Crypto assets have seen an exponential growth in terms of adoption by Indian investors – many crypto exchanges operating in the country boast user bases in the millions, and annual trade volumes in tens of billion USD. Despite the high level of market activity in the country, crypto assets continue to hang in a legal limbo, with India not having taken a final decision on regulating / prohibiting crypto assets. The regulatory dilemma arises particularly strongly in the Indian context given the considerable exposure of retail investors in the country to crypto assets, as the economic shock caused by an outright ban on crypto assets will likely hit this segment of investors the hardest, contrasted with the concerns brought up by regulators in the country.
This piece takes stock of the journey of crypto asset regulation in India, examines clues regarding the current outlook towards the perennial question of their regulation vs. prohibition and gives an overview of the factors a regulator will have to take into account while making the decision.
The State of Play in India
It was almost a decade ago when the Indian central bank, the Reserve Bank of India (“RBI”), issued its preliminary views on ‘virtual currencies’ (“VCs”).1 The regulator’s concerns revolved around the various risks posed by VCs including money laundering, terror financing, technology-related risks, value, and safety risks. In light of the same, the RBI released a statement on December 24, 2013 (“2013 RBI Statement”) cautioning the users of crypto platforms of the risks associated with VCs, however, it did not impose any restrictions on the use of crypto assets.2
The 2013 RBI Statement offers valuable insights into its concerns that would shape its future decisions. The RBI inter alia flagged the following risks: (i) the lack of an authorized central agency which would not allow customers to have an established dispute recourse framework since payments are performed on a peer-to-peer, decentralized platform; (ii) being in digital form, the high possibilities of hacking, compromise of personal credentials and passwords, malware attacks, loss of VCs held in wallets, etc.; (iii) valuation volatility as there is no underlying or backing of any asset for VCs; (iv) the legal and financial risks that users are exposed to due to uncertainty of status and usage of VC trades in other jurisdictions; and (v) potential illicit and illegal activities which lead to money laundering risks and terror financing risks.
The RBI through a statement released on February 1, 2017 clarified to users, traders, holders, investors, etc. dealing with VCs that it had not permitted or issued any license / authorization to any persons or entity to operate or deal with any VC and any such activity undertaken would be at their own risk.3 The markets witnessed unexpected volatility in valuation of VCs and a growth in initial coin offerings later that year. Following this period of instability, the RBI addressed the situation with the release of another cautionary statement on December 5, 2017 reiterating its concerns stated in earlier press releases.4
A high-level report prepared by an Inter-Ministerial Committee (“IMC”), released on February 28, 2019, addressed issues regarding crypto assets, distributed ledger technology and their implications for the financial services industry.5 Noting the private nature of most crypto assets globally as they are not issued by a sovereign central authority and the lack of an underlying value structure, the IMC concluded
that crypto assets lacked the characteristics of currency. The IMC proposed a ban on crypto assets in India and instead recommended the adoption of a central bank digital currency (“CBDC”).
On April 5, 2018, the RBI announced its intention to prohibit VC transactions and entities dealing in it through the RBI’s Statement on Developmental and Regulatory Policies. This was followed by an RBI Circular dated April 6, 2018, in which the regulator prohibited entities regulated by it in dealing in VCs or providing services to facilitate any person or entity in dealing with or settling VCs, through a circular titled ‘Prohibition on dealing in Virtual Currencies’ (“2018 RBI Circular”).6 These services included maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer / receipt of money in accounts relating to purchase / sale of VCs.
The 2018 RBI Circular was challenged through a writ petition before the Supreme Court of India (“SC”) in Internet and Mobile Association of India v. RBI (“IMAI Judgment”), in which the court struck down the 2018 RBI Circular as being disproportionate.7 The court analysed whether the regulation of VCs would fall within the regulatory ambit of the RBI, given its wide powers to manage and regulate the monetary and financial ecosystem of the country; while there was uncertainty regarding the legal status of VCs / cryptocurrencies as money / currency, or assets / security, or as a payment system. The SC noted that the RBI’s regulatory purview would extend to anything that may pose a threat to or impact the country’s financial system and thus, VCs would fall within the regulatory scope of the RBI. However, the failure on the RBI’s part to demonstrate the degree of harm justifying a complete prohibition on entities dealing in VC transactions, resulted in the 2018 RBI Circular being struck down as disproportionate.
