Virtual Currency in the current Indian legal regime

Abhinav Singh Chauhan

In 2018, the Reserve Bank of India (RBI) forbade all the entities controlled by it[2] from dealing in and facilitating any transaction concerning Virtual Currencies ("VC"). Nevertheless, in 2020, the same order was set aside by the Supreme Court,[3] thus enabling the entities under the RBI to facilitate and deal with VCs' transactions.

After the Supreme Court’s decision, crypto-trading in India saw an all-time hike,[4] despite VCs being unregulated. The hike in crypto-trading after the Court’s decision depicts the country’s receptiveness towards VCs.

VCs are systems that allow for secure online payments by denominating them in terms of virtual tokens, recorded by the system's internal ledger entries. In the words of European Banking Association, VC is "a digital representation of value that is neither issued by a central bank or public authority nor necessarily attached to a fiat (conventional) currency but is accepted by natural or legal persons as a means of exchange and can be transferred, stored or traded electronically.”[5]

VCs use Blockchain or Distributed Ledger Technology (DLT),[6] which is a publicly distributed chain, encrypted to provide pseudo-anonymity to the transactors, and prevents double-spending, i.e. using the same currency twice. VCs are transferred directly from one person to another,[7] with no intermediaries. They are generated as per demand, by the people maintaining the Blockchain Transactions, using cryptographic algorithms. The transfer of VC requires authentication and registration of the transaction on the DLT,[8] which is immutable.

One of the significant differences between VCs and E-Money (Money on payment wallets, such as Paytm) is that the former uses a Blockchain or a Distributed Ledger Technology to record and process transactions, while the latter has its values stored in chips; or the records of a trusted third-party facilitating the transaction, which is legally guaranteed by the legislation of the state under which the hardware is issued.

VC as virtual money

VCs do not attach themselves to any commodity or fiat currency; they do not inherit any value. A VC’s value is defined by its ability to be traded.[9] If the VC has a high demand with low supply, its price will rise and vice-versa, making the VC highly volatile. Therefore, VCs are not recognised as legal tender, but merely a medium of exchange.

However, VCs can be regulated by the RBI u/s 3 of the RBI Act,[10] which empowers RBI to manage the currency, including something which can become currency.[11] Hence, VCs can be treated as currency u/s 2(h) of the FEMA,[12] under which currency can be of any form which is notified by the RBI, eventually enabling authorities to scrutinize VC transactions for Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) regulations. This allows VCs to be treated at par with fiat currency.

Though no regulations currently govern VC transactions, the actions in pursuance of the transactions of the VC can be dealt with the existing laws in the country. The major concerns regarding financing of terrorist activities can be dealt with under §17 r/w §40 of UAPA,[13] which prohibits collecting or providing funds for such activities. The concerns regarding the money laundering transactions can be dealt under §3 of Prevention of Money Laundering Act.[14] The definition of funds both under UAPA and PMLA are wide enough to include any type of transaction and funding, and need to be specifically done in a notified currency.[15]

To regulate VCs, the government plans to introduce “The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021”. Since much details are not available regarding the bill, we look at a previous draft bill, i.e., “Banning of Cryptocurrency & Regulation of Official Digital Currency Bill 2019”.[16] The 2019 Bill is aimed to ban the use of private VCs or cryptocurrencies, which are not a part of any official digital currency.

The Government's main contention is to ban the use of cryptocurrencies, except those backed by a sovereign, thereby introducing the concept of Central Bank Digital Currency (CBDC). The same was also recommended by the committee report on the draft bill,[17] and discussed by the RBI in one of its articles.[18]

CBDC’s Viability in India

CBDC is a digital form of currency backed by a central bank that is different from balance in traditional reserve or settlement accounts,[19] which can serve as a medium of exchange, and store value, thereby making it a digital form of fiat money. The key difference between other VCs and CBDCs is that the CBDCs are backed by the sovereign or the central bank, and are recognised as legal tender.

