The Blockchain Push in the Legal Industry

The transformative power of blockchain technology is visible in many areas. The adoption of decentralised blockchain systems that are arguably more tamper-proof than traditional software systems can greatly benefit the legal services industry too. This process has already begun, with a judge in the UK allowing legal documents to be served using blockchain technologies. Earlier this year, a US court too authorised service of the suit via a “hot wallet” in another cryptoasset case.

Fabrazio D’Aloia, the founder of an online gambling company, sued a cryptocurrency exchange and other cryptobrokerage platforms by claiming that his cryptoassets were fraudulently accessed and cloned. D’Aloia’s suit (in a UK court) claims that the perpetrators used their platform to impersonate another platform and led him to transfer money from his cryptocurrency wallets for what he believed to be legitimate trades. The legal documents were served by transferring a token on a blockchain via wallets that originally belonged to D’Aloia but were stolen or exploited by unknown fraudsters.

Implications of such an allowance by the Courts

Traditionally, suits and notices could only be served via the mechanisms agreed upon by the parties in advance; options included post; in person by a representative; fax; email or other forms of electronic communication. These channels were largely adequate when the identity and contact information of the parties were known or easily traceable. However, in the digital world, many frauds are increasingly being perpetrated by “unknown persons”. Especially in such cases, when the identity of fraudsters/cybercrooks is not known but the suit has to be served, the blockchain route is a useful option because it uses the “digital wallets” compromised by the scamsters to reach them.

The other significant aspect of the UK court’s decision goes beyond communication channels: it recognises that the defendants are “constructive trustees.” This essentially means that cryptoasset exchanges and other intermediaries can be held liable for breach of trust if they do not take the necessary measures to ringfence the underlying cryptoasset. This will be a deterrent and force various players in the crypto industry to be more diligent. Indeed, this may also have implications for digital supply chains in the banking and financial services space as well.

Blockchain can transform many more aspects of the legal industry

Blockchain also has applications in other areas, such as litigation, IPR matters (both applying for patents and resolving disputes by providing evidence of creation, first use, rights management, tracking distribution), etc. Smart contracts can make it easier for artists (singers, painters, writers, etc.) to get paid. Each use case will obviously involve different user personas (roles- e.g., the parties and their lawyers, competent authorities, courts, etc.). Maintaining records of events such as birth, health, marriage, adoption, change in citizenship, death, etc. on the blockchain can make it easier to maintain tamper-proof records. Even property records can be maintained on the blockchain.

Such innovations will save parties and lawyers significant time and effort. This is an important benefit in a country like India, where a lot of time is wasted only because of the inefficiencies in accessing records and verifying their authenticity. The risk of forgery increases the presence of false evidence in various cases, thus leading to protracted legal proceedings. Improving the efficiency of various processes in the justice delivery system can speed up court decisions and reviews of appeals.

It appears that the adoption of blockchain-based paradigms can reduce pendency in various courts across the country- a major challenge for the judiciary that affects not only ordinary citizens but also our country’s reputation in terms of the ease of doing business and speed of delivering justice.

There is a sense of inevitability that the digital revolution will accelerate the evolution of different industry sectors in different ways and at varying times. India, with its large pool of technical talent, is well-positioned to take the lead. Just as our DBT/UPI technology stacks, blockchain solutions too can become attractive to a large chunk of the world. But we have to move fast and in a concerted manner at all levels of our complex judicial system.

The adoption of decentralised blockchain systems that are arguably more tamper-proof than traditional software systems can greatly benefit the legal services industry too.

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Blockchain Technology: Don’t Throw the Baby Out with the Bath Water!

Blockchain technology, which underlies cryptoassets, is revolutionary because it is the opposite of conventional software designs. Data is not recorded and stored in a central database, with identified database administrators responsible for updating it and maintaining security. Think of a blockchain as a shared digital ledger of transactions. Unlike a traditional database that relies on tables, blockchains use “blocks” to store information. Each block has a certain storage capacity. When a block is filled (with transaction data), it is closed and cryptographically linked to the previously-filled block. Thus, information is distributed across a “chain of blocks.”

Whenever a new transaction occurs on the blockchain, a record of that transaction is added to the ledger of every participant in the blockchain. This paradigm is supposed to make blockchain applications much harder to hack or for a small group of individuals to act in cohort with the objective of cheating or committing fraud. Cryptocurrencies and NFTs are built and traded using blockchain technology; in fact, blockchains were first used to create Bitcoin, the world’s first-and probably best-known-cryptocurrency.

