more than 4000 cryptocurrencies in existence.[5] The enthusiasm around this new type of currency has provoked many countries to bring about the reform in their markets so that cryptocurrencies can be efficiently regulated. Many countries like the USA and Japan have welcomed it and are working towards improving the technology but some like china are skeptical and fear its potential to be used as a terrorist financing tool.[6] But, almost all the central authorities have consensus on the need to understand the technology and find out the way to utilize the technology embedded in it.

Technology behind Cryptocurrency

The cryptocurrency is based on the blockchain technology. A blockchain is a continuously growing list of records, called blocks, which are linked and secured using cryptography.[7] It is “an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way”.  A distributed ledger is essential to keep the crypto decentralized as using this system any individual can facilitate the transactions between any other two people and get a fee in the form of crypto for that. This fee for transaction is very low and hence it is a better alternative to the central banks which has comparatively larger fee for the similar job. There are multiple ways to acquire crypto. One way is to facilitate the transaction and get fee for your service but there are other ways to get it like, one can mine those using computers by solving complex mathematical problems, which can be done by using many programs available online. Other way to get crypto is to purchase it using fiat money. The acquired crypto can then be traded or sent to another person as a payment for any transactions. Crypto uses peer-to-peer system which means that one can send or receive money from anyone at anytime, no matter which part of the world they both live in without any external intervention. All the records of the transactions are maintained in a public ledger which uses blockchain technology and thus provides security as well as transparency.

Drawbacks

There are many advantages of crypto like it can make it easier to transfer funds between two individuals without any need for a third party like a bank or credit card company and it uses minimal processing fees for transactions thus allowing them to avoid high fees of banks but, it has many problems that need to be recognized before solving them. Firstly, the semi-autonomous nature of it makes it easier to be used for illegal activities like money laundering and tax evasion. Secondly, since the crypto is a digital currency and are not actually backed up in any database, a crypto balance can be lost completely if the hard drive in which it is stored gets lost or destroyed. It is also susceptible to drastic fluctuation and thus has a huge risk when investing in any particular crypto. Due to these reasons according to many economists crypto are nothing more than a short-lived fad or speculative bubble which will fall eventually.[8] The mining of Bitcoin uses a lot of electrical power which is bad for the environment. No matter how many miners, it still takes 10 minutes to mine one bitcoin. At 600 seconds (10 minutes), all else being equal, it will take 72,000 GW (or 72 Terawatts) of power to mine a bitcoin using the average power usage provided by ASIC miners.[9]

Considering all these issues many countries have banned its use and many have resorted to developing their own centralized digital currency. In India also cryptocurrency has gone through many phases to reach where it is today with more than $1.5 Billion invested by Indians in crypto.[10]

Cryptocurrencies’ legal battle in India

India with the population as large as it has plays key role in any kind of technological revolution and it is no different with digital currency. As of January 2021, around 45% Indians have access to telecoms and Internet services.[11] This kind of Internet penetration is indicative of a potential market for crypto in the country. Bitcoin and other cryptocurrencies have been operational in the country for years now. As early as 2012, which were still initial days for Bitcoin, small-scale Bitcoin transactions were operational in the country. When in 2013, Bitcoin was gaining popularity internationally and few businesses started accepting Bitcoin as payment in India a vintage era pizza shop called “Kolonial” in the Worli, Mumbai became the first restaurant in India to accept Bitcoin payments.[12] Soon after that cryptocurrency exchanges began to spring up within the country. People were very enthusiastic about this new kind of currency. Apart from these online exchanges there were also a number of Over the Counter (OTC) crypto shops and Bitcoin ATMs in numerous major cities in the country.[13] All of this has brought the crypto to the levels which it is today.

But, probably one of the two most important events that led to the widespread adoption of cryptocurrency in India was when on November 8, 2016, Prime Minister Narendra Modi announced for the demonetization of almost 86% of the country’s paper currency.[14] This demonetization was a shock for the entire subcontinent of India. Individuals with large cash holdings started looking for ways to continue holding such wealth without substantial tax cuts. One of the ways was to buy substantially large amount of Bitcoin and then sell it at a later date. This helped them to effectively avoid considerable amount of taxes which would have been inevitable had they tried to circulate their wealth through the banking system. The demonetization also ignited a conversation against the mainstream financial system in the country. People were questioning the ambiguity of the fact that in the span of just 24 hours more than 80 percent of the country’s paper currency in circulation had been rendered valueless, just by a single proclamation of the government. People started speculating that “fiat” money isn’t exactly real money as it isn’t backed up by anything and thus they started seeking for an alternative currency model.