On May 31, 2021 the RBI released a clarificatory circular titled, ‘Customer Due Diligence for transactions in VCs’ (“2021 RBI Circular”),8 which upheld the invalidity of the 2018 RBI Circular from the date of the IMAI Judgement, and therefore, could not be used as an evidentiary source in any case. Notably, the 2021 RBI Circular imposed mandatory duties on entities dealing in VCs to carry out due diligence processes in consonance with laws and regulations regarding: (i) know your customer norms; (ii) anti-money laundering; (iii) combating financing of terrorism; and (iv) foreign exchange for overseas remittances under the Foreign Exchange Management Act, 1999.
Clues towards the Legislative Outlook
In 2019, based on the report of the IMC, the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 (“2019 Bill”) sought to prohibit mining, holding, selling, trade, issuance, disposal or use of crypto assets in India.9 While the 2019 Bill was not passed, it is interesting to note that its penalties included prison sentences of up to ten years and monetary fines of thrice the amount of loss caused / gain made, and where such amount remained unquantifiable, a fine up to INR 25 crore (approx. USD 3.3 million).
More recently, in November 2021, the Lok Sabha’s (the lower house of the Indian Parliament) Bulletin, which sets out the agenda for the Parliamentary session included an entry for the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (“2021 Bill”). While the title of the 2021 Bill drops the words ‘Banning of’ compared to its 2019 counterpart, the purport of the bill was listed as:
To create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India. The Bill also seeks to prohibit all private cryptocurrencies in India; however, it allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses.
The purport of the 2021 Bill was therefore on the same lines as the 2019 Bill. However, as a copy of the 2021 Bill was neither released nor tabled before the Parliament during its final session in the year, it remains unknown if the government’s intent was to introduce a bill which did not deviate significantly from the strong provisions in its 2019 form.
Weighing the Scales
Around the globe, regulators have dealt with the question of prohibiting vs. regulating crypto assets, and the debate has played out differently worldwide.10 While there are a few outlier jurisdictions which have either completely banned the use and sale of crypto assets or completely embraced their use (even as legal tender), a sizeable number have sought to strike a balance between the extremes. These jurisdictions have enacted anti-money laundering and terror financing on crypto asset transactions, while limiting themselves to only public warnings about the volatility of investing in crypto assets.
An outright prohibition on crypto assets has been struck down as disproportionate in the IMAI Judgment – future attempts to prohibit crypto assets completely will therefore have to pass muster with the SC. Indian regulators may consider looking outwards to jurisdictions such as Singapore as case studies to regulate crypto assets.
An important decision-making point for the government is the appropriate regulator for crypto assets in the country. The IMAI Judgment has already ruled that crypto assets are within the regulatory purview of the RBI per its founding statute, but other options include the Indian securities regulator, the Securities and Exchange Board of India (SEBI), a self-regulatory organisation such as the Japan Virtual Currency Exchange Association, or the creation of a new umbrella regulator for crypto assets in the country. The decision to choose the appropriate regulator ties in closely with the government’s intended treatment of crypto assets (whether as ‘goods’, ‘securities’ or otherwise).
The Road Ahead
Unfortunately, 2021 has not brought regulatory certainty in relation to crypto assets’ treatment in India. Media reports suggest that the matter is a priority item for the government, which is currently being presented with views from various stakeholders. The risks presented by crypto assets will need to be balanced with the heavy exposure of the Indian retail investor base, to avoid sudden financial shocks. A prohibition on crypto assets may also face a tough challenge in the courts, given the view taken by the SC in the IMAI Judgment.