Cryptocurrencies have crashed- but is blockchain to blame?

In recent weeks, however, various cryptocurrencies have lost significant value, spurring numerous debates around their relevance, safety and sustainability. It appears that the drop in value of most cryptocurrencies was caused by the spectacular drop in Terra, a supposedly stable “fiat-backed” coin that was pegged to the USD, South Korean Won and Mongolian Tugrik and Luna, its sister cryptocurrency. It is believed that massive withdrawals from Anchor, a Terra-based decentralized finance (DeFi) protocol, led to Terra’s UST stablecoin being “depegged” from the USD.

It is not yet clear is why such massive withdrawals happened, and whether it was the result of some kind of conspiracy (the high correlation with stock market movements does suggest some wrongdoing, although it is not clear by whom and with what intent). It is sad that investors lost billions of dollars in a matter of hours and days, and although a new version of Terra coin has been launched, it is too early to say if it will succeed. Naturally, questions are being raised about the much-vaunted safety of blockchain technologies.

Trust is critical to any innovation- the key is to find better ways of applying blockchain

Whether it is the world of cryptoassets or real assets, a key lesson to be learnt is that: trustworthiness will always trump technology and other tangible traits that underlie any physical or financial asset. One must therefore resist the temptation to throw the baby out with the bathwater. In this case, I am referring to blockchains: we should not, based on the failure of cryptocurrencies, give up on blockchains. Instead, we must work on enhancing its trustworthiness even further, so that even inadvertent loopholes don’t arise.

Blockchain technology is finding application in a number of other areas as well. These include supply chain management, shipping & logistics, e-governance, energy, education and financial services. Food traceability, enforcing music rights, securing payments and even tamper-proof vaccination certificates can all be delivered via blockchain. Many of these use cases are already under implementation in India. Even the emerging metaverse world is expected to make use of blockchain concepts.

Image Credits:

Photo by Ivan Babydov: https://www.pexels.com/photo/gold-bitcoin-coin-on-background-of-growth-chart-7788009/

Blockchain technology is finding application in a number of other areas as well. These include supply chain management, shipping & logistics, e-governance, energy, education and financial services. 

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Cryptocurrency and Money Laundering: Deciphering the Why and the How

The financial sector continues to revel in the advancement of disruptive technological innovations. Due to the attractive rates and fees, ease of access and account setup, variety of innovative products and services, and improved service quality and product features, financial technology is attracting more customers and investors today.[1] Despite the numerous advantages of these sectoral transformations, it is impossible to deny that the digitization and ease with which the internet has enabled all of us to function effectively in our day-to-day work has also created a space for virtual crimes.

Amidst the pioneering fintech revolution, cryptocurrency has emerged as a modern financial technology that can be used to easily launder money. Despite rapid market fluctuations and an uncertain legal status, cryptocurrency continues to captivate Indian investors, who are undeterred and unbothered by the associated risks of cyber fraud.

This article will explore how the crypto market nurtures a convenient and fertile ground for money laundering activities.

 

Cryptocurrency and India

 

The Indian regulatory market has had a hot and cold relationship with cryptocurrency over the years. The RBI, vide Circular DBR.No.BP.BC.104/08.13.102/2017-18 dated April 06, 2018[2], restricted all crypto transactions. However, in 2020, the Supreme Court effectively struck down the ban. As a result, the RBI stated in Circular DOR. AML.REC 18/14.01.001/2021-22 that banks and financial institutions cannot cite the aforementioned circular to warn their customers against dealing in Virtual Currencies. However, it did state that, “Banks, as well as other entities addressed above, may, however, continue to carry out customer due diligence processes in line with regulations governing standards for Know Your Customer (KYC), Anti-Money Laundering (AML), Combating Financing of Terrorism (CFT) and obligations of regulated entities under the Prevention of Money Laundering Act (PMLA), 2002, in addition to ensuring compliance with relevant provisions under the Foreign Exchange Management Act (FEMA) for overseas remittances.”[3]

At present, while the talks of implementing comprehensive legislation governing cryptocurrencies have fizzled out, the Union Budget 2022 brought digital currencies under the tax net. As of 2022, the crypto asset market in India stands at an approximated evaluation of 45,000 Crores and 15 million investors[4].

