ASC Legal, Solicitors and Advocates June 2020

Cryptocurrency - India’s Likely Belligerent Response Amid Covid-

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The upswing of Cryptocurrencies or Crypto Assets or Virtual Currencies has gained attention
around the world, so much so that it is being viewed as analogous to the industrial
revolution, and the next big digital revolution after the internet.

About three years ago, on May 20, 2017, the Indian Government’s Ministry of Finance
invited suggestions from the public regarding the digital currency framework. Of the nearly
four thousand comments submitted, many favored legalization and regulation of
cryptocurrency trading in India. Others recommended a ban on the same, citing
cybersecurity concerns. Considering such suggestions, the Government decided to conduct
research of its own and sought advice from economic experts. For this purpose, a committee
under the chairmanship of the then Hon’ble Secretary, Department of Economic Affairs,
Ministry of Finance was constituted.

While such developments were taking place, a petition was filed before the Hon’ble Supreme
Court of India in July 2017, seeking directions regarding regulation of trade and flow of
bitcoin and other cryptocurrencies. The Court directed India’s Central banker, The Reserve
Bank of India (RBI) and concerned ministries to clarify their stance and bring legislation on
the same before disposing off the Public Interest Litigation on July 14, 2017.

Latest reports indicate that in the near future, the Indian Union Cabinet is likely to deliberate
upon a draft legislation that proposes to ban virtual currencies altogether.

Before the issue sought intervention and attention of the Judiciary and Regulators, there was
a lack of clarity, coupled with periodic warnings from both the RBI and Ministry of Finance
regarding the potential negative effects of investment and trading in cryptocurrencies. These
were accompanied by the Enforcement Directorate and Income Tax Department conducting
on-site tax surveys and surprise investigations against bitcoin exchanges and users alike.
 
Background:
 
The Oxford Dictionary defines ‘cryptocurrency’ as follows:

“A digital currency in which encryption techniques are used to regulate the generation of
units of currency and verify the transfer of funds, operating independently of a central bank.”

Virtual currency is a digital representation of value capable of being traded digitally, and
functioning as a medium of exchange, and/or unit of account, and/or store of value.

Bitcoin was the first cryptocurrency to be launched in November 2008. As of date, hundreds

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of cryptocurrencies are in existence. Their market capitalization has shown tremendous
increase since 2009, by way of price inflations and introduction of new cryptocurrencies.
Bitcoin has the highest market cap, followed by Ethereum, Ripple, and Cardano. Despite
such rapid growth and popularity, doubts over their treatment by regulators of various
regimes persist. The legality of cryptocurrencies varies on an individual’s location, as well as
the purpose of its usage.

The two defining features of cryptocurrencies are:

1. Decentralization
2. Absence of intermediaries

Cryptocurrency functions exclusively on peer-to-peer networks known as Digital Ledger

Technologies (Blockchain, which constitutes the foundation of Bitcoin, is an example).
Though trading of cryptocurrencies is commonly done through centralized cryptocurrency
exchanges working in a manner like regular stock exchanges, distributed ledgers make use
of nodes (independent computers) to record, share and synchronize transactions in their
respective electronic ledgers. Resultantly, the requirement for keeping data in a centralized
ledger is dispensed with. Thus, seen as a whole, it is a decentralized system of trading.

While cryptocurrencies may have their pros and cons, it is a fact that certain elements of the
concept have immense advantages in making banking accessible without the interference of
any third party. It provides the possibility for an alternate payment system with smaller
transaction fee, cross-subsidized by the newly minted cryptocurrency. The focus on
irreversibility and decentralization of transactions by design may have beneficial uses in
financial intermediation, payment systems etc.

In status quo, the world economy functions on fiat currency issued by respective
governments.  The main requirement of these currencies is that they require a central
regulatory body to govern them.  Such procedure suffers from the underlying vulnerabilities
of the trust-based model, along with over-reliance on financial institutions to undertake
payments. On the other hand, cryptocurrencies use cryptography for twin purposes; Firstly,
to control the generation or “Mining” of fresh units; Secondly, to secure transactions.  It
works on the concept of “Proof of Work” also known as “crypto proof,” which provides an
alternative to the trust factor and allows entities to transact with each other securely, without
a need for a third party. This provides an ability to transact with anonymity and transparency
at the same time. Further, the value of cryptocurrency is based wholly on the principle of
demand and supply, having no inherent value, thereby freeing them from government
intervention.

Global Regulatory Environment

 
In a global context, any discussion around virtual currencies would end up being classified
into three categories:
 Legal status
 Regulatory framework
 State support

Nearly all jurisdictions, including that ones that prefer regulation over banning, warn citizens
about the potential harms associated with virtual currencies. This is mostly done via circulars
issued by their respective Central Banks. The emphasis is on cryptocurrencies not being
guaranteed by the State. It is also pointed out that they are prone to volatility since most of
the operators are unregulated entities and the nature of trading is highly speculative, thereby
limiting their attractiveness as a store of value. Lastly, the potential of misuse for illegal
activities is highlighted, especially in relation to terror financing and money laundering, due
to the anonymity provided by design. Countries such as Canada & Australia have gone

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beyond issuing warnings and included cryptocurrencies under their money laundering and
terror financing laws. Regardless of the regulatory framework adopted, no country has given
cryptocurrencies the status of legal tender, although some cantons in Switzerland permit
their usage as a mode of payment along with traditional currency.

The level of restriction imposed on trading and investment in virtual currencies varies from
an outright ban, to an indirect ban by restricting financial institutions from facilitating such
transactions. Some jurisdictions ban trading locally but allow their citizens to invest in virtual
currencies abroad.

Source: Government of India Committee to propose specific actions to be taken in relation to

Virtual Currencies dated February 28, 2019

On the other end the spectrum, there is also news of State-generated sovereign
cryptocurrencies from China and Venezuela. Others acknowledge the potential of the
technology driving it and seek to develop crypto-friendly regulatory regimes to attract
technological companies working in the sector e.g. Cayman Islands.

Taxation of Trade and Investment in Cryptocurrencies

For the purposes of taxation, it would have to be determined whether the gains derived from
mining and trading are classified as income or capital gains. Israel taxes them as an asset,
while Switzerland treats them as foreign currency. Argentina and Spain mandate the paying

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of income tax on virtual currencies. The UK adopts a threefold classification; Corporations
are required to pay corporate tax, unregulated entities pay income tax, while individuals pay
capital gains tax. Mining is almost universally exempt from tax liability.

In 2015, in Skatteverket v David Hedqvist, (Case C-264/14) [2015] BVC 34, The European
Court of Justice held that transactions to exchange traditional currency for virtual currencies
constitute the supply of services for consideration but fall under the exemption from Value-
Added Tax (VAT). Thus, buying or selling cryptocurrencies is exempt from VAT in all EU
Member States.

Indian Regulatory Efforts 

On April 5, 2018, The RBI issued a Statement on Developmental and Regulatory

Policies directing the entities regulated by RBI:
 Not to deal with or provide services to any individual or business entities dealing with
or settling virtual currencies; and
 Exit the relationship, if they already have one, with such individuals/ business
entities, dealing with or settling virtual currencies
(Thereby effectively imposing an indirect ban on trade in cryptocurrencies)

On the same day itself, the RBI issued a press release, paragraph 13 of which categorically
stated that in light of concerns related to cryptocurrencies (consumer protection, market
integrity, financial stability, money laundering etc.), and in absence of cryptocurrency
regulation, RBI will no longer provide services to individuals/ businesses that deal in
cryptocurrencies. The text of the said paragraph reads as follows:

“13. Ring-fencing regulated entities from virtual currencies

Technological innovations, including those underlying virtual currencies, have the potential
to improve the efficiency and inclusiveness of the financial system. However, Virtual
Currencies (VCs), also variously referred to as crypto currencies and crypto assets, raise
concerns of consumer protection, market integrity and money laundering, among others.

Reserve Bank has repeatedly cautioned users, holders and traders of virtual currencies,
including Bitcoins, regarding various risks associated in dealing with such virtual currencies.
In view of the associated risks, it has been decided that, with immediate effect, entities
regulated by RBI shall not deal with or provide services to any individual or business entities
dealing with or settling VCs. Regulated entities which already provide such services shall
exit the relationship within a specified time. A circular in this regard is being issued
separately.”

Judicial Intervention: Verdict of the Hon’ble Supreme Court

Following the RBI circular and statement, a writ petition was filed before the Hon’ble Delhi
High Court challenging the validity of said statement and circular and seeking a direction
against RBI to prevent it from restricting or restraining banks and financial institutions from
providing access to banking services to those engaged in transactions in crypto assets.
Meanwhile, The RBI filed a Transfer Petition before the Hon’ble Supreme Court seeking to
transfer the cases pending for adjudication before various Hon’ble High Courts, to avoid
diverging views on the subject. The Hon’ble Apex Court passed an order directing that no
Hon’ble High Courts of India shall entertain any petition relating to the statement and circular
issued by the RBI.

The Writ Petition before the Hon’ble Delhi High Court was filed against RBI for violating
Articles 19(1)(g) and 14 of the Constitution. Article 14 “Equality Before Law” says that the

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State shall not deny to any person equality before the law or the equal protection of the laws
within the territory of India, prohibition of discrimination on grounds of religion, race, caste,
sex or place of birth. Article 19(1)(g), guarantees to all citizens the “Right to practice any
profession, or to carry on any occupation, trade or business”.

The petitioners argued that the RBI circular dated April 5, 2018, is arbitrary and
unconstitutional as RBI does not state strong facts as to why it is against the business of
cryptocurrencies. By Constitutional standards, it was incumbent upon The RBI to provide
logical and well-reasoned arguments backed by concrete facts to put a stop to any such
business in India.

The RBI statement and circular also do appear to have violated Article 301 of Indian
Constitution, which guarantees to all persons the “Freedom of trade, commerce, and
intercourse throughout the territory of India”. A direct result of the RBI action was that
financial institutions were restricted from transacting with cryptocurrency traders and
exchanges.

On March 4, 2020, the Hon’ble Supreme Court in the matter titled Internet and Mobile
Association of India v. Reserve Bank of India (Writ Petition (Civil) No.