Inter-Ministerial Committee on Regulation of Cryptocurrency in India: A Critical Analysis (Part II)

This post is the second part of a two-part series written by our intern Hatim Hussain on the recent move by the Government to regulate cryptocurrencies in India. It explores in detail the recommendations of the Inter-Ministerial Committee set up to provide suggestions on the regulatory framework governing cryptoassets. Part one explored some of the existing legal frameworks governing cryptoassets in the country, and can be accessed here.

  1. Recommendations of the Inter-ministerial Committee

On promoting the use of DLT Frameworks

The Inter-Ministerial Committee (Committee) recommendations, as stated before, encourages the use of decentralized ledger frameworks in clear terms, in functions ranging from trade financing, clearing and settlements, and digital identity management, to multi-jurisdictional fund transfers and mortgage loan applications. Specifically, it recommends its usage in compliance mechanisms such as KYC, as well as in trade invoicing under the GSTN network. The Committee, in its report (Report) seems to allude to the fact that individual regulators should explore drafting appropriate regulations regarding cryptoassets and undertake necessary measures to facilitate the use of distributed ledger technology (DLT) in finance.

‘Non-Official’ Virtual Currencies

The Committee, however, believes that non-official virtual currencies do not possess the benefits associated with traditional fiat currencies. This is because unlike fiat currencies, cryptocurrencies do not have a sovereign backing, nor do they have a formal, verified track of a bullion. Further, the Committee notes that the market potential of cryptocurrencies is subject to technological and behavioural changes, making the intrinsic value of cryptocurrencies negligible and amenable to severe shocks and fluctuations. Although these are legitimate concerns and must be addressed by due process of law, cryptocurrencies have emerged to address the existing market frictions, and do so in a decentralized, secure, consensus-based and censorship-resistant manner, without any need for intermediary central banks like the RBI. In essence, the inefficiency of fiat currency systems was in itself the primary concern that steered Satoshi Nakamuto towards devising the world’s first DLT system (called the ‘Bitcoin blockchain’), the benefits of which the Committee promotes categorically. Given this, it is hard to overlook the Committee’s incongruence in promoting DLT frameworks, while at the same time rejecting its primary use case.

It is true that the functionalities of most virtual currencies that exist today are subject to market and behavioural changes. Nevertheless, this phenomenon seems to be addressed with the rise of cryptocurrencies like ‘stablecoins’ (where the price is linked to a stable asset or a basket of such assets, for e.g. Facebook’s Libra). Besides, it is not easy to ignore the potential use cases the adoption of virtual currencies can bring forth as a result of their accessibility, decentralization, lack of intermediary networks, transparency and improved security features, especially in a country like India — including financial inclusion and reduced transaction costs.

In either case, whether or not cryptocurrencies act as a store of value is not relevant to whether and how we strengthen the regulations surrounding it. It would be extremely impractical to outlaw crypto-activities rather than scrutinizing them more intensively in order to regulate them, especially since banning them would not ensure their removal, given the allure they hold to those seeking to circumvent government supervision, evade taxes, and engage in illegal transactions. Regulating them ensures that norms are set around legal and judicious use of cryptocurrencies in India.

Central Bank Digital Currencies

On a positive note, the Committee has sought to explore the use of a central bank-backed digital currency (also referred to as CBDCs). The Committee has recommended an inter-departmental study on the potential use and development of an appropriate model of digital currency in India and a consequent change, if adopted, in the legal framework, specifically in the Coinage Act, 2011 and the RBI Act, 1934.

CBDCs are essentially a digital representation of fiat money issued by the Central Bank of a country, in addition to cash and reserve monies, done on a peer-to-peer basis or through accounts opened by the Central Bank. The RBI had first hinted at the use of CBDCs in a 2018 report[1], announcing the formation of an inter-departmental group to study and provide guidance on its feasibility. It is worthwhile to note that various other countries have already considered the use of CBDCs as an addition to the existing fiat currency models. For instance, China recently announced plans to roll out a government-backed digital currency very soon.[2] A brief overview of crypto-asset regulations and the approach adopted by select jurisdictions considered by the Report is given below:

Source: Global Cryptoasset Regulatory Landscape Study (April 2019; University of Cambridge)[3]

B. Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019

The draft ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’ (Bill) is the first ever attempt by the Government to regulate cryptocurrencies in India. Notably, the Bill in the Report adopts a policy of prohibition rather than regulation, by proposing fine or imprisonment up to ten years for persons who “mine, generate, hold, sell, transfer, dispose, issue or deal in cryptocurrencies”[4], and fine or imprisonment up to seven years for abetment of activities involving its use.[5] It also makes offences under clause 8(1) of the Bill cognizable and non-bailable.[6] The Bill also stipulates a fine of three times the loss or harm caused by the person or two times the gain accrued, whichever is higher, to be imposed on the offender of the provisions contained therein.

