By Debanis Roy Chowdhury, Associate, COMPAD

In what might be termed as a watershed moment as far as new-age tech, more specifically cryptocurrencies are concerned, the Supreme Court of India struck down a circular issued by the Reserve Bank of India (RBI) which directed banks not to deal in transactions involving cryptocurrency (Internet Mobile Association of India v. Reserve Bank of India). judgment was rendered by the Bench of Justices Rohinton Nariman, Aniruddha Bose, and V Ramasubramanian.

The origins of the case lie in the circular brought out by RBI in April 2018.  The Reserve Bank of India had issued a circular barring banking and financial services from dealing in transactions involving virtual currency or Cryptocurrency such as BitCoin. It was this circular that was challenged before the Supreme Court by Internet Mobile Association of India (IAMAI).

Breaking Down the Judgment

A. The main grounds of the Petitioners in this case can be summarized as follows:

I. RBI has no power to prohibit the activity of trading in virtual currencies through Virtual Currency Exchanges (VCEs) since:

(i) Virtual currencies are not legal tender but tradable commodities/digital goods, not falling within the regulatory framework of the RBI Act, 1934 or the Banking Regulation Act, 1949.

(ii) Virtual currencies do not even fall within the credit system of the country, so as to enable RBI to fall back upon the Preamble to the RBI Act 1934, which gives a mandate to RBI to operate the currency and credit system of the country to its advantage.

(iii) While regulation of a trade or business through reasonable restrictions imposed under a law made in the interests of the general public is saved by Article 19(6) of the Constitution, a total prohibition, especially through a subordinate legislation such as a directive from RBI, of an activity not declared by law to be unlawful, is violative of Article 19(1)(g). Whether a directive would tantamount to “regulation” or “prohibition”, depends upon the impact of the directive.

Further, based on the first premise, it was also submitted by the Petitioners that Virtual Currencies (VCs) do not fall within the definition of “payment system” u/s 2(1)(i) of the Payment and Settlements Act, 2007.

B. Defining the Powers of the RBI

The SC after duly deliberating on the statutes governing the functioning of the RBI, delineated the boundary for the RBI, it said, the RBI Act, 1934, the Banking Regulation Act, 1949 and the Payment and Settlement Systems Act, 2007 cumulatively recognize and also confer very wide powers upon RBI (i) to operate the currency and credit system of the country to its advantage (ii) to take over the management of the currency from central government (iii) to have the sole right to make and issue bank notes that would constitute legal tender at any place in India (iv) regulate the financial system of the country to its advantage (v) to have a say in the determination of inflation target in terms of the consumer price index (vi) to have complete control over banking companies (vii) to regulate and supervise the payment systems (viii) to prescribe standards and guidelines for the proper and efficient management of the payment systems (ix) to issue directions to a payment system or a system participant which in RBI’s opinion is engaging in any act that is likely to result in systemic risk being inadequately controlled or is likely to affect the payment system, the monetary policy or the credit policy of the country and (x) to issue directions to system providers or the system participants or any other person generally, to regulate the payment systems or in the interest of management or operation of any of the payment systems or in public interest. Thus, laying down an important precedent for the entire judiciary in future.  By far this has been the most comprehensive analysis of the powers and the aegis of RBI. 

C. Identity of VCs

After referring to a host of foreign legislations and reports, definitions used by various International Bodies like the IMF, Financial Action Task Force (FATF), European Central Bank (ECB), the SC opined that, “there is unanimity of opinion among all the regulators and the governments of various countries that though virtual currencies have not acquired the status of legal tender, they nevertheless constitute digital representations of value and that they are capable of functioning as (i) medium of exchange and (ii) an unit of account (iii) a store of value”.

It was also argued that cryptocurrencies were not "currency" in the strict sense and that they could be termed as a medium of exchange or a store of value. Senior Advocate Shyam Divan, appearing for RBI, disagreed and said that it was a mode of digital payment, which the RBI had the power to control.

After due deliberation on foreign judgments the Court observed that, “virtual currencies are capable of being used as real money”.  The Court added that though virtual currencies were not recognised as legal tender, they were capable of performing most functions of real currency. It said, “…true that VCs are not recognized as legal tender, as it is true that they are capable of performing some or most of the functions of the real currency”.

The Court further held that the RBI had the power to regulate or prohibit an activity of this nature, “we hold that RBI has the requisite power to regulate or prohibit an activity of this nature. If at all, the power is only to regulate, not prohibit”. Thus, the Supreme Court made it clear that for future purpose RBI will have the sole authority to frame policies bring our circulars, and oversee the functioning of VCs in India. This is a welcome step from the apex court of the land as it clears the air pertaining to the powers of the RBI overviewing the VC market and functioning.

