Cryptocurrency & Regulation 23 May 2022

Cryptocurrency & Regulation: Total Ban Not A Solution

Authors: M. Hossain, Founder, LLC; & Reshmi Hossain , IP & Commercial Law Specialist, LLC 

Cryptocurrency in India

The crypto craze has only just begun! Starting from RBI’s 2018 Circular to Supreme Court’s 2020 ruling quashing the circular, to the government’s crypto tax, to ASCI’s February 2022 advertising guidelines to even the recent proposal from SEBI for ban on celebrity endorsements of crypto, the cryptocurrency climate is constantly evolving.

The cryptocurrency trajectory in India has been palpably fluctuating over the last few years with remarkable shifts in the attitude towards the virtual currency. Although there had been initial uncertainties with a total ban on the cryptocurrency vide a Reserve Bank of India Circular of 6th April 2018, the Hon’ble Supreme Court of India quashed the same in March 2020. The Apex Court’s ruling had a significant effect on the cryptocurrency’s foreseeable future in India as it expressly opined that RBI indeed had sufficient power to issue directions to its regulated entities in the interest of public depositors, banking policy, banking company or in public interest. However, the uncertainty revolving around other issues of cryptocurrency including its regulation, taxation and promotion had not fully settled.

Post the Supreme Court Order in 2020, the virtual currency enthusiasm went into overdrive and many cryptocurrency exchanges entered the market riding billions of dollars in investments coupled with celebrity endorsements and attracting the citizens with an alternative to traditional forms of investments. The apparent sudden stupendous opportunity for citizens to invest their savings through readily available exchanges and platforms resulted in India garnering top spot globally for crypto investments. This itself was indicative of the notion that very few believed that a total ban at all would be possible in India through a new statute along the lines of the 2018 Circular which had gone for whole scale prohibition.

In one of the later developments, a public interest litigation (PIL) was filed before the Hon’ble High Court of Bombay in October 2021 petitioning for directions for the central government to enact appropriate laws. The PIL referred to a growing threat of unregulated cryptocurrencies and purported malpractices of trading platforms. The Bench comprising of Hon’ble Chief Justice Dipankar Datta and Hon’ble Justice M. S. Karnik directed the Union Government vide Order dated 29th November 2021 to update the Court on the proposed cryptocurrency legislation. The matter is currently pending.

Another breakthrough development was witnessed in early 2022, wherein Hon’ble Finance Minister Nirmala Sitharaman, post the winter budget session, said that the government had decided to tax the profits emanating from cryptocurrency transactions at a flat rate of 30 per cent, without any deduction or exemption. Moreover, the loss from the sale of these assets could not be set off against any other income. A TDS at the rate of 1% was proposed to be imposed on payments made on transfer of digital assets. It was further reiterated that the government had not done anything to legalise, ban or regulate it.

The decision to tax virtual assets had sparked a debate over the legality of cryptocurrencies in India. While many had welcomed the decision to tax digital currencies thinking that it was the first step to recognise the virtual currencies, the government has not yet expressly clarified whether currencies like Bitcoin can be considered legal tender in India anytime in the recent future. In that context, the Hon’ble Finance Minister Nirmala Sitharaman recently made a remark wherein it was stated that the decision to tax income from virtual digital assets should be seen as a step to check the source and trail. The need for global regulation of cryptocurrencies to tackle the risks of money laundering and terror funding was also highlighted. An emphasis was laid on the relevance of a global approach for regulating and understanding the technology on cryptocurrencies, expressing that intervention at a global level is the only possible way of countering money laundering and various other associated risks.

Brief Background

In the recent times, the finance industry in combination with newer technologies, have caused the emergence of a new field – Fintech (financial technology). Cryptocurrencies have been one of the most consequential outcomes of this industry. A cryptocurrency or crypto, as it is referred to in daily parlance, is a virtual currency that uses an online ledger with robust cryptography to secure online transactions. Cryptocurrencies work using a mechanism called blockchain, a decentralized technology spread across many computers that manages and records transactions. Blockchain consists of verifiable, permanent transactions between two parties without involving any other third party and storing them securely using cryptographic methods. With its robust security features, blockchain proves to be increasingly effective in many sectors like food chain, E-governance among others.