However, it is pertinent to note that it is transactions, not investments, in the digital currency that pose an issue. In India, the Enforcement Directorate discovered over 4,000 crores of such illegal cryptocurrency transactions in 2021. As per the 2022 Crypto Crime Report by blockchain data firm Chainalysis[5], cybercriminals laundered $8.6 billion worth of cryptocurrency in 2021, $6.6 billion in 2020 and $10.9 billion in 2019. Furthermore, the study discovered that at the moment, darknet market sales or ransomware attack profits are virtually derived in cryptocurrency rather than fiat currency, thus significantly contributing to the data. 

Money laundering, terror financing, drug dealing, and other criminal activities are all done using cryptocurrency transactions. Although these transactions are recorded on a blockchain and are traceable, criminals use mixers and tumblers to make it difficult for a third party to track them.

 

The Laundering Mechanism

                           

                                    Eurospider Information Technology AG, “Mixers Tumbler Example,” fig.

For clarity, refer to the above image. Using the OHNE mixer, A sends 20 bitcoins to B, U sends 15 bitcoins to V, and X sends 5 bitcoins to Y. These are single-layer transactions that are simple to trace and identify.

The transaction takes place in a different way in the second image, where the MIT mixer is used. For the sake of brevity, let us consider a single layer of mixer being used. In real life, the number of mixers used is in the thousands. Here, A sends 20 bitcoins to M1, U sends 15 bitcoins to M2 and X sends 5 bitcoins to M3. In the next stage, B receives 20 bitcoins from M2, V receives 15 bitcoins from M1, and Y receives 5 bitcoins from M1. The difference we must notice is that B, V, and Y are receiving the same number of bitcoins as in picture one, but not from A, U and X, respectively. Because there is no information about A sending bitcoins to B, U sending bitcoins to V, or X sending bitcoins to Y, these transactions are not single-layered and are impossible to trace. Hence, making the transaction anonymous.

Criminals use a similar method to send money using cryptocurrencies. Consider the following scenario to gain a better understanding: A, B, C, and Z are cryptocurrency users who keep their coins in their digital wallets. They use the same mixing service to make transactions. A, B, and C are law-abiding citizens, while Z is a criminal involved in drug trafficking. A has to pay X a certain amount of money. X is paid, but the bitcoins he received were deposited by Z, a drug trafficker. When X received the payment, he had no idea that the bitcoins he had were dirty bitcoins and had been used for illegal activities. This is a straightforward explanation of how dirty bitcoins are making their way through the market, paving the way for money laundering. 

 

What can be done?

 

The International Monetary Fund (IMF) has released a report titled “Global Financial Stability Report”[6] which discusses the following details about how cryptocurrencies should be regulated, considering their increasing market capitalization and the growing exposure of banking and financial systems to crypto assets:

  1. Implementation of global standards applicable to crypto-assets should be the key focus area of national policies.
  2. Regulators should identify and control the associated risks of crypto assets, specifically in areas of systemic importance.
  3. Coordination among national regulators is key for effective enforcement and fewer instances of regulatory arbitrage.
  4. Data gaps and monitoring of the crypto ecosystem for better policy decisions should be prioritised by the regulators.

The report also discusses how stablecoins and decentralized finance pose a significant risk to the crypto market and the overall economy if they are not properly regulated and supervised by issuers.

  1. Regulations should be proportionate to the risk and in line with those of global stablecoins.
  2. Coordination is a must, to implement requisite recommendations in the areas of acute risks, enhanced disclosure, independent audit of reserves, and fit and proper rules for network administrators and issuers.

The report also discusses the importance of managing macro-financial risks through:

  1. Enactment of de-dollarization policies, including enhancing monetary policy credibility.
  2. Formulating a sound fiscal position with effective legal and regulatory measures and implementing central bank digital currencies
  3. Reconsidering Capital Flow Restrictions with respect to their effectiveness, supervision, and enforcement

However, according to the report, cryptoization would make finance more cost-effective, quick, and accessible.

There is also an intergovernmental organisation known as the Financial Action Task Force, which is constantly updating its recommendations to maintain legal, regulatory, and operational methods for combating money laundering, terrorism financing, proliferation, and other threats to the integrity of the international financial system. The Financial Action Task Force (FATF) recently released a compliance framework recommending that all anti-money laundering rules that traditional financial systems follow be applied to stable coins, cryptocurrency, and virtual asset service providers. Even though identifying the source of such funds and keeping track of who is the beneficiary of such funds is difficult, countries are still being encouraged to develop provisions that provide for due diligence, record keeping, and the reporting of suspicious transactions.[7]

 

The Legislative Way Forward for India

 

At present, there is no comprehensive legislative framework to govern fintech advancements encompassing blockchain and cryptocurrencies. At best, the present regulatory framework is a patchy, cross-networked arrangement that demands careful deliberations in alignment with the evolving technological innovations in the sector.

