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The Supreme Court on Wednesday set aside the Reserve Bank of India (RBI) circular banning financial services from trading in virtual currency or cryptocurrency on grounds of proportionality.
In a detailed judgment, the Court examined not only the role and functions of the RBI, but also the exact nature of virtual currency (VC) in order to establish whether or not the banking regulator has the power to issue directions barring banking services from trading in VCs.
The Court found that while the RBI has very wide powers and functions, the availability of the same is very different from the extent to which they can be used. It was held that the RBI is entrusted with the function of taking pre-emptive steps to ensure that the entities it governs are not adversely affected.
However, it was noted that the RBI failed to demonstrate the damage that trading in cryptocurrency caused to banking and financial services.
"The availability of power is different from the manner and extent to which it can be exercised. While we have recognized elsewhere in this order, the power of RBI to take a pre-emptive action, we are testing in this part of the order the proportionality of such measure, for the determination of which RBI needs to show at least some semblance of any damage suffered by its regulated entities. But there is none."
In April 2018, the RBI issued a ciruclar barring banking and financial services from trading in cryptocurrency or virtual currency.
In the challenge to the same, various grounds were raised before the Apex Court, one being that VCs are not currency per se but are in fact commodities. The petition also questioned the authority of the RBI to govern and regulate cryptocurrency.
The judgment elaborates that the experiment to develop bitcoin was undertaken to tackle the problem of "debasement of currency by central agency." The Court remarks,
While addressing the unique nature of virtual currency and whether the RBI has the power to regulate it, the Court found that the RBI indeed has the power to regulate transactions of this nature, given that "access to banking services without any interference from the central authority over a long period of time is perceived as a threat to the very existence of the central authority."
The Court mainly delved into three aspects on the issue - the role and function of the RBI, the identity of virtual currency, and whether the RBI has the power to regulate virtual currency.
Taking into account the provisions under various statutes from the historical Imperial Bank of India Act, 1920 to the Reserve Bank of India Act, including the 2016 amendment, the Banking Regulations Act, as well as the Payment and Settlement Systems Act of 2007, the Court concluded that the RBI has very wide powers.
The primary functions of the RBI include regulation of issuing of bank notes, keeping reserves, and operating and managing the currency credit system. The natural next question was where, in all these layers, does cryptocurrency fit. The Court said that the exact identity of virtual currency eludes precision.
The Court placed reliance on the meaning attached to virtual currency and cryptocurrency by various international regulators and statutory enactments by different governments. It concluded that there exists unanimity of opinion that while virtual currency does not have the status of legal tender, it still constitutes as a digital representation of value.
The Court said that it is true that despite the fact that virtual currencies are not recognised as legal tender, they are very much capable of performing some of the functions of actual and real currency.
The Court examined the definition and scope of the term "currency" under the Foreign Exchange Management Act, which includes instruments such as postal notes, postal orders, money orders, cheques, drafts, travelers cheque, letters of credit, bills of exchange and promissory notes, and credit cards as currency and leaves room for more with the phrase "other similar instruments".
While virtual currency falls short of being notified as being included under the purview of such "other similar instruments", the Court noted that the contention that cryptocurrency is a commodity cannot be accepted given that instruments like promissiory notes and bills of exchange are also not "exactly currency" but much like virtual currency, operate as valid discharge of debt.
With the conclusion that the virtual currency is accepted as valid payment by some insitutions, the Court said that there cannot be an escape from being regulated by the RBI, as this fell squarely under the domain of the banking regulator.
Having held that cryptocurrency can be used for various functions of actual currency and that the RBI has the power to govern and regulate the same, it is on the grounds of proportionality ultimately that the RBI's April 2018 circular came to be set aside.
The Court noted that the present and accepted position of the RBI stood that there exists no ban on virtual currency. Additionally, an Inter Ministerial Committee constituted in 2017 had opined that banning cryptocurrency altogether would be an "extreme tool."
Therefore, the Court concluded that with the RBI required to be responsible for the entitites it governs, and the RBI failing to show adverse effect of virtual currency on the banking and NBFC entities, a ban on such a trade was disproportionate and a less intrusive approach could have been adopted.
The Apex Court thus set aside the circular.