CBDCs offers safer and faster payment settlement, more manageable & cheaper cross border transactions, and higher financial stability, among other advantages.[20]The functionality of CBDC is easy to confuse with current e-payment options, like Paytm and UPI, but the significant difference is that these e-payment options need an aggregator to transfer the payment; whereas CBDC does not require any such intermediary.

Though CBDCs will enable faster payments without intermediaries and make payments cost-effective; they cannot be regarded as Virtual Currency in its true spirit. Introduction of CBDCs, as a substitute to private VCs depicting them as a safer and secure form of Digital currency, defeats the very purpose for which VCs were introduced.

VCs were introduced as a decentralised substitute to traditional currency. Countering issues arose when central agencies debased the currency.[21] Since private VCs are not owned or issued by anyone, they can be freely transacted. In contrast, CBDC would require the sanction of authorities for transactions and would be regulated as well.

For all the good of CBDCs, the users have to part away with their privacy, which is ensured in Cash transactions. Since data is centrally stored and the central bank can monitor each transaction, there lies a possibility that the central bank could share this information with other government agencies for various purposes.[22] In the worst possible scenario, CBDCs can be used as a surveillance mechanism to track people's spending trends.[23] Moreover, the same financial information can be used to curb dissent against the government,[24] as freezing accounts and stopping payments becomes more manageable in an online setup than in cash transactions.

Anonymity and the sovereign guarantee of CBDC transactions would offer liquidity and anonymity of cash, but without the cash's portability limits. Therefore, the Central Bank's dilemma would be whether to ensure people's privacy or to keep a check on transactions that may be inconsistent with Anti Money Laundering (AML) and Combating the Financing of Terrorism (CFT) regulations. If CBDC allows privacy and anonymity, it will make it easier for the user to avoid AML regulations.[25] On the other hand, if the government chooses to keep a check on illegal transactions, it will put others' privacy into peril.

In India, Financial information is fundamentally sensitive and is considered the private information of an individual.[26] Moreover, the right to privacy emerges from the fundamental right to life. In order to take away a CBDC users' privacy, Central Bank would need a just, fair, and reasonable law. Furthermore, the Supreme Court in the Aadhar Case[27] observed, that the state must put a robust regime that ensures the fulfilment of a three-fold requirement of law. The three-fold requirement of law ensures a reasonable aim employing proportional means to achieve the object sought. It also requires domestic law to afford adequate guarantees that ensure personal data is efficiently protected from misuse and abuse.

This compromise on the part of the users with their privacy has both, pros and cons. On the negative side, they may be subject to surveillance, where their spending habits and trends may be recorded; whilst on the other hand, they may be safeguarded from various scams.

Like everything on the internet, CBDC too would be prone to internet attacks. These attacks can take away the user’s CBDC, or corrupt the system, thereby deleting CBDC. Further risks include the process delaying,[28] or transfer of CBDC to a mock destination causing loss to the legitimate recipient. Moreover, the frequent hacking of Twitter accounts of famous personalities and duping of people by promising double returns on bitcoins sent on a particular wallet address,[29] the risk associated is critical. The major hurdle to trace such transactions is the anonymous and immutable nature of the bitcoin. This contention of being scammed gets resolved to some extent with the advent of CBDC. CBDC is guaranteed by a sovereign and is centrally recorded. Therefore every transaction gets recorded and thus, the chances of un-traceability decrease, thereby making CBDC safer than other private VCs.

In most of the countries, CBDCs are only in a research state, and in a few countries like China, CBDCs are implemented as a pilot project.[30] In countries like Venezuela,[31] and Marshall Islands,[32] have already made CBDC operational. Ecuador, on the other hand, decommissioned their CBDC in 2018 which was released in 2014.[33] Major economies, like US, Russia, UK, China, etc. are considering CBDC as an alternative to cash for retail use.[34] Furthermore, a bill to recognize cryptocurrency as a property for purpose of its taxation is pending in the Russian Parliament.[35] One significant difference between the India and the countries considering CBDC as an alternative to Cash is the Data Protection Regimes established. While in US, UK, China, and Russia there is some or other form of data protection, India lacks a similar strong data protection regime. The only way to check data sharing is either through the Information Technology Act, and subsequent rules therein, or safeguarding privacy by invoking writ jurisdiction of High Courts or the Supreme Court for violation of the fundamental right to privacy, in extreme cases.