`The first released cryptocurrency was Bitcoin (2009) by one Satoshi Nakamoto. Since then, thousands of cryptocurrencies have been created till date. Much of the interest in these unregulated currencies is to trade for profit. Although Bitcoin was the first established cryptocurrency, there had been previous attempts at creating online currencies with ledgers secured by encryption. Two examples of these were B-Money and Bit Gold, which were formulated but never fully developed. As Bitcoins (BTC) had never been traded and only mined, it was impossible to assign a monetary value to the units of the emerging cryptocurrency. It was only in 2010 that apparently someone decided to sell their coins for the first time – swapping 10,000 of them for two pizzas. 1000 BTC today is worth a staggering 50 million USD. Another cryptocurrency that is currently being revered is the Ethereum. A gradual increase in the places where crypto can be spent has contributed to the continued growth in popularity. As the recognition for this form of currency has increased dramatically, so has the regulatory issues leading to some jurisdictions completely outlawing it. While many have remained ambivalent till date, some countries have decided to embrace and create laws as well as regulatory bodies. Lately, diverse schools of thoughts have described this form of currency as everything from the future of money to an outright scam but what seems to be consistent is that such virtual currencies are here to stay and need some consistent regulation with more and more mainstream populations starting to put their savings in this form of investment. One of the most controversial debates is whether it can succeed in becoming a distributed and decentralized alternative of the government-controlled currencies.

Crypto Timeline in India

In the year 2013, the Reserve Bank of India (RBI) had stated that it had not issued regulation as it was trying to ‘understand the subject’ cautioning people about Bitcoin. It was the same year that Indian crypto exchanges came online, including Unocoin, CoinSecure and ZebPay. There was a time when the outlets of Café Coffee Day were giving out Unocoin scratch cards, encouraging people to sign up and claim a fraction of Bitcoin for free.

In 2015, some Indian crypto exchanges came online, playing a central role in introducing Indians to the wider world of Bitcoin. They were still limited to buying and selling currencies while global exchanges began to add financial services such as leverage, for margin trading. The stablecoin Tether (USDT) and Ethereum (ETH) grew in usage too.

The year 2017 was considered to be the golden year that raised Bitcoin’s value by a great margin – from under $1000 in January to $19,497 in December. It was in the second half of the year 2017 that the RBI issued a press release stating that the value of ‘virtual currencies’ was driven by speculation. In October and November 2017, two Public Interest Litigation (PIL) cases were filed in the Supreme Court of India seeking a ban and regulation of cryptocurrencies in India.

The RBI at the very outset displayed a conservative attitude towards cryptocurrencies with repeated warnings of grave concerns and reservations and then in 2018 banned cryptocurrencies altogether via a circular that “prohibited providing any service in relation to virtual currencies, including those of transfer or receipt of money in accounts relating to the purchase or sale of virtual currencies”.

However, in March 2020, as a fresh lease of life to the virtual currency, the Hon’ble Supreme Court quashed the RBI Circular. The Bench overturned the central bank’s Circular on grounds of disproportionality. The judgment noted that the RBI had failed to show “at least some semblance of any damage suffered by its regulated entities” to back its decision to effectively bar cryptocurrencies in India. It was however elucidated that there could be no dispute in terms of RBI possessing sufficient power to issue such directions to its regulated entities in the interest of depositors, banking policy or in public interest. However, when it came to the test of proportionality of the 2018 Circular, the central bank was required to provide sufficient proof that its regulated entities were damaged by virtual currency exchanges and other entities.

Consequent to the lifting of the ban, there was an understandable upsurge of interest in India to invest in crypto-assets, propelled even further by the aggressive marketing campaigns of the crypto exchanges. The question that arises at this point is whether the unregulated sector has the potential to impact and endanger the wider economy.