Numerous Indians, particularly those in the 45% section with access to the Internet started to take up Bitcoin and other cryptocurrencies. The 2016 demonetization may have ignited the selection of cryptocurrency over conventional money among an extensive segment of the populace, but the development of the market in the country was hampered due to several reasons.[15] In spite of its large population, India just contributes 2% of the global crypto market capitalization.[16] Such a little job played by an enormous economy like India can be ascribed to the high crypto cost and the government crackdown led by the Reserve Bank of India (RBI). The level of prices of cryptos is higher than the global average. RBI has consistently warned citizens about the risks associated with the crypto and the government has not exactly banned it but it surely hasn’t endorsed it.

RBI’s crackdown

India being an untapped market with immense capability for the crypto market to flourish, it has seen massive surge of cryptocurrency exchanges. Due to the massive popularity of crypto market, its usage within a year of its introduction, and potential revenue loss, the government of India and other regulators and authorities started eyeing it with caution and in 2013 RBI issued a press release, cautioning the people about the risks related to Bitcoin and Altcoins.[17]

Inter-Ministerial committee of 2017

In 2017 the government formed an Inter-Ministerial committee(IMC) to report on various issues relating to cryptocurrency.

The IMC identified several problems with non-official digital currencies in its 2019 report. It came to the conclusion that they need to be banned. Some of the main issues they found were the threat of financial and economic instability due to its decentralized system, risks of fraud and price manipulation, potential to be used for criminal activities and massive energy consumption.[18] Considering all these problems, IMC came up with the Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019 (hereinafter draft bill).

According to Draft Bill’s section 2(1)(a),

“Cryptocurrency, by whatever name called, means any information or code or number or token not being part of any Official Digital Currency, generated through cryptographic means or otherwise, providing a digital representation of value which is exchanged with or without consideration, with the promise or representation of having inherent value in any business activity which may involve risk of loss or an expectation of profits or income, or functions as a store of value or a unit of account and includes its use in any financial transaction or investment, but not limited to, investment schemes”[19]

This definition not only covers all the virtual currencies of any kind. This means that the ‘frequent flyer rewards’ of Indigo or the Paytm’s ‘first points’ and any other digital representation of value that has the capability to be exchanged also comes under the ambit of its definition. The widespread ban on all types of digital currency was a disproportionate measure since the committee’s report with respect to the protection of consumers mainly pertained to cryptos.

As a result of employing a broad definition, the Draft Bill prohibits the mining, generation, holding, sale, dealing in, issue, transfer, disposal or use of all VCs other than the official digital currency in the territory of India.[20]

In April 2018 the RBI had advised all entities regulated by it not to deal in cryptocurrencies or provide services for facilitating any person or entity in dealing with or settling them.[21] In 2018, the finance ministry also issued a statement, stating “the government does not consider cryptocurrencies as legal tender or coin and will take all measures to eliminate the use of these crypto-assets in financing illegitimate activities or a part of the payment system.”[22] This put the entire Indian cryptocurrency trading industry in turmoil as the exchanges needed the banks for carrying on the function of sending and receiving the money which would then be converted into cryptocurrency and for the payment of salaries of employees, office space and other things that comes along with it.

Although, after all the commotion, a ray of sunshine finally shined on March 4, 2020, in the form of the Supreme Court of India as it passed a decision in a very thorough judgment quashing the earlier ban imposed by the RBI for being unconstitutional in Internet and Mobile Association v. RBI.[23]

 

Internet and Mobile Association v. RBI

The crypto-trading entities moved the Supreme Court against the circular of RBI that banned the financial institutions from providing services to businesses dealing in crypto trade and exchange. In the following case the circular was struck down by SC. The Supreme Court held that cryptocurrency is capable of being accepted as valid payment for the purchase of goods and services, and payment systems can be regulated by the RBI.[24]

The SC made observations on the role of RBI in the economy. It recognized the objective of RBI to maintain the price stability. Court held that the RBI was well within its rights issuing the concerned circular as it was doing it to protect the interest of the public, depositors and the banking policy itself. SC went on to say that irrespective of any activity not forming the part of the credit system or payment system, RBI can regulate or even prohibit it if it can potentially pose a threat to the financial system of the country. Court dismissed the contention that there had been an excessive use of power by RBI since the circular was only issued to protect the public at large.