Conclusion

On the one hand, the government is banning private VCs altogether. And on the other hand, it speculates whether to introduce CBDC as a substitute and a more secure form of private VCs. Although CBDCs have the advantages of being a secure cryptocurrency, a centralised CBDC will give more power and control to the Central Bank. By means of this control and power, the central bank can easily influence the market by issuing more of the currency, through quantitative easing by buying longer term securities from government or commercial banks for credit-risk free CBDCs.[36] Therefore, CBDC being under the control of the Central Bank makes it the antithesis of Cryptocurrency's philosophy, which aims to bring currency out of control of the Central Bank.[37]

It will be speculative how RBI would bring CBCDs under the definition of ‘currency’. Whether RBI will release a notification, as it did for ATM or Debit cards,[38] or whether the RBI will refrain from taking any action, because the CBCDs have sovereign backing, so by definition they form a part of the currency.

Nevertheless, before the government introduces CBDC in India, India needs a substantial change in its law regime to ensure that CBDC is not used for any transaction, for which the private VCs will be banned. The policy change has to be done without jeopardising the rights of CBDC users.

Introducing CBDCs on the lines of other countries as an alternative to cash may not be feasible for India, due to lack of data protection regime. Thus, a legislation is the need of the hour to regulate the illicit transactions by CBDCs and safeguard users in case of any fraud or hacking of the CBDC network. The legislation also needs to provide the compensation for any breach or hacking of the CBDC network, or in case the CBDC gets corrupted due to malware or by any other means.