The objectives of the Committee on imposing a general prohibition on all cryptocurrency-related activities was stated by an official from the Department of Economic Affairs as follows:

“Money laundering and financing terrorism are not the only concern for India. Bitcoin and other virtual assets (cryptocurrencies) have unrestricted access across the borders. We are looking at the greater concerns like Russian involvement in the American presidential election as well as the market risks involved. We don’t currently have the infrastructure to deal with such big threats.”[7]

It may be worthwhile to note that the broad scope of the definition of cryptocurrencies adopted by the Committee is akin to more regulatory advanced nations like Abu Dhabi,[8] Australia,[9] and Hong Kong.[10] The definition of cryptocurrency in the Bill is as follows:

“―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.”

While the definition in the Bill restricts itself to defining only ‘cryptocurrencies’, it should be kept in mind that any and all tokens issued on blockchains can represent traditional types of agreements (e.g. a share of common stock) held in a new form. This new infrastructure, which includes an integrated value transfer mechanism, enables new forms of asset creation, distribution, and transfer. However, the nature and subsequent legal obligations of the underlying asset does not change automatically. From a regulator’s perspective, therefore, a distinction could be made between traditional assets held in these new formats and previously non-existent asset types that exhibit distinct characteristics represented in a new form. Hence, such new-asset types/tokens may require distinct regulation compared to traditional assets.[11]

The definition has also adopted a technology-neutral approach as seen in most jurisdictions, as it does not explicitly mention the use of DLT or blockchain technology as a defining characteristic. However, the expansive scope of the definition raises some concerns, because it includes the use of cryptocurrencies in any financial transactions and/or schemes within its ambit. Read with Clause 7, which prohibits the use of cryptocurrencies, directly or indirectly, for a range of activities — including payments, investments, fund-raising, issuances of credit, buying, selling or trading for other cryptocurrencies — it creates major barriers for the promotion of the use of DLT for other financial services (which is also a recommendation put forth by the Committee in its Report).

Notably, the Government, while actively considering banning cryptoassets, has adopted a favorable position with respect to blockchain and promoted its use. However, as stated earlier, a ban on cryptoassets would negatively affect not only investors and traders but also the entire Indian blockchain software development ecosystem, since the two are intrinsically connected. Further, banning the use of cryptoassets in India will result in legitimate investments and trading being stopped, with illicit activities likely to continue anyway. This is because cryptoassets are available to anyone using the Internet, and trading and usage remain difficult to trace unless reported. Moreover, after the RBI issued its Directive on 6 April 2018 (2018 Directive), the prohibition on the use of banking channels for cryptoasset transactions has led to an increase in cash transactions, hawala transactions, and dabba trading, as well as increased usage of cash, dark pools and offshore trading.[12]

Additionally, the Bill fails to adequately regulate ‘digital rupee’ (defined as a ‘form of currency issued digitally by the RBI and approved by the Central Government to be legal tender’), nor does it go into the specifics of the functioning of the CBDC, if the same was to be adopted, under Chapter IV. As such, the regulation of digital rupee/CBDC under Chapter IV seems inadequate and deserves more attention. These are some necessary questions to be considered, since financial disintermediation, scalability and accessibility are critical issues that need to be addressed before the RBI can roll out a functioning digital currency as legal tender in the country.

Concluding remarks

Given the above, the Bill has a long way to go before it becomes a law. It would ideally need to be approved by the Ministry of Finance and the Cabinet before being introduced in Parliament. Moreover, it also needs to be published for public comments before being introduced. There is a possibility that the Bill may be examined by a Standing Committee before being considered by both the Houses of Parliament. The Supreme Court is also scheduled to hear arguments on the constitutional validity of the 2018 Directive prohibiting virtual currency transactions from regulated financial institutions, among other issues.[13]

It must be noted that one of the universally recognized principles of financial regulation is to ensure that the markets are transparent and honest, letting investors make their own decisions and refraining from making normative judgements.[14] Thus, in regulating virtual currencies out of existence, the Committee recommendations seem less thoughtful or practical.