One of the main contentions before the court was that the circular had hampered the constitutional right of people to carry on any trade or profession and thus was violative of the Article 19(1)(g). The court upheld this contention but it differentiated among the three categories of individuals. Firstly, those who trade in crypto as a hobby, then, those who engage in crypto trading as their occupation and lastly ‘the cryptocurrency exchanges’. The individuals in the first group can’t base their claims on Article 19(1)(g) as it only covers occupation, profession or business.[25] The individuals in the second group can also not claim that the circular completely shut their businesses, as they could still use the currencies they already have in their respective wallets to make payments for the purchase of things to those who are prepared to accept the same, in India or anywhere else in the world. Thus, it is only the people in the third category that truly suffered due to the circular because they had no other means to survive due to the disconnection of banking channels.

Although the RBI was well within its rights to issue the said circular, the circular was struck down due to the lack of “proportional damage” suffered by RBI regulated entities in dealing with businesses operating in cryptocurrencies. It was noted that the RBI did not explore the availability of alternative and less intrusive measures such as regulating crypto trading and exchanges before issuing the circular.

This particular judgment turned out to be the other most important event with respect to the development of crypto market in India. It restored confidence in the public’s mind and has cleared the way for further investments and technological advancement in the field.

Recent Developments

The Indian government has introduced a new bill titled “Cryptocurrency and Regulation of Official Digital Currency Bill, 2021” which is very much similar to its predecessor i.e. draft bill, 2019. Finance Minister Nirmala Sitharaman has said that the inter-ministerial committee (IMC) has suggested a ban on private cryptocurrencies in India, like Bitcoin, in India. The same committee has also stressed on the introduction of an official digital currency that will be appropriately regulated by the Reserve Bank of India.[26]

The RBI has cautioned the general public on the matter of possible misuse of private cryptocurrencies time and again. However, if the New Bill imposes a complete ban on cryptocurrencies then the crypto traders will just move to an un-monitored platform for trading. The real reason for introducing a law related to virtual currency/ cryptocurrency is to simplify the process of trading and holding in a safer technological environment instead of banning it completely. The bill also has provision of introducing a state-owned cryptocurrency which will be regulated by the central bank. Even after the introduction of state-owned cryptocurrency regulated by the RBI, the risk factor involved in investment and holding of cryptocurrency shall remain the same.

An RBI regulated digital currency or the Central Bank Digital Currency (hereinafter CBDC), if introduced, has both advantages and disadvantages in its impact on the monetary policy and financial stability. A CBDC can result in lower transaction costs and increase technology efficiency by removing the need for intermediaries like banks. It will create an attractive ecosystem that will encourage economic growth and digital innovation. On the other hand, it being a virtual currency is also subject to price volatility and speculations. This can result in competition for commercial banks and may lead to banks increasing their deposit rates. The CBDC has geographical limitation wherein it is only accepted in the issuing country and poses other infrastructural challenges.

Moreover, even with the introduction of state-owned cryptocurrency which shall be regulated by the RBI, the risk factor involved in investment and holding of cryptocurrency shall remain the same.

MCA’s notification  

In the last week of March 2021, through the latest amendments to the Schedule III of the Companies Act, 2013, the Government of India has mandated that the companies have to now disclose profit or loss on transactions involving cryptocurrency/ virtual currency, the amount of holding, and details of deposits or advances from any person for the purpose of trading or investing in cryptocurrency/ virtual currency.

The notification reads:

“Where the Company has traded or invested in Crypto currency or Virtual Currency during the financial year, the following shall be disclosed:-

  •  profit or loss on transactions involving crypto currency or virtual currency
  • amount of currency held as at the reporting date,
  • deposits or advances from any person for the purpose of trading or investing in crypto currency/virtual currency,”[27]

This amended schedule although have to approved by the parliament will come into force from April 1, 2021.[28] This particular step has been welcomed by the people dealing in the crypto sector, as it is understood the same would open the door for all Indian companies to have Crypto on their balance sheets and thus recognizing the crypto transactions.