The Information Technology Act, 2000:

While the legislation successfully addresses issues like identity theft, hacking, and ransomware and provides a means to tackle the issue of extraterritorial jurisdiction, it is safe to conclude that the serpentine considerations of blockchain cannot be comprehended and addressed by the Act.

The Prevention of Money Laundering Act, 2002 and the Prevention of Money Laundering Rules, 2005

The offences listed in Parts A, B and C of the PMLA Schedule attract the penalties enumerated under the Act.

Part A categorises offences under: Indian Penal Code, Narcotics Drugs and Psychotropic Substances Act, Prevention of Corruption Act, Antiquities and Art Treasures Act, Copyright Act, Trademark Act, Wildlife Protection Act, and Information Technology Act.

Part B enlists offences under Part A with a valuation of Rs 1 crore or more.

Part C exclusively deals with trans-border crimes.

Recently, the Enforcement Directorate attached proceeds of crimes amounting to Rs 135 crores in 7 cases in which the usage of cryptocurrency for money laundering activities was flagged by the authorities.[8]

However, it is pertinent to note that the offences recognised under the respective parts of the schedule only comprise the offences under the current framework of legislation, which is at present not equipped to regulate any segment of cryptocurrency transactions and digital currency operations in the country. 

Foreign Exchange Management Act, 1999

Even though the Act specifies procedures to conduct cross-border and foreign exchange transactions, it fails to identify the role of technology as an instrumental enabler of such transactions at present. However, it is interesting to note that it empowers the RBI to establish a regulatory framework to address the same.

The Payment and Settlement Systems Act, 2007

The PSS Act was enacted with the objective of establishing a regulatory framework for banks and ancillary financial institutions, designating RBI as the nodal authority. Section 4 of the Act states that no payment system shall operate in India without the prior due authorization of the RBI.

Apart from the above-mentioned legislation, regulators like SEBI, Ministry of Electronics and Information Technology (MeitY), Insurance Regulatory and Development Authority of India (IRDAI), and Ministry of Corporate Affairs (MCA) have also undertaken initiatives to implement specialised guidelines. While these regulations deal with the contemporary issues of payments, digital lending and global remittances, none of them has managed to find a concrete ground for effectively supervising and regulating cryptocurrency transactions backed by blockchain in the current volatile ecosystem.

At present, key industry regulators and stakeholders should collaborate to understand the novelty, process and extent of the present disruptive fintech trends. Furthermore, initiatives should be taken to ensure transparency of such transactions, establish secure authentication transactions for the exchanges and tighten the legislative noose on cyber security systems in the country. Additionally, establishing a centralised statutory body and local self-regulatory bodies across the sovereign, and implementing an extensive centralised framework is also imperative. The current scheme of criminal activities in virtual space transcends geographical boundaries, hence it is crucial for global policymakers to implement mechanisms to ensure coordination and collaboration by institutionalising inter-governmental bodies.

References: 

[1] ‘The Current Landscape Of The Fintech Industry – Fintech Crimes’ (Fintech Crimes, 2022) <https://fintechcrimes.com/the-landscape-of-fintech-in-year-2020/> accessed 9 February 2022.

[2] https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=11243&fn=2&Mode=0

[3] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12103

[4] https://timesofindia.indiatimes.com/business/india-business/union-budget-2022-no-crypto-bill-listed-this-budget-session/articleshow/89265038.cms

[5] https://go.chainalysis.com/rs/503-FAP-074/images/Crypto-Crime-Report-2022.pdf

[6] ‘Global Financial Stability Report’ (2021) <https://www.imf.org/en/Publications/GFSR/Issues/2021/10/12/global-financial-stability-report-october-2021> accessed 11 February 2022.

[7] ‘VIRTUAL ASSETS AND VIRTUAL ASSET SERVICE PROVIDERS’ (2021) <https://www.fatf-gafi.org/media/fatf/documents/recommendations/Updated-Guidance-VA-VASP.pdf> accessed 11 February 2022.