Further the Court after going through the European Union Parliament report on cryptocurrencies in detail, opined that, “Thus, the ultimate recommendation made by the European Union Parliament in the paragraph extracted above, is not to go for a total ban of the interaction between crypto currency business and the formal financial sector as a whole.” And also noted that RBI did not consider the availability of the alternatives before coming out with the impugned circular which has had decapitating effect on the VCEs prevailing in India at that point in time. The fact that only VCE remains operational today in the country out of the many that were existing back then when the RBI had decided to come out with the Circular reflects the damage done to the VCEs.

D. Quashes the RBI circular dated 06/04/2018 on the ground of Proportionality

Thus, while the Court acknowledged the power of RBI to regulate cryptocurrencies, it quashed the circular banning banking services to crypto businesses on the ground of “proportionality”. It held, “The position as on date is that VCs are not banned, but the trading in VCs and the functioning of VC exchanges are sent to comatose by the impugned Circular by disconnecting their lifeline namely, the interface with the regular banking sector. What is worse is that this has been done (i) despite RBI not finding anything wrong about the way in which these exchanges function and (ii) despite the fact that VCs are not banned.”  

The RBI contended that it had, right from 2013, been cautioning users of cryptocurrencies and that it considers cryptocurrency a digital means of payment which has to be nipped in the bud so that the payment system in the country is not jeopardized. The regulator also argued that it is empowered to take decisions banning cryptocurrencies.

The Apex Court also noted in its order that, “Persons who have suffered a deadly blow from the impugned Circular are only those running VC exchanges and not even those who are trading in VCs. Persons trading in VCs, even now have different options, some of which we have discussed above (wizards may have many more options). But the VC exchanges do not appear to have found out any other means of survival (at least as of now) if they are disconnected from the banking channels.” The fact that the Supreme Court acknowledged that due to the impugned RBI circular only VCEs have been facing problems without any means for finding any way for their survival lays down the prologue for the Court to infer later on in the judgment that the blanket ban imposed by virtue of the said Circular infringes the Fundamental Rights enshrined in and guaranteed by the Constitution of India under Article 19 (1)(g).

The Court therefore enunciated the fact that even though currently VCs are not banned in India, via the purported Circular dated 06/04/2018 RBI had imposed a blanket ban on the VCEs in India, which is not proportional as there must have been at least some empirical data about the degree of harm suffered by the regulated entities (after establishing that they were harmed). The Court further held that, “It is not the case of RBI that any of the entities regulated by it has suffered on account of the provision of banking services to the online platforms running VC exchanges.”  Thus, the imposition of a blanket ban by the RBI was not found to be proportional, and the same had violated the fundamental rights of the VCEs under Article 19(1)(g) of the Indian Constitution, therefore the said Circular was quashed by the SC.

In several developed jurisdictions, it is considered a good practice to conduct a cost-benefit analysis and place this in the public domain before any regulation is framed. Similarly, an impact analysis is regularly carried out following the issuance of a rule to ascertain whether it is having the intended effect and whether it has had any unintended consequences. The top court’s judgement could perhaps nudge RBI to adopt similar practices, which could serve to demonstrate the mode, manner and basis of the exercise of its regulatory powers. It would also serve as a defence if and when its regulatory actions are challenged.

E. Going Forward

India’s virtual currency industry had come to a standstill following the April 2018 notification that prohibited use of banking channels for transactions of cryptocurrencies such as Bitcoin. Several exchanges shifted overseas or closed their business altogether in the last two years. Many companies had to shift their entire business models from crypto to blockchain and many which did not have the amount of resources to go through such transition shut doors, or left the country citing unfeasibility of operational costs. The ban of cryptocurrency dealt a crippling blow to the industry and saw a closure of more than a dozen exchanges in India, including Coinome, Zebpay, Koinex, Cryptokart to name a few.

With the SC clearing the air on the future of VCEs in India the start-up community stands to gain the most from this, as over the last year investments had stopped and start-ups were staying away from starting business in the crypto and blockchain space in India which will change now. Investors say peer to peer (P2P) companies will see inflow of capital, similar to what has been happening globally. According to Crypto founders, investors and industry bodies the order would open up more avenues for a cryptocurrency ecosystem to be built. Despite its population and online presence, India only accounted for around 3% of the global cryptocurrency market before the ban but many reports suggest that the crypto market in India to have around 100 start-ups in future which will help in job creation, and a real contribution to the Indian Economy.

Further, the judgment of the SC will give a massive push for innovation, Bankers within the regulatory framework of the RBI would now have a nuanced understanding of crypto technology and regulate it in a way that will encourage innovations. The uplifting of the ban by the Supreme Court is going to open new opportunities for India in terms of investments, economic growth, financial inclusion, and market maturation.

Lastly, to sum it up all, The Supreme Court’s judgement is an example of the country’s top court respecting RBI’s autonomy while fostering responsive regulation. This should not be mistaken as judicial activism, as it has reinforced the powers of the central bank and its unique role in the economy, while also encouraging it to exercise its powers with proportionality and responsibility, backed with adequate empirical evidence.