Inter-Ministerial Committee on Regulation of Cryptocurrency in India: A Critical Analysis (Part I)
This post is one of a two-part series written by our intern Hatim Hussain on the recent move by the Government to regulate cryptocurrencies in India, and it explores some of the existing legal frameworks governing cryptocurrencies in the country. The subsequent post will explore the nuances of the Inter-Ministerial Committee report and the proposed ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’.
On July 22, 2019, the Department of Economic Affairs (DEA) released the much-anticipated report of the high-level Inter-Ministerial Committee (Committee) constituted to study issues and propose actions to be taken in relation to virtual currencies, headed by the then Economic Affairs Secretary, Subhash Garg. The Committee, set up in November 2017, with representation from country’s foremost regulators — the Ministry of Finance, the Ministry of Electronics and Information Technology, the Security and Exchange Board of India and the Reserve Bank of India — primarily aimed at examining the legal and regulatory framework for the regulation of crypto-assets. Guided by the long-standing stance of the Parliament on eliminating the use of virtual currencies in financing illegitimate activities[1], the Committee comprehensively analysed the regulatory framework across jurisdictions and explored its potential use cases in the financial field.
However, as far as bridging the gap between the promise offered by virtual currencies and its reality is concerned, perhaps overbearingly, the Committee assumed the crypotocurrency market’s lack of potential for improving the efficiency and inclusiveness of the financial system in India. It did not adequately provide principles for framing regulations providing for adequate regulatory oversight for the use of digital currencies in India.
In Part I of this blog post, I aim to analyse the existing laws with respect to regulation of crypto-assets viz a viz the recently released report of the Committee and the suggested recommendations. In Part II of this blog post, I will analyse the Committee report and the draft Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 (Draft Bill) in detail and scrutinize the far-reaching implications it has on the Indian economy.
Objectives of the Committee
The Committee was formed with four main objectives, to:
(i) take stock of the present status of virtual currencies both in India, and globally;
(ii) examine the existing global regulatory and legal structures governing virtual currencies;
(iii) suggest measures to deal with such virtual currencies including issues relating to consumer protection, money laundering, etc.; and
(iv) examine any other matter related to virtual currencies which may be relevant.
In meeting these objectives, the Committee has purportedly gone beyond its scope, by discussing the use of Distributed Ledger Technologies (DLT) — the underlying technology behind virtual currencies, as important and beneficial in the areas of trade financing, lowering the costs of personal identification for ‘Know Your Customer’ (KYC) related issues, and improving access to credit. Though it recommends the use of DLT in the financial domain, it ironically seeks to ban the use of private cryptocurrencies, notwithstanding the fact that both go hand in hand, and it is often difficult to separate one from the other.
The Committee has also welcomed the Directive issued by the Reserve Bank of India (RBI) on 6 April 2018 (2018 Directive) in eliminating the use of regulated financial institutions to deal in cryptocurrencies.[2] It goes further — in recommending a similar prohibition on all exchanges, people, traders and other financial system participants and criminalizing the carrying on of any activities connected with cryptocurrencies in India. Notably, the recommendations do not suggest how to enforce the prohibition, which seems rather unrealistic considering the pseudonymous, decentralized and multi-jurisdictional nature of virtual currency transactions.[3] The suggestions of the Committee are also against the joint commitment declared in June by the G20 nations, including India, to enforce positive regulations by applying crypto standards set by the Financial Action Task Force (FATF) within individual nations.
The ‘wait and see’ approach of the Committee in regulating virtual currencies is clear from the fact that it advises the Government to consider the introduction of an official ‘digital currency’ (referred to colloquially as Central Bank Digital Currency or CBDC), by keeping an ‘open mind’ and visualizing models of official digital currencies in the future. Part II of this blog post will delve into analysing the specifics of the Committee report and the Draft Bill. In the succeeding part of this post, I will elaborate upon the existing legal framework governing cryptocurrencies in India, in an attempt to provide clarity to readers.
Existing legal framework
Given the regulatory uncertainty surrounding the governance of crypto-assets around the world, before analysing the Committee recommendations prohibiting the use of virtual currencies and the Draft Bill, it is quite important to understand the prevailing regulatory landscape regarding crypto-assets in India.[4] Although India currently does not have a specific law regulating cryptocurrencies and related transactions, a number of sector-specific regulations are applicable which trigger various regulatory requirements.
To begin with, virtual currencies are not covered under the legal definition of currency in India.[5] However, there is currently no law restricting the rights of two contracting parties to accept virtual currencies (except restrictions on dealing through the exchanges as discussed below) as the mode of consideration for a transaction.
The RBI issued the infamous 2018 Directive prohibiting entities regulated by it in dealing in virtual currencies or providing services for facilitating any person or entity in dealing with or settling virtual currencies. Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer / receipt of money in accounts relating to purchase/ sale of virtual currencies.[6]
The Indian Government has also undertaken a series of regulatory measures to curb activities related to cryptocurrencies with an objective to prevent financial risk and investor protection. These measures principally include the restriction of the primary business of cryptocurrency trading platforms, and a series of press releases by the RBI cautioning users, holders and traders of virtual currencies (including bitcoins) about the potential financial, operational, legal, customer protection and security related risks.[7]
Regulation of Crypto-asset Tokens
With respect to token offerings, so far, they are unregulated in India. However, the applicability of general laws can be explained as follows-
1. Security Tokens: under Indian laws, if the ‘security’ test under the Securities Contracts (Regulation) Act, 1956 (SCRA), is met, implications under the SCRA (e.g., securities can only be listed on recognized stock exchanges), and possibly the Companies Act, 2013 and Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (e.g., as regards the issuance of securities), arise. The applicability of SCRA to crypto-asset tokens is, however, unclear, with no regulatory guidance on its application to virtual currency context.