Since the introduction of CBDC will make the users choose between their privacy and benefits offered by CBDCs, India's receptivity towards cryptocurrencies might be drastically affected by the country's policy change.
[1] Abhinav is a 2nd year student at NLU Odisha. His interests lie in Data Protection and Constitutional Law. For any discussion related to the article, he can be contacted via LinkedIn at linkedin.com/in/abhinav2727
[2]Prohibition on dealing in Virtual Currencies VCs, Reserve Bank of India, https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NOTI15465B741A10B0E45E896C62A9C83AB938F.PDF (last visited Feb. 10, 2021).
[3]Internet and Mobile Association of India v. Reserve Bank of India, WP (Civil) 528 of 2018 : (2020) MANU 0264 (SC).
[4] Shiraz Jagati, Indian crypto P2P market size triples despite regulatory uncertainty, CoinTelegraph, (Aug. 26, 2020)https://cointelegraph.com/news/indian-crypto-p2p-market-size-triples-despite-regulatory-uncertainty.
[5]European Opinion on Virtual Currencies, European Banking Authority, EBA/Op/2014/08 ¶19 (hereinafter EBA Virtual Currency).
[6] Jake Frankenfield, Cryptocurrency, Investopedia (May 5, 2020) https://www.investopedia.com/terms/c/cryptocurrency.asp.
[7]EBA Virtual Currency supra note 4, ¶23.
[8]Orla Ward & Sabrina Rochemont, Understanding Central Bank Digital Currencies (CBDC), Institute and Faculty of Actuaries (Mar. 2019) https://www.actuaries.org.uk/system/files/field/document/Understanding%20CBDCs%20Final%20-%20disc.pdf(hereinafter IFOA CBDC).
[9]ChrisjanPauw, How Cryptocurrency Prices Work, Explained, CoinTelegraph, (Jul. 24, 2018) https://cointelegraph.com/explained/how-cryptocurrency-prices-work-explained.
[10]The Reserve Bank of India Act, 1934, No. 2, Acts of Parliament, 1934.
[11]Internet and Mobile Association of India v. Reserve Bank of India,WP (Civil) 528 of 2018 : (2020) MANU 0264 (SC), para 6.90.
[12]The Foreign Exchange Management Act, 1999, No. 42, Acts of Parliament, 1999.
[13] The Unlawful Actvities (Prevention) Act, 1967, No. 37 of 1967, Acts of Parliament, 1967.
[14] Prevention of Money Laundering Act, 2002, No,15 of 2003,Acts of Paliament, 2003.
[15] Guidance for a Risk-Based Approachto Virtual Assets and Virtual Asset Service Providers, FATF, Paris (Jun., 2019)http://www.fatf-gafi.org/media/fatf/documents/recommendations/RBA-VA-VASPs.pdf.
[16] Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019.
[17] Subhash Chandra Garg, Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies, Department of Economic Affairs, Ministry of Finance, (Feb. 28, 2019) https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf (hereinafter DEA report on CBDC).
[18]Distributed Ledger Technology, Blockchain and Central Banks, Reserve Bank of India (Feb. 11, 2020) https://m.rbi.org.in/Scripts/BS_ViewBulletin.aspx?Id=18766.
[19]Central bank digital currencies, Bank for International Settlements (Mar., 2018) https://www.bis.org/cpmi/publ/d174.pdf (hereinafter BIS CBDC).
[20]Ajit Tripathi, 4 Reasons Central Banks Should Launch Retail Digital Currencies, CoinDesk (Mar. 21, 2020) https://www.coindesk.com/4-reasons-central-banks-should-launch-retail-digital-currencies.
[21]Internet and Mobile Association of India v. Reserve Bank of India,WP (Civil) 528 of 2018 : (2020) MANU 0264 (SC), para 6.90.
[22] John Kiff, et al., A Survey of Research on Retail Central Bank Digital Currency, IMF Working Paper (WP/20/104, June 2020) 28-31 (hereinafter John Kiff IMF)
[23] Vince Tabora, Two Sides To Central Bank Digital Currency (CBDC), Medium (Mar. 29, 2020) https://medium.com/datadriveninvestor/two-sides-to-central-bank-digital-currency-cbdc-38035036c013.
[24] John Kiff IMF, supra note 21, 30-31.
[25] IFOA CBDC, supra note 7.
[26] Information Technology (Reasonable security practices and procedures and sensitive personal data or information) Rules 2011, s 3.
[27]Justice K.S. Puttuswamy v. Union of India (2019) 1 SCC 1.
[28] DEA report on CBDC, supra note 16.
[29]Sarah Perez, Taylor Hatmaker & Zack Whittaker, Apple, Biden, Musk and other high-profile Twitter accounts hacked in crypto scam, TechCrunch (Jul. 16, 2020 )https://techcrunch.com/2020/07/15/twitter-accounts-hacked-crypto-scam/.
[30] Decentralized Dog, Central Bank Digital Currencies — A Map of the World Coin MarketCap (Nov. 17, 2020) https://coinmarketcap.com/alexandria/article/central-bank-digital-currencies-a-map-of-the-world.
[31] Petro.gob.ve, https://www.petro.gob.ve/eng/index.html (last visited Mar. 03, 2021).
[32] SOV Foundation, https://sov.foundation (last visited Mar. 03, 2021).
[33] Larry White, The World's First Central Bank Electronic Money Has Come – And Gone: Ecuador, 2014-2018, ALT-M (Mar. 29, 2018) https://www.alt-m.org/2018/03/29/the-worlds-first-central-bank-electronic-money-has-come-and-gone-ecuador-2014-2018.
[34] Raphael Auer et al., Rise of the central bank digital currencies: drivers, approaches and technologies, Bank for International Settlements (Aug., 2020) https://www.bis.org/publ/work880.pdf.
[35] Jamie Crawley, Russia’s Crypto Tax Bill Passes First Reading at State Duma (Feb. 17, 2021) https://www.coindesk.com/russia-lower-house-approves-crypto-taxation-bill-in-first-reading.
[36] BIS CBDC, supra note 18.
[37] Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System, https://bitcoin.org/bitcoin.pdf (last visited Feb. 23, 2021).
[38]Definition of currency, Reserve Bank of India, Notification No. FEMA 15 (R)/2015 – RB (Dec. 29, 2015).

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