Towards an enabling framework for cryptocurrency in India
The recent judgement of the Supreme Court of India (‘SC’) in Internet and Mobile Association of India v. Reserve Bank of India (‘IAMAI’) has lifted the functional ban on operating crypto-asset exchanges in India, by striking down the Reserve Bank of India’s (‘RBI’) Notification on Prohibition on dealing in Virtual Currencies (VCs) (‘Circular’).
This article analyzes the potential impact of IAMAI on the draft Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 (‘Bill’) which seeks to prohibit most commercial activities surrounding cryptocurrency.
The Bill forms part of the Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies, 2019. The Bill, in essence, defines cryptocurrency as “any information or code or number or token generated through cryptographic means or otherwise” providing a digital representation of value, representing value in any business activity, exchanged with or without consideration, with the promise of inherent value in any business activity involving the risk of loss, profits or income, or functioning as a store of value or a unit of account. The Bill excludes Official Digital Currency (‘ODC’) from the definition of cryptocurrency.
The Bill seeks to prohibit the use of cryptocurrency, and also provides a framework for regulating ODCs as legal tender. There is a complete prohibition on mining, generating, holding, selling, issuing, transferring and disposing cryptocurrency, except for research and experimentation purposes, with the Central Government having powers to further exempt specified activities. The Bill disallows using cryptocurrency as a medium of exchange or as legal tender. This ban extends to the direct and indirect use of cryptocurrency in any form, including buying and selling, providing cryptocurrency-related services and issuing cryptocurrency-related financial products. Additionally, existing holders are required to do away with cryptocurrency in their possession, within a 90-day period. In the event of non-compliance, the Bill provides for strict penalties.
Understanding IAMAI v. Reserve Bank of India
In IAMAI, the validity of the Circular prohibiting entities regulated by the RBI (such as banks, non-banking financial companies etc.) from dealing in virtual currency (‘VC’) or providing services for facilitating dealing with or settling trade in VCs, was challenged. The challenge to the Circular was brought by a diverse group of individuals, including persons operating crypto-asset exchanges, who were adversely impacted by a denial of access to banking facilities. Consequent to the Circular, crypto-assets exchanges were unable to transfer their earnings to bank accounts, which had been frozen, leading to losses.
The SC, striking down the Circular, held that it disproportionately interfered with a crypto-asset exchange manager’s fundamental right to carry on any occupation, trade or business or occupation under Article 19(1) (g) of the Constitution, by completely disconnecting them from the banking system. Observing that the Circular had almost wiped the VC exchanges (a subset of crypto-asset exchanges), the SC viewed that the doctrine of proportionality ensured that laws adopting drastically restrictive measures, such as the Circular, should be evaluated vis-à-vis public interest served, and the possibility of adopting less drastic restrictions.
In IAMAI, establishing public interest would have required the RBI to explore measures less drastic than completely severing the relationship between VC exchange operators and the formal financial economy. This was observed by the SC, in light of the judgement in Md. Faruk v. State of Madhya Pradesh, where it was laid down that a law directly infringing the freedoms guaranteed under Article 19(1) (g), would be upheld only “if it is established that it seeks to impose reasonable restrictions in the interest of the general public and that a less drastic restriction will not ensure the interest of the general public.”
The SC also noted that the RBI had not furnished any empirical evidence of the harm suffered by regulated entities, by providing services to VC exchanges, which in turn rendered the Circular disproportionate. Drawing from State of Maharashtra v. Indian Hotel and Restaurants Associations, the SC held it necessary for the RBI to provide empirical data of the harm suffered by banks in their interaction with crypto-asset exchanges, prior to denying access to banking facilities.
Assessing IAMAI’s potential impact on the Bill
The striking down of the Circular, on grounds of proportionality, suggests that future legislative responses to crypto-assets will most likely be subject to satisfying the doctrine of proportionality. This flows directly from the SC’s observations in IAMAI, when it noted that citizens whose occupation or trade is the sale and purchase of VCs “can certainly pitch in their claims on the basis of Article 19(1) (g).”
Therefore, it is arguable that the near-complete ban on trade in cryptocurrency as proposed by the Bill, lends itself to challenges on the ground of the test of proportionality, as enunciated in IAMAI. While IAMAI incorporates different aspects of the proportionality test as laid down in Modern Dental College and Research Centre v. State of Madhya Pradesh, it itself adds two significant aspects viz. identifying less drastic alternatives than complete prohibition, and providing empirical evidence of harm suffered.
On the issue of less drastic alternatives, the SC observed that the Bill was preceded by the Crypto-token Regulation Bill, 2018 which allowed the sale and purchase of crypto-tokens at recognized exchanges. This ‘volte-face’ by the Government, the SC concluded, led to the Circular being held as a disproportionate measure.
The existence of a previous draft legislation advocating a contrary position was not the only alternative finding mention in IAMAI. Additionally, IAMAI brought to the RBI’s notice, varying safeguards relating to trade in VCs such as developing a dashboard and a central repository, enabling trading only on white-listed addresses and the adoption of Aadhaar based e-KYC for VCs. IAMAI also discussed the possibility of a nuanced regulatory framework, differentiating between anonymous and pseudo-anonymous VCs. Going forward, it may be prudent to consider some of these measures before banning the use of VCs for commercial purposes. These factors are important, pointing to the existence of potential alternatives to a complete ban on trade in VCs. A revised Bill which considers and incorporates such safeguards will ensure that the legal threshold established by the test of proportionality is appropriately fulfilled.
On the issue of empirical evidence of harm, it is important that Courts adjudicate on financial legislation, particularly laws that restrict the use of VCs, keeping in mind both arguments and evidence. A primary concern with VCs is money laundering, ascertaining which requires monitoring VC transfers by regulators/enforcement agencies. This is difficult precisely due to the prevalence of anonymous peer-to-peer systems masking the identity of account holders. Enforcement agencies, therefore, may find it hard to obtain credible data on harm suffered by permitting trade in VCs. Consequently, it may be challenging to prove that restrictions on activities concerning VCs satisfy the proportionality test, if empirical evidence of harm is mandatorily required to prove the reasonableness of such restriction.
The Bill is timely and relevant for multiple reasons. Several of its key aspects such as the promotion of Distributed Ledger Technology and the potential introduction of ODC, are positive, future-facing initiatives that require legislative impetus. While the Bill is yet to be introduced in the parliament, IAMAI makes it clear that the proposed provisions relating to a prohibition on trading in cryptocurrency, may require a relook from the perspective of the proportionality doctrine. Doing this would ensure that future legal challenges to the revised Bill are obviated, and that India’s nascent cryptocurrency regulatory framework develops unhindered.
The authors are Shardul S. Shroff, Executive Chairman of Shardul Amarchand Mangaldas & Co., Ulka Bhattacharyya, a Research Fellow at Shardul Amarchand Mangaldas & Co., and KS Roshan Menon, a Research Scholar at Shardul Amarchand Mangaldas & Co.
The authors are grateful to Ms. Veena Sivaramakrishnan and Mr. Sumant Prashant for their comments on the piece.