Problems with cryptocurrency in India’s context

Cryptocurrencies in Indian context portrays few limitations. They are as follows:

  1. Lack of regulatory body: Indian government is pursuing a wait and watch policy towards cryptocurrencies; whereas other nations of the world have already responded to the use of cryptocurrency. There are no regulatory bodies to look after the transaction of cryptocurrencies. This has led to increased chances of fraud, threat to investor protection, monitoring of the movement of money in the economy. Reserve bank of India along with other central banks of the world was unable to track the activities of cryptocurrencies.
  2. Safety and Security: One of the most concerning problem with the cryptocurrency is that it is susceptible to be used for money laundering and for terror financing and providing a platform for criminal to convert the black money into white.[29] It has also become a common place for hackers.[30] This has brought tiredness among the population to a larger extent as it brings lesser security and lack of reliability.
  3. KYC delay: An investor who signs up for a cryptocurrency transaction have to go under the KYC standards which may require some time for the approval by the respective wallets. This approval time taken could take a few days time. In such cases there is a possibility of the investors to lose the chance of making profit as the value of the currency would be fluctuating sharply.
  4. Risky: Due to large number of cryptocurrencies in the market it is very difficult to choose which crypto to invest in. The reason for the same is that not all crypto will fetch good returns. Guesswork becomes the key player and thus the risk factor comes in.
  5.  Taxing problem: Although the profits from crypto are taxable as long-term capital gains and short-term capital gains depending upon the duration of holding, the Income Tax rules are not clear enough about the taxation cryptocurrency.
  6. Price Volatility: Cryptocurrency is a highly volatile market as the pricing strategy depends upon demand and supplies along with speculation.

Way Forward

Cryptocurrency is probably going to be future of financial transactions. As a country we should think about the ways to embrace this technological advancement in its early stages and innovate it for using in other field as well. The government also said that it will explore the use of blockchain technology proactively for assuring in the digital economy considering that the 2017 Inter-Ministerial committee’s report along with the draft bill had highlighted the positive aspect of the distributed ledger technology and suggested for its various applications, especially in the financial services, for its use in India, including banks and other financial firm.Now, the government surely does have a difficult task which is to provide an environment for it to flourish and at the same time making sure that it is not used for any terrorist activity and other illegal activities. This is a chance for India to dominate this new market by utilizing its large populace and internet renaissance that it had in the recent years. There sure is a need for regulation in this market and it will be a difficult but achievable task. Some independent crypto exchange companies like ‘CoinSwitch Kuber’ is already helping by completing a thorough KYC check before registering anyone.[31]

Conclusion

It is true that there is still a lack of clarity with respect to the crypto regulation in India but India has a reputation of being a technological friendly nation and thus entire world is looking for India’s next move. One thing is clear that banning it is not going to be such a great idea and instead, the government should look for ways to bring about a reformation in Indian market to regulate cryptocurrency efficiently. There should also be experiments with crypto technology in other places like elections, health infrastructure, etc. Many countries are adopting crypto after making appropriate reforms. After El Salvador, Paraguay is about to bring a legislation to give bitcoin the status of legal tender.[32]Approximately 25 years ago internet also disrupted the world and revolutionized the technological world. Today we are witnessing another revolution unfolding right before our eyes. We can either choose to take advantage of it by utilizing it in businesses and helping it grow to be more secure and efficient or we can choose to wait for someone to develop the technology and then just adopt it. Either way it is clear that crypto as a conventional currency is the future that is not so distant and India can help a lot in ensuring that it happens sooner.

Author: Aman Raj, Vivekananda Institute of Professional Studies, Pitampura, New Delhi.


[1]  Chinese Police Arrest 1,100 People for Money Laundering With Cryptocurrencies, available at: https://www.wsj.com/articles/chinese-police-arrest-1-100-people-for-money-laundering-with-cryptocurrencies-11623332776 (last visited on June 25, 2021)

[2]  This 25-year-old says he’s a millionaire after investing early in ether and Bitcoin, available at: https://www.cnbc.com/2021/05/21/how-crypto-investor-bought-btc-eth-early-used-defi.html (last visited on June 20, 2021)

[3]  WATCH: Tesla CEO Elon Musk threatened over crypto tweets by hacker group Anonymous, available at: https://www.dnaindia.com/technology/report-watch-tesla-ceo-elon-musk-threatened-over-crypto-tweets-by-hacker-group-anonymous-viral-video-2893855 (last visited on June 25, 2021)

[4]  Andy Greenberg, “Crypto Currency” Forbes, August 31 2014

[5]  The 10 Most Important Cryptocurrencies Other Than Bitcoin, available at: https://www.investopedia.com/tech/most-important-cryptocurrencies-other-than-bitcoin/ (last visited on June 13, 2021)

[6]  23 Approved Cryptocurrency Exchanges in Japan — Number Rises Despite Pandemic, available at: https://news.bitcoin.com/cryptocurrency-exchanges-japan/ (last visited on June 13, 2021)