[8] https://economictimes.indiatimes.com/news/india/ed-investigating-7-cases-of-cryptocurrency-usage-in-money-laundering-attaches-rs-135-crore/articleshow/90200012.cms

 

Image Credits: Photo by Bermix Studio on Unsplash

At present, key industry regulators and stakeholders should collaborate to understand the novelty, process and extent of the present disruptive fintech trends. Further, initiatives should be undertaken to ensure transparency of such transactions, establish secure authentication transactions of the exchanges and tighten the legislative noose on cyber security systems in the country.

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India's Own Crypto Asset Regulations Soon: Plugging an Important Gap

Till last year, most people (at least in India) had probably only heard of cryptocurrencies such as Bitcoin and Ethereum; now, many other names such as Dogecoin, Solana, Polkadot, XRP, Tether, Binance etc. are being spoken of commonly in media. The global cryptocurrency market cap is estimated at over US$2.5 Trillion.

India too is witnessing a surge in investment in cryptotokens – especially by millennials. There is a correspondingly increase in the number of advertisements for cryptocurrencies on national television as well as on various web sites; mainstream media reports extensively on the daily price movement of cryptocurrencies. One estimate puts the number of crypto investors in India at between 15-20 million, and the total holdings to be in excess of US$5.3Billion. 

This surge in unregulated cryptoassets is a matter of rising concern globally. Recently, PM Modi urged democracies around the world to work together to ensure that cryptocurrencies do not “end up in the wrong hands, as this can “spoil our youth”. His exhortation came just days after RBI Governor Shaktikanta Das spoke of “serious concerns” around cryptocurrencies.

The RBI’s 2018 blanket ban on cryptocurrencies was lifted by the Supreme Court in 2020. However, the time has now come for the government and regulators to act quickly, and there are indications that regulations are just around the corner. At the time of writing, the government has already announced its intention to table The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 in parliament in the winter session.

It is expected that through this legislation, the Indian government will seek to ban private cryptoassets. This means that those trade in such cryptoassets may be liable for penalties and/or other punishment. It is also expected that there will be tighter regulations around advertising such products and platforms where cryptoassets can be bought and sold. Another regulatory salvo could be around taxing cryptogains at a higher rate (although such notifications may have to wait for the next budget due to be announced in another three months). The bill is also expected to deny the status of “currency” to cryptoassets because the prevailing ones are issued by private enterprises, and not backed by any sovereign.

The government has also acknowledged the potential of sovereign digital currencies (or CBDC- Central Bank Digital Currency, as they are officially called) in the days ahead. Countries such as China and the USA, are at various stages of launching their own digital currencies, and experts predict that such CBDC will be the “future of money”. In this context, the proposed bill is expected to create a “facilitative framework” to pave the way for the RBI to launch India’s sovereign digital currency in the days ahead by. In fact, the RBI is already working on India’s CBDC, and some media reports suggest that such a launch may happen in the next couple of months (which may also explain the timing of tabling the The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, at this time). CBDCs too require crypto and blockchain technologies that are similar to those that underpin cryptoassets, so the bill is also expected to promote these technologies for specific purposes. Indeed, not doing so would be akin to throwing out the baby with the bathwater.

Given their wide global reach, cryptoassets arguably will have a role to play in the world’s financial system. However, countries such as India must ensure proper regulation because by their very nature, cryptoassets can easily be misused for various activities that can destabilize the nation. They will allow for free inward/outward remittances that will make it harder to trace; being encrypted, the origins of such wealth too will become easier to hide. All this will make cryptoassets even more convenient ideal for nefarious activities such as money laundering, terror-funding, drugs-financing etc. In the absence of appropriate regulations, the rising supply of cryptocurrencies can hobble the RBI’s ability to perform its basic role. Its ability to manage the Rupee’s value against global currencies too will weaken, as will its ability to use domestic interest rates as a means to balance the economy’s twin needs of inflation management and providing growth impetus. This is a scary scenario, but not one that could unfold in the short-term. Even so, India needs to be prepared.

PS: The Indian government’s announcement to regulate cryptoassets has already triggered a significant (8-10%) correction in the prices of various cryptoassets. It’s therefore a good idea for resident Indians holding cryptoassets to sell them. They can decide on their future course of action once there is clarity on the specific regulatory impact of the proposed bill.