2. Utility Tokens: some tokens can often involve acceptance of monetary deposits and therefore, can be seen as acknowledgements issued in return for advance paid for services to be rendered in the future. If these are classified as deposits, the regulations under the Companies Act, 2013 would apply. The Companies (Acceptance of Deposits) Rules, 2014 (CADR), specify the conditions when receipt of money by way of deposit or loan or in any other form by a company would be termed a ‘deposit’, and also provide certain exemptions from its applicability.
For example, any amount received in the course of business as an advance for the supply of goods or services would not be a ‘deposit’ if such advance is appropriated against supply of such goods or services within a period of three hundred and sixty-five days. If a crypto-business is deemed to be accepting ‘deposits’, a variety of compliances under the Companies Act, 2013 and its rules, along with RBI regulations, would be triggered.
Further, it has also become essential for virtual currency token issuers to now ensure that any advance received in lieu of tokens is not an ‘unregulated deposit scheme’ under the Banning of Unregulated Deposits Schemes Bill 2019, passed recently by the Parliament. Under this Bill, a deposit-taking scheme is defined as unregulated if it is taken for a business purpose and is not registered with the regulators mentioned in the Bill. It defines a “deposit”, in essence, to mean money received by a deposit-taker with a promise to return it, whether in cash or kind or in the form of a service.[8] It also stipulates that where the deposit-taker does not obtain the necessary permissions under law to deal with the goods/services for which the money is taken, such amounts would be deemed to be deposits.[9] The regulatory landscape for crypto-businesses, especially when it comes to accepting money from the public, is therefore not straightforward at present.
3. Payment tokens: a token may be intended to be used as a means of payment for trading goods and services. In such cases, the payment tokens may be subject to regulation under the Payment and Settlement Systems Act, 2007 (PSS Act).
Payment Systems Regulation
Payment systems are generally governed under the PSS Act, which defines them as those ‘enabling payment (indebtedness relating to funds, securities, foreign exchange, derivatives or other transactions) to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange”. Under the PSS Act, any entity desiring to commence a payment system is required to obtain authorization from the RBI.[10]
It must be noted that if a token offering were to constitute a “payment system” or other regulated activity, the issuer would need payment system authorization from the RBI under the PSS Act, and would become a regulated entity. It would then need to follow KYC/AML norms as stipulated under the Prevention of Money Laundering Act, 2002 (PMLA). However, it is unclear whether these regulations apply to crypto-businesses. Notably, the crypto-industry has previously adopted a ‘self regulatory code’ in the absence of clear compliance requirements under law, initially prepared by the Digital Asset and Blockchain Foundation of India (DABFI) and later subsumed into the Internet and Mobile Association of India (IAMAI).
Licensing Requirements
Although licensing requirements are not directly applicable to intermediaries performing storage, exchange, payments, mining etc., Indian laws do regulate various kinds of financial services. For instance, requirement of licenses is necessary for investment advisory (but with exceptions — for example, assisting private companies in obtaining funding is outside the scope), merchant banking, custodians, stock brokers, underwriters, foreign institutional investors, depositories, venture capital funds and stock exchanges.
There are also stringent eligibility requirements for P2P lending platforms (which are required to be registered as ‘Non-Banking Financial Corporations’ with the RBI) which may also apply to such P2P platforms for crypto-asset backed loans. Further, under Indian laws, since virtual currencies can also be classified as being rights in intangible movable property, it may be subject to import and export transactions if a person resident in India enters into a purchase/sale transaction with any resident outside India, as per the provisions of Foreign Exchange Management Act, 1999 (FEMA). In such cases, the FEMA (Current Account Transactions) Rules, 2000 may also apply.
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] Budget Speech, 2018 (para 112). Available at: https://www.indiabudget.gov.in/budget2018-2019/ub2018-19/bs/bs.pdf.
[2] Reserve Bank of India (April 6, 2018), Prohibition on dealing in Virtual Currencies (VCs), RBI/2017–18/154. Available at: https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=11243&fn=2&Mode=0.
[3] <https://indianexpress.com/article/opinion/columns/cryptocurrency-india-digital-currency-rbi-5864865/>
[4] A brief overview of the laws currently applicable to crypto-assets in India is available here. A more detailed model on crypto-assets with a country report on India is available in the study published here.
[5] As per the relevant Indian laws — Indian Coinage Act, 2011, Reserve Bank of India Act, 1934, Foreign Exchange Management Act, 1999 and the Payments and Settlement Systems Act, 2007 — cryptocurrencies do not fit in any of the definitions of a currency, coin, or money.
[6] Supra at note 3.
[7] A similar approach is seen in countries like China and Iran. In this regard, RBI has said, “The absence of information of counter-parties in such peer-to-peer anonymous/ pseudonymous systems could subject the users to unintentional breaches of anti-money laundering and combating the financing of terrorism (AML/CFT) laws.” See, Reserve Bank of India (February 1, 2017), RBI Cautions users of Virtual Currencies, Press Release 2016–17/2054. Available at: https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=39435. Similar warnings have also been issued on December 24, 2013 (Available at: https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=30247) and December 5, 2017 (Available at: https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=42462).
[8] Clause 1 (4), Banning of Unregulated Deposits Schemes Bill, 2019. The Bill has been passed by both the Houses of Parliament in July 2019.
[9] Ibid.
[10] Also see Section 4, Payments and Settlements Systems Act, 2007. Available at: https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/86706.pdf.