[7]  The great chain of being sure about things, available at: https://www.economist.com/briefing/2015/10/31/the-great-chain-of-being-sure-about-things (last visited on June 26, 2021)

[8]  The Future of Bitcoin, Available at: https://economics.rabobank.com/publications/2021/april/the-future-of-bitcoin/ (last visited on June 26, 2021)

[9]  How Much Power It Takes to Create a Bitcoin, available at: https://www.thebalance.com/how-much-power-does-the-bitcoin-network-use-391280 (last visited on June 26, 2021)

[10]  Interview Artur Schaback, Co-Founder and Chief Operating Officer of Paxful, News18, June 3, 2021

[11]  Internet penetration rate in India 2007-2021, available at: https://www.statista.com/statistics/792074/india-internet-penetration-rate/  (last visited on 26 June 2021)

[12]  On the Bitcoin bandwagon, available at: https://www.thehindu.com/life-and-style/food/pay-with-bitcoin-and-get-free-biryani-at-this-chennai-restaurant/article21832095.ece (last visited on June 25, 2021)

[13]  Shailak Jani, The Growth of Cryptocurrency in India: Its Challenges & Potential Impacts on Legislation(2018),( 10.13140/RG.2.2.14220.36486)

[14]  Why India wiped out 86% of its cash overnight, available at: https://www.bbc.com/news/world-asia-india-37974423 (last visited on 26 June 2021)

[15]  Karan Kashyap, “India’s Demonetization Is Causing Bitcoin To Surge Inside The Country” Forbes, December 12, 2016

[16]  Shailak Jani, The Growth of Cryptocurrency in India: Its Challenges & Potential Impacts on Legislation(2018),( 10.13140/RG.2.2.14220.36486)

[17]  Press Release: 2013-2014/1261, https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=30247

[18]  Department of Economic Affairs, Ministry of Finance, “Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies” (February 2019)

[19]  Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019, s. 2(1)(a)

[20]  Ibid., s. 7

[21]  DBR.No.BP.BC.104/08.13.102/2017- 18, https://rbidocs.rbi.org.in/rdocs/Notification/PDFs/NOTI15465B741A10B0E45E896C62A9C83AB938F.PDF

[22]  Are your crypto investments legal? Here’s everything you need to know, Available at: https://economictimes.indiatimes.com/markets/forex/forex-news/are-your-crypto-investments-legal-heres-everything-you-need-to-know/articleshow/82259869.cms (last visited on June 21, 2021)

[23]  Internet and Mobile Association of India V. Reserve Bank of India, Writ Petition (Civil) No.528 of 2018

[24]  Ibid.

[25]  The Constitution of India, art. 19

[26]  Govt committee recommends ban all cryptocurrencies, except those issued by state: FM, Available at: https://www.livemint.com/market/cryptocurrency/govt-committee-says-ban-all-cryptocurrencies-except-those-issued-by-state-fm-11612866715432.html (last visited on June 20, 2021)

[27]  GOVERNMENT OF INDIA, MINISTRY OF CORPORATE AFFAIRS, Notification, URL: https://mca.gov.in/Ministry/pdf/ScheduleIIIAmendmentNotification_24032021.pdf

[28]  Latest Amendments in Schedule III of Companies Act, w.e.f from 1st April 2021, Available at:

https://incorpadvisory.in/blog/amendments-in-schedule-iii-of-companies-act/ (last visited on June 26, 2021)

[29]  Bitcoin Money Laundering: How Criminals Use Crypto, Available at:

https://www.elliptic.co/blog/bitcoin-money-laundering (last visited on June 21, 2021)

[30]  Yes, Blockchain Can Be Hacked: 3 Ways It Can Be Done, Available at: https://www.epiqglobal.com/en-us/thinking/blog/blockchain-can-be-hacked (last visited on June 22, 2021)

[31]  Are your crypto investments legal? Here’s everything you need to know, Available at: https://economictimes.indiatimes.com/markets/forex/forex-news/are-your-crypto-investments-legal-heres-everything-you-need-to-know/articleshow/82259869.cms (last visited on June 21, 2021)

[32]  Paraguay becomes second country to propose a bill to make Bitcoin legal tender, Available at:

https://www.indiatoday.in/technology/news/story/paraguay-becomes-second-country-to-propose-a-bill-to-make-bitcoin-legal-tender-1819142-2021-06-25 (last visited on June 26, 2021)

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