 

Image Credits: 

Photo by Worldspectrum from Pexels

Given their wide global reach, cryptoassets arguably will have a role to play in the world’s financial system. However, countries such as India must ensure proper regulation because by their very nature, cryptoassets can easily be misused for various activities that can destabilize the nation.

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Supreme Court lifts the RBI notification prohibiting banking services to Virtual Currency Business: Analysis

After providing the reference of more than 50 cases about legality of virtual currency from across the world in its 180-page-long judgement, the Supreme Court, on March 4th, 2020 lifted the RBI notification prohibiting banking services to Virtual Currency (VC) business.

‘Cryptocurrency’ means “a math-based, decentralised convertible Virtual Currency Protected by cryptography by relying on public and private keys to transfer value from one person to another and signed cryptographically each time it is transferred.”[1]

“‘Virtual currency (VC)’ as the name suggests is a digital representation of value that can be traded digitally and functioning as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but not having a legal tender status.” [2]

On a global level, regulatory responses to cryptocurrency have ranged from a complete clamp down in some jurisdictions to a comparatively ‘light-touch regulatory approach.

Though cryptocurrency may not currently pose systemic risks, its increasing popularity leading to price bubbles raises serious concerns for consumer and investor protection and market integrity. The cryptocurrency eco-system may affect the existing payment and settlement system which could, in turn, influence the transmission of monetary policy.[3]

Brief facts:

It was in 2013, for the first time, RBI had noted and discussed the risks of the development of technology and VCs in its Financial Stability Report[4]. In the report, RBI had mentioned VCs as unregulated money and that regulators were studying the impact of the same.  A press release was thereafter issued by RBI on the potential impact and risks associated with VCs. Later that year newspapers reported about the first-ever raid in India by enforcement authorities on two Bitcoin firms.

On 01-02-2017, RBI again issued a Press Release[5] cautioning users, vendors and holders of VCs. Closely on the heels of the Press Release, the Ministry of Finance constituted an Interdisciplinary committee and the committee gave its report on 25-07-2017. The committee recommended issuing warnings to the general public that the Government does not support cryptocurrencies and those offering to buy or sell these currencies must stop such activities. However, it was clarified that there was no restriction on the use of blockchain technology.

RBI issued a “Statement on Developmental and Regulatory Policies[6]” followed by a circular[7] dated April 6, 2018,  directing the entities regulated by it (i) not to deal in virtual currencies nor to provide services for facilitating any person or entity in dealing with or settling virtual currencies and (ii) to exit the relationship with such persons or entities, if they were already providing such services to them. It appears that at around the same time (April 2018), the Inter-Ministerial Committee submitted its initial report, (or a precursor to the report) along with a draft bill known as ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’.[8]

Challenging the said Statement and Circular and seeking a direction to the RBI not to restrict or restrain banks and financial institutions regulated by RBI from providing access to banking services to those engaged in transactions in crypto assets, these writ petitions were filed. The petitioner in the first writ petition is a specialized industry body known as the ‘Internet and Mobile Association of India’ which represents the interests of the online and digital services industry. The petitioners in the second writ petition comprise a few companies which run online crypto assets exchange platforms, the shareholders/founders of these companies, and a few individual crypto-assets traders.

After detailed analysis, the Hon’ble Supreme Court bench comprising of Hon’ble Justices R.F. Nariman, Aniruddha Bose, and V. Ramasubramanian set aside the impugned circular issued by RBI on “directing  the entities regulated by RBI (i) not to deal in virtual currencies nor to provide services for facilitating any person or entity in dealing with or settling virtual currencies and (ii) to exit the relationship with such persons or entities, if they were already providing such services to them.” [9]

There were two main issues raised before the Hon’ble Supreme Court.

 

  1. Whether RBI had the power to prohibit the activities of trading in VCs?

 

No power at all:

One of the major contention raised by the  Petitioners is that RBI has no power to prohibit VC as it is neither a  legal tender nor comes within the credit system of the country so as to enable RBI to act upon the power conferred in it. Also, that, it does not have any characteristics of money for RBI to have the power to regulate the same.  

RBI in its counter-argument agreed to the fact that VC does not satisfy with being acknowledged as currency, however, stated that VCs do not have any formal or structured mechanism for handling consumer disputes/ grievances. Further, due to its anonymity/pseudo-anonymity characteristic, it is capable of being used for illegal activities. Increased use of VCs would eventually erode the monetary stability of the Indian currency and the credit system. Therefore, RBI has every power to regulate and control the activities of trading in VCs.