While inadequate regulatory mechanisms certainly create gaps that can be misused, recent developments in the cryptocurrency ecosystem prove that digital assets are going to be an important part of the future. If we are to play a crucial role in the global economic landscape, it seems much wiser to allay dystopian regulatory concerns and act on shaping a sensible regulatory framework that limits the fears of misuse and promotes the use of new technologies within the financial system.

Hatim Hussain is a final year law student at Gujarat National Law University, Gandhinagar and a Research Assistant at Cambridge Centre for Alternative Finance, University of Cambridge, UK. He is currently interning with the Esya Centre and can be reached at hatimhussain110@gmail.com.

The views, thoughts, and opinions expressed in the text belong solely to the author and are not attributable to the Esya Centre.

[1] Statement on Developmental and Regulatory Policies, 2018, available at: https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/ PR264270719E5CB28249D7BCE07C5B3196C904.PDF

[2] China’s central bank digital currency is “ready” after 5 years of development, The Block, available at: https://www.theblockcrypto.com/tiny/chinas-central-bank-digital-currency-is-ready-after-5-years-of-development/.

[3] Data on concentration of cryptoassets as of November 2018.

[4] Clause 3, Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019.

[5] Clause 8(3)), Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019.

[6] Section 12, Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019.

[7] Available at: https://inc42.com/features/union-budget-2019-to-ban-or-not-to-ban-cryptocurrency-thats-the-question/.

[8] Abu Dhabi Global Market (2018) Guidance — Regulation of Crypto Asset Activities in ADGM. Available at:

https://www.adgm.com/doing-business/adgm-legal-framework/guidance-and-policy-statements/adgm-wide- guidance/. A cryptoasset is 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 in any jurisdiction. A Crypto Asset is (a) neither issued nor guaranteed by any jurisdiction, and fulfils the above functions only by agreement within the community of users of the Crypto Asset; and (b) distinguished from Fiat Currency and E-money.

[9] Australian Government (2017) Anti-Money Laundering and Counter-Terrorism Financing Amendment Act 2017.

Available at: https://www.legislation.gov.au/Details/C2017A00130. A digital currency is (a) a digital representation

of value that: (i) functions as a medium of exchange, a store of economic value, or a unit of account; and (ii) is not issued by or under the authority of a government body; and(iii) is interchangeable with money (including through the crediting of an account) and may be used as consideration for the supply of goods or services; and(iv) is generally available to members of the public without any restriction on its use as consideration; or(b) a means of exchange or digital process or crediting declared to be digital currency by the AML/CFT Rules.

[10] Securities and Future Commission (2018) Statement on regulatory framework for virtual asset portfolios managers, fund distributors and trading platform operators. Available at https://www.sfc.hk/web/EN/news-and-announcements/policy-statements-and-announcements/reg-framework-virtual-asset-portfolios-managers-fund-distributors-trading-platform-operators.html. A virtual asset is a digital representation of value, which is also known as ‘cryptocurrency’, ‘crypto-asset’ or ‘digital token’. The polymorphous and evolving features of virtual assets mean that they may be, or claim to be, a means of payment, may confer a right to present or future earnings or enable a token holder to access a product or service, or a combination of any of these functions.

[11] Apolline Blandin, Michel Rauchs, Hatim Hussain et al, Global Cryptoasset Regulatory Landscape Study (April 2019). Available at: https://jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/cryptoasset-regulation/.

[12] See, Dabba Trading sees an upsurge in the wake of RBI’s Cryptocurrency Ban, Business Today (July 30, 2018). Available at: https://www.businesstoday.in/current/corporate/dabba-trading-sees-an-upsurge-in-wake-of-rbi-diktat-banning-cryptocurrencies/story/280800.html.

[13] Siddharth Dalmia v UOI, W.P. © №001071 — I of 2017.

[14] Timothy Massad, Former Chairman, US Commodity Futures Trading Commission, It’s Time to Strengthen the Regulation of Cryptoassets (March 2019), Brookings. Available at: https://www.brookings.edu/wp-content/uploads/2019/03/Timothy-Massad-Its-Time-to-Strengthen-the-Regulation-of-Crypto-Assets-2.pdf.

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The Esya Centre is a technology policy think tank based in New Delhi, India

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The Esya Centre is a technology policy think tank based in New Delhi, India