The Crypto-Sphere in India: What Did the Regulatory Bodies Decide?
The stance that Indian regulatory bodies take on cryptocurrency is a largely regressive one as evidenced with the circulars passed by the RBI in 2013, and then two subsequent ones in 2017. The circular passed in 2018, inter alia, effectively banned trades and exchanges of cryptocurrencies in India. However, the Supreme Court passed a landmark judgement in March 2020 in which it struck down this circular, terming it unconstitutional. A year after this, the Parliament was planning to propose the Cryptocurrency and Regulation of Official Digital Currency Bill, which frames regulations for the virtual currencies [VCs] (cryptocurrencies).
Most following the news might be aware of this legal timeline, but many often look over why the regulatory bodies did what they did. As individuals who are crypto enthusiasts, it might suffice to know what the current stance is. A demystification of the same however, strengthens ones understanding of the larger picture, equipping one to reflect on other stakeholders.
Trust – What Happens When People Stop Trusting…
Any market has three key stakeholders that engage in a transactional relationship – consumers, producers and often, a third-party regulatory authority that legitimizes the interaction. As with any transaction, trust is a key factor that needs to be encoded amongst the interacting agents in order to ensure that the value of their deal is preserved and fairly arbitrated. With something like money, the legal tender of exchange, trust becomes all the more important. Banks and other financial intermediaries (such as government institutions) therefore, have been entrusted with the regulation of money in any economy; they have acted as the primary regulator of financial transactions between individuals and firms for a long time. However, what happens if a technology has the potential to sideline these regulatory authorities if people start to lose trust in them?
This is exactly what happened when the 2008 financial crisis struck the globe. In the frenzy and recession that followed, people’s trust in financial institutions such as banks started declining. Against this backdrop was the inception of the technology that introduced what the RBI initially perceived as the Pandora’s box – cryptocurrencies. The technology that makes it possible is blockchain.
One of the integral components to record transactions are ledgers – it forms the base of financial systems. Traditionally however, not all consumers are privy to these transactions. Blockchain is revolutionary because of its ‘distributed ledger technology’.
Imagine if you have a way of directly validating your transactions without a third-party, like your bank, and you and your ‘peer’ can access and inspect these transactions in a way that is secure and safe. That’s the basic rundown of the distributed ledger system. The ‘validation’ bit comes from cryptography – complex mathematical and computer principles that can encode and transmit your data in a secure way. Now if everyone can inspect your transactions, then the network is public, but if there are some restrictions placed on who can view the transactions, then the network is private.
The key takeaway is that this system eradicates the need for a third-party regulator – it is called a ‘peer-to-peer’ system. Highly secure owing to the complexity of the cryptography involved, the risks of transacting in this manner are minimal.
However, this lack of regulation is, in essence, what bothers RBI.
The RBI Circulars
2013 marked the first time that the RBI cautioned the users, holders and traders of cryptocurrencies in a press release. The reasons cited include:
The lack of central agency to regulate transactions means that there are no redressal mechanisms should there arise any problem or dispute
Digital wallets can be vulnerable to “hacking, loss of password, compromise of access credentials, malware attacks, etc.”
The high volatility associated with the value of the cryptocurrencies
“Scope for illicit and illegal activities and unintentional omittance to comply with antimoney laundering and combating the financing of terrorism (AML/CFT) laws.”
In 2017, two RBI circulars essentially declared that there is no authorization or license for Indian customers of crypto and echoed the risks, advising caution when trading with the VCs.
Then finally in 2018, the RBI issued a circular that banned "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 VCs."
If we cut through the jargon, it meant that all trade and dealing with VCs were virtually halted.
From the perspective of the regulatory body, RBI, it was well-intentioned. It is the responsibility to ensure that consumers are protected, and should any problem arise, there should be redressal mechanisms in place. It is equally their responsibility to insure against high volatility; people blindly follow what a high-profile celebrity such as Elon Musk does or says to make their decision, this can and has dramatically influenced the value of the crypto, Dogecoin.
However, the other two stakeholders, the individuals trading cryptos and those that own crypto exchanges were, reasonably, angry. Therefore, the 2018 Circular was challenged by these stakeholders before the Supreme Court.
Supreme Court’s Decision – Some Discussion
On March 4th, 2020, the Supreme Court struck down the bill because it was ‘unconstitutional.’ On what grounds?
Some of the major challenges included that:
The RBI does not have the jurisdiction to ban or regulate cryptocurrencies since VCs fall outside the purview of the three Acts – RBI Act, 1934, the Banking Regulation Act, 1949 and the Payment and Settlement Systems Act, 2007.
The circular is disproportionate (vis-à-vis the application of the ‘doctrine of proportionality’) and fails the reasonableness test under Article 19(1)(g) of the Indian Constitution which guarantees the citizens the right to carry on any occupation, trade or business
How did the Court respond?
It acknowledged that VCs have the potential to create a parallel system which falls under the purview of RBI – it can invoke its power to regulate it.
The article does not go into the legality of the doctrine of proportionality. But essentially, the Court ruled that the Circular was curbing the livelihoods of those that owned the crypto exchanges and this was violating a fundamental right provided in the Constitution – if the VCs were not outrightly banned, banning crypto exchanges from accessing banking and payment channels makes it ‘disproportionate’. Moreover, there was no evidence to suggest that the RBI had suffered harm on account of virtual currency exchanges.
In layman terms, the Supreme Court’s judgement can be regarded as pro-cryptocurrencies for the most part. Post the striking of the 2018 Circular, the status of the VCs remains unregulated by the RBI.
To Trust or Not to Trust?
How can we interpret this in terms of trust? Basically, the Supreme Court’s decision can be understood as an affirmation in recognizing the potency that cryptocurrency can bring into the economy. This signals to stakeholders as a form of faith entrusted with the individuals participating in the transactions – even amid the potential regulations that the 2021 bill could bring, the crypto-investment has grown steadily. The volumes are an estimated 100 billion rupees with about 10 million investors, the numbers only steadily growing.
However, the judgement, in declaring that the RBI can potentially regulate VCs, the 2021 bill proposes an alternative – India’s own cryptocurrency, regulated by the RBI, at the cost of banning all the private cryptocurrencies. Given the gaining momentum of cryptocurrencies, whether or not people understand the inherent principle of trust in a transaction instituted vis-à-vis a regular, people are understanding that the regulator it is not necessary. This could also mean that the regulator – the RBI – is now seen more of an enforcer, curbing one’s freedom, which might force people to pursue the very mechanisms that the RBI hopes to insure against – parallel markets in environments that could exacerbate the risks.
But what do we make of the event when Mt. Gox collapsed in early 2014, where 850,000 bitcoins were stolen, losing more than $460 million? Albeit a much smaller loss than 2008 financial crises, it is this kind of risk that the RBI could have been worried about. Where do the individuals go? Of course, this is not for all individuals, but for those that ride the bandwagon without knowing what they’re trading or entering into. For an economy like India, the kind of economic losses it can cascade into, can be dangerous.
The solution isn’t to fully ban the cryptocurrencies however. Japan managed to address the crisis by instituting a well-regulated framework. Therefore, it is not impossible to efficiently regulate private cryptocurrencies. India’s economy is a potential hotspot for the VC market and FinTech as a whole. If the regulatory bodies are cognizant of that, we could perhaps expect laws that are favorable of the newer technologies and the opportunities it brings can be ‘mined’ successfully.
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