With regard to the above contentions and arguments, the Supreme Court after analyzing opinions and definitions of various legislations observed that though VCs are not recognized as legal tender, they are capable of performing some or most of the functions of real currency. The statutory obligation that RBI has, as a central bank, is  (i) to operate the currency and credit system, (ii) to regulate the financial system, and (iii) to ensure the payment system of the country to be on track, would compel them naturally to address all issues that are perceived as potential risks to the monetary, currency, payment, credit and financial systems of the country. Therefore, anything that may pose a threat to or have an impact on the financial system of the country can be regulated or prohibited by RBI, despite the said activity not forming part of the credit system or payment system. and concluded that the users and traders of virtual currencies carry on an activity that falls squarely within the purview of the RBI.

If at all power, only to regulate:

Another contention made by the Petitioners was that, if at all RBI is conferred with any power it is only to regulate, but not to prohibit.  It was contended by petitioners that the power to prohibit something as res extra commercium was always a legislative policy and that therefore the same could not be done through executive fiat.  In support of its contention, the petitioners referred to the definition of the expression “payment system” under the Payment and Settlement Act and contented that VC Exchanges do not operate any payment system and that since the power to issue directions under Section 18 of the Payment and settlement systems Act was only to regulate payment systems, the invocation of the said power to something that did not fall within the purview of payment system was arbitrary.

RBI in its counter-argument stated that the impugned decision of RBI was legislative in character and was in the realm of an economic policy decision taken by an expert body warranting a hands-off approach from the Court.  

In this regard, the Supreme Court observed that the power of RBI was not merely curative but also preventive. Further, in any case, the projection of the impugned decisions of RBI as a total prohibition of activity altogether, might not be correct. The impugned Circular did not impose a prohibition on the use of or the trading in VCs. It merely directed the entities regulated by RBI not to provide banking services to those engaged in the trading or facilitating the trading in VCs. The fact that the functioning of VC Exchanges automatically got paralyzed or crippled because of the impugned Circular, was no ground to hold that it tantamounted to total prohibition.

Supreme court in this issue held that in the overall scheme of the Payment and Settlement Systems Act, 2007, it was impossible to say that RBI did not have the power to frame policies and issue directions to banks who are system participants, with respect to transactions that would fall under the category of payment obligation or payment instruction, if not a payment system. Hence, the argument revolving around Section 18 failed.

  1. If RBI has the power to deal with carrying out activities related to VCs, whether this impugned circular was a proper exercise of that power?

The second issue raised was regarding the mode of exercise of power and the court-tested its appropriateness and validity based on certain well-established parameters.

No application of mind

One of the major contentions by the petitioner was that RBI had not adequately applied its mind. However, SC was of the view that RBI had been brooding over the issue for almost five years without taking any extreme step. RBI had even issued a press release titled “RBI cautions users of Virtual Currencies against Risks”. Therefore, RBI could hardly be held guilty of non-application of mind.

Malice in law

Another contention made by petitioners was that the impugned Circular was a colorable exercise of power and tainted by malice in law, in as much as it sought to achieve an object completely different from the one for which the power was entrusted.

However, SC observed that in order to constitute colorable exercise of power, the act must have been done in bad faith and the power must have been exercised not with the object of protecting the regulated entities or the public in general, but with the object of hitting those who form the target. To constitute malice in law, the act must have been done wrongfully and wilfully without reasonable or probable cause which is not the case here. Hence, SC rejected the argument.

Violative of Article 19 and proportionality

The next ground of issue raised before the Supreme Court was on the basis of Article 19(1)(g) of the Constitution. It was contended by the Petitioners that since access to banking was the equivalent of the supply of oxygen in any modern economy, the denial of such access to those who carry on a trade which was not prohibited by law, was not a reasonable restriction, rather it was extremely disproportionate. It was further contended that the right to access the banking system was actually integral to the right to carry on any trade or profession and therefore legislation, subordinate or otherwise whose effect or impact severely impairs the right to carry on a trade or business, not prohibited by law, would be violative of Article 19(1)(g).

RBI raised two fundamental objections in this regard. The first was that corporate bodies/entities that had come up with the challenge were not ‘citizens’ and hence, not entitled to maintain a challenge under Article 19(1)(g). Secondly, there was no fundamental right to purchase, sell, transact and/or invest in VCs and that therefore, the petitioners could not invoke Article 19(1)(g).