Following the Supreme Court decision in 2020, the RBI extended clarifications to certain banking institutions who had continued to refer to RBI’s 2018 Circular and had persistently flagged transactions involving cryptocurrency and warned customers of account closures. The RBI officially clarified that its 2018 circular, which had prohibited cryptocurrency, did not stand after the Hon’ble Supreme Court’s verdict.

Recent Developments

India’s official stance on cryptocurrencies and its regulation will ultimately have a major effect on many aspects including the fate of the millions of investors already tied in with the crypto world, billions invested in the market and the growing adoption of blockchain technology in general. The first-ever parliamentary meeting on regulations of cryptocurrencies was held on 23rd November 2021. This was momentous in many ways as it was India's first-ever official interaction between government officials and crypto stakeholders, reflecting on the welcoming approach that was being adopted. The meeting paved the way for further deliberations on crypto regulation in India.

The decision of the Government to tax crypto earnings is reflective of the Centre’s views on RBI’s objections being too severe implying that India’s stand on cryptocurrencies needed to emulate the moderate regulations of the European countries instead of the the blanket ban model.

It continues to be widely speculated that proactive steps will indeed be taken to introduce the country’s own digital currency issued by the Reserve Bank of India. Furthermore, a new regulatory body may also be established in future under the ambit of the Reserve Bank of India. While all the information cited above may be speculative and based on conjectures, the only probable expectation that remains, is that there will not be a blanket ban.

An upsurge in advertisements in the cryptocurrency space in India has raised some concerns. Crypto exchanges of the likes of CoinDCX, WazirX, Coinswitch Kuber, Binance among others have been flexing their marketing budgets through elaborate advertisement campaigns and most have hired film & tv personalities and social media influencers in an attempt to urge the populace to invest in diverse crypto portals with the implied lure of easy investments with tiny fractions as low as 100 INR and potentially stellar life-changing returns. Some cryptocurrencies that seem to be well known are Bitcoin, Ethereum, Cardano, Litecoin & Polkadot among many others. With more than 20 Million Indians having invested in crypto, leading to a race among crypto exchanges to acquire new users, the industry regulators have flagged such aggressive campaigns as they suppress the risks involved with trading.

In order to safeguard consumers from being misled by not being fully informed of the looming dangers and from undertaking uncalculated risks with the lures of stellar returns, the Advertising Standards Council of India (ASCI) has considered it imperative to regulate the proliferating advertising of such financial products. The ASCI has stated that: "Advertising for these products [VDA's] has been very aggressive over the past few months. The Advertising Standards Council of India (ASCI) noted that several of these advertisements do not adequately disclose the risks associated with such products. In order to safeguard consumer interest, and to ensure that ads do not mislead or exploit consumers' lack of expertise on these products, ASCI has extensively consulted with different stakeholders including government and the virtual digital asset industry - to frame guidelines for virtual digital asset advertising." With regards to the same, in February 2022, the ASCI released guidelines to regulate the advertising and promotional campaigns of Virtual Digital Asset and trading platforms, as a necessary interim measure till the Indian government introduces a comprehensive regulatory structure to control such assets. A significant direction has also been laid down, wherein it has been asserted that, advertisers and media owners must ensure that all earlier advertisements must not appear in the public domain unless they comply with the guidelines, post 15th of April 2022.

Recently, the Securities & Exchange Board of India (SEBI) has reportedly suggested that prominent public figures such as celebrities and sportspeople should not endorse crypto products. With stringent measures being employed across various regulatory sectors as a curb on the crypto space in India, it is imperative to note that such measures are only recommendations as neither the ASCI, nor the SEBI has the authority to ban celebrities from endorsing crypto products or platforms. Such ban would of course need to be imposed by the Government of India.

SEBI’s latest suggestion to ban celebrities from advertising cryptos mirrors the regulations that are in place for mutual funds and other regulated financial assets as mutual fund related advertisements warn users of the market speculations and the associated risks.

In the Indian context, the relative lack of financial education and the absence of access to regulated financial products for many have previously resulted in a series of Ponzi schemes that have caused large-scale damage. Hence the looming dangers of cryptocurrency in an entirely unregulated sector at the present time is disconcerting and must be taken into account in order to safeguard the investing citizens.

Until now, the crypto exchanges have been running on self-regulatory guidelines, mostly set in place by the BACC board, however the government's intervention with its own set of regulations could change the structure while bringing an official acknowledgement to this new form of asset.

Some Global Approaches

El Salvador has become the first country in the world to accept Bitcoin as legal tender with the government of El Salvador claiming that the move will give many citizens of the country access to bank services for the first time.

While India has not made these digital currencies legal tenders, the system is still letting these volatile currencies breathe. However, there are some countries that have completely closed their doors on cryptocurrency and have imposed a stringent ban on these digital tokens.

For instance, China has banned the advent of these digital currencies in total, with the embargo getting intense every year. To counter crypto giants like Bitcoin, China even introduced their own centrally regulated digital currency called Digital Renminbi (RMB). The Central Bank of Indonesia devised a new set of rules and regulations surrounding the promotion and trade of cryptocurrencies and put a complete ban on the digital tokens starting from January 1, 2018. Turkey was also among the few that witnessed the maximum number of transactions before the central bank in the country imposed a new set of guidelines making it illegal to use cryptocurrencies, directly or indirectly, for any goods or services. Egypt, adhering to its primary Islamic advisory body Dar al-lfta, considered any cryptocurrency transaction as ‘haram’ under the Sharia Law thus strictly prohibiting it under Islamic law.

While South-Asian nations like Singapore are seen to clamp down on entry of cryptocurrency platforms, the European countries however have a relatively relaxed approach as introduction of regulatory practices are on the rise. For instance, Spanish banks are preparing to offer crypto assets directly to their customers, for which the banks are making requisite arrangements to meet the upcoming regulations. In Spain, cryptocurrency is largely unregulated because they are not considered financial instruments under the Spanish law. However, amendments to the Spanish Law were approved in March 2021, in order to regulate cryptocurrency advertising within the country to protect Spanish investors from the risks associated with cryptocurrency trading. It is also pertinent to take into account that in 2020, Spanish legislators had proposed an amendment to Spain’s Anti Money Laundering (AML) and terrorist financing laws to comply with the EU’s AML directive. The amendments viewed in light of cryptocurrencies require crypto-providers to register with the Bank of Spain. Additionally, incomes from cryptocurrency transactions are subject to personal income taxes, corporate income taxes, and non-resident income taxes, thereby including crypto-transactions as a significant part of the economy.

In France, The French PACTE law (The Plan d'Action pour la Croissance et la Transformation des Entreprises; PACTE – Action Plan for Business Growth and Transformation) was introduced in 2019 intending to regulate the crypto sector. French regulations mandate that crypto firms must be registered. The new regulations make crypto services and trading platforms operating in France subject to the same Anti Money Laundering/KYC obligations and mandatory registration as other crypto firms operating in countries with AML regulatory practices within Europe.

The cryptocurrency regulatory framework for the European Union addressed as MiCA (Markets in Crypto Assets) was introduced in 2020 to provide a sound legal regulatory framework for crypto-asset markets to develop within the EU. It is intended for MiCA to ensure a high level of consumer and investor protection and market integrity in the crypto-asset markets, along with other associated risks that could arise from a wide use of crypto-assets. MiCA also includes measures against market manipulation to prevent money laundering, terrorist financing and other criminal activities. On 14th of March 2022, the European Parliament adopted its negotiating position on MiCA as it moved along in the legislative process after lawmakers rejected a controversial provision which had sought to restrict the use of and effectively ban popular cryptocurrencies like bitcoin (BTC) and ether (ETH). The EU Bill was first proposed in 2020 and will likely take effect in 2024. After the parliament vote, the MiCA draft is currently shifting to a "trilogue", a formal round of negotiations between the European Commission, Council and Parliament. However, it is to be noted that any agreements reached in the trilogues are informal and need to be formally approved by each of the institutions involved. Issues such as MiCA covering NFTs could also be revisited, but would have to be formally approved.

Even the Commissioner for financial services, financial stability and capital markets union at the European Commission has called for global regulators to work together to address potential risks in the crypto market.

The anti-money laundering directive that was issued by the European Union required Virtual Asset Service Providers to register with their local government. The directive came into effect in 2020 and specifically laid out goals that EU countries had to achieve, however it left it up to the respective individual countries to create and implement their own laws regarding cryptocurrency.

Hence, at the present moment, EU countries have their own regulatory requirements for crypto assets in accordance with some guidelines, which in turn causes far-reaching confusion with regards to the modus operandi in different countries within the EU. For instance, it is not clear as to whether there would be a need for a trading platform to apply for 30 different registrations to operate in different countries within the EU. Hence a centralised system such as the one intended to be in the form of MiCA is a great move for the EU.

Conclusion - Will India impose a blanket ban on Cryptocurrencies?

Would India emulate the workings of the above mentioned nations who have barred crypto altogether or would it embrace the virtual currency, is a potent question. Although there is no definitive answer yet, however one thing clear from the various events is that cryptocurrency is here to stay for a while in the Indian financial market. With imposition of tax on crypto transactions to advertising guidelines from Advertising Standards Council of India (ASCI) to even suggestions from regulatory body like SEBI on ban on the usage of celebrity endorsements for crypto exchanges or platforms, it is clear that the opinions are divided but no one is calling out for a blanket ban. The overall environment is for caution as cryptocurrencies have been created by non-sovereigns and are originating from entirely private enterprises. It can be argued that there is no underlying intrinsic value of these private cryptocurrencies, due to which they lack all the attributes of a currency. Moreover, it may be argued that there is no fixed nominal value of these private cryptocurrencies owing to the extreme fluctuations in their prices.

It is clear that India has to adopt a cogent policy on crypto assets. The possibility of banning crypto assets and crypto currencies however seem unlikely as the world today is ubiquitously connected. With the number of cryptocurrency investors growing in the country along with a burgeoning ecosystem of blockchain applications, banning cryptocurrencies altogether may not be the solution.

Ultimately, the important objective is to afford protection to people who are investing in the blockchain/crypto ecosystem, as they must have access to legal remedies. There is no denying the fact that the volatility and the speculative nature of crypto assets will continue to keep on increasing with the passage of time and this is one area where legislation alone will not be of any help. However, the government will try to provide protection for the rights of Indian consumers and investors by deploying checks and balances to avoid instances of fraud and money laundering and detailed norms on penalties in cases of frauds against investors.

It remains to be seen whether SEBI or a new entity is made the regulator for the cryptocurrencies compared to RBI as SEBI, argued by some crypto trading companies, is apparently better suited to the regulation of such assets and aligned to commodities. However, the crucial point to note from the Hon’ble Supreme Court’s Order in 2020 is whether RBI can be excluded in totality as it was observed that the various bodies in India could play an equally significant role in the regulation of crypto assets depending on which aspect of the cryptosystem was being regulated or governed. The Supreme Court had held, “Enforcement Directorate can step in only when actual money laundering takes place, since the statutory scheme of Prevention of Money Laundering Act deals with a procedure which is quasi-criminal. SEBI can step in only when the transactions involve securities within the meaning of Section 2(h) of the Securities Contracts (Regulation) Act, 1956. CBDT will come into the picture only when the transaction related to the sale and purchase of taxable goods/commodities. Every one of these stakeholders has a different function to perform and are entitled to have an approach depending upon the prism through which they are obliged to look at the issue”.

One of the pressing needs of the hour is to implement appropriate regulation through a carefully crafted legislation and the appointment of a regulatory body so that the investments of millions of citizens are not washed away amidst uncertainty. With a new crypto law on the horizon, a lot of attention is focussed on the statute’s final form and should the law appear overtly restrictive or infringing there is every possibility of legal challenges pursued before the Hon’ble Supreme Court of India.

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