The SC, however, objected to the contentions of RBI for two reasons namely, (i) that at least some of the petitioners are not claiming any right to purchase, sell or transact in VCs, but claiming a right to provide a platform for facilitating an activity of trading in VCs between individuals/entities who want to buy and sell VCs) which is not yet prohibited by law and (ii) that in any case, the impugned Circular does not per se prohibit the purchase or sale of VCs.

SC observed that, despite the fact that the users and traders of VCs are also prevented by the impugned Circular from accessing the banking services, the circular has not paralyzed many of the other ways in which crypto-currencies can still find their way to or from the market. It was further noted by the apex court that if a central authority like RBI, on a conspectus of various factors perceive the trend as the growth of a parallel economy and severs the umbilical cord that virtual currency has with fiat currency, the same cannot be very lightly nullified as offending Article 19(1)(g).

On the question of proportionality, the petitioners relied upon the four-pronged test summed up in the opinion of the majority in Modern Dental College and Research Centre v. State of Madhya Pradesh. These four tests were (i) that the measure was designated for a proper purpose (ii) that the measures were rationally connected to the fulfillment of the purpose (iii) that there were no alternative less invasive measures and (iv) that there was a proper relation between the importance of achieving the aim and the importance of limiting the right.

SC observed that the impugned circular was issued with the aim of prohibiting the trade in VCs. The object of hitting at trading in VCs was to ensure (i) consumer protection (ii) prevention of violation of money laundering laws (iii) curbing the menace of financing of terrorism and (iv) safeguarding of the existing monetary/payment/credit system from being polluted. However, in the process, it has hit VC Exchanges and not the actual trading of VCs, consequently, the volume of transactions in VCs (perhaps through VCEs alone) is stated to have come down.

SC further observed that at the time when the impugned Circular was issued, RBI had not obviously addressed many of the issues flagged by the writ petitioners. SC held that RBI failed to pass the test of proportionality due to the following reasons:

  • Even though RBI states that it can adversely impact its regulated entities, consumers, and the economy, RBI has not so far found, in the past 5 years or more, the activities of VC exchanges to have actually impacted adversely, the way the entities regulated by RBI function. Before taking any pre-emptive action against VCs, the RBI is required to show some semblance of any damage suffered to it or regulated entities. Since they don’t have any substantial evidence to show damage, RBI failed in the test of proportionality.
  • Secondly, despite coming out with various circulars, statements against cryptocurrency, RBI has consistently taken the stand that it has not prohibited VCs in the country. Therefore, RBI’s position is still murky.
  • Thirdly, the Government of India is unable to take a call despite several committees coming up with several proposals including two bills. It is also worthwhile to mention that the draft bills also take opposite stands where one bill tries to ban cryptocurrency while the other bill tries to regulate them.

Order:

In light of answering the final issue, SC held that petitioners are entitled to succeed, and the impugned Circular dated 06-04-2018 is liable to be set aside on the ground of proportionality.

Conclusion:

It is only in the last leg that the apex court held against the respondent RBI and ordered to set aside the circular. The ruling was based on the reasons that- (i) RBI has failed to provide any empirical evidence to show that VCs have negatively impacted the banking sector or other entities regulated by the RBI; (ii) the inconsistencies in proposals made by Govt and; (iii) RBIs consistent position that they have not banned VC.

However, notably, this judgement lost the opportunity to answer crucial questions or take a definitive stand on cryptocurrency. The Court could take measures to legalize cryptocurrencies or direct the RBI to come up with more documentation and legal backing to ban the same.   

Even though this judgement held in favour of the cryptocurrency communities, we cannot conclude that that the apex court is for VC it in fact empowered RBI to regulate virtual currency clearly confirming the powers of RBI in this regard.

Till this judgement, RBI wasn’t very sure about whether it has the power to hit VC directly. With that dilemma, RBI issued this impugned (now banned) Circular by ring-fencing them.   This judgement now paves a way for RBI to take a decision on whether to completely ban VC or should it come up with alternate solution capable of dealing with virtual currencies for the stability of the financial system. Though the judgement set aside the RBI circular, it in fact empowered RBI to regulate and even ban VC’s in the future. You can now expect some fresh regulatory steps from RBI or from the government.   

This judgment lost the opportunity to answer crucial questions or take a definitive stand on cryptocurrency. The Court could take measures to legalize cryptocurrencies or direct the RBI to come up with more documentation and legal backing to ban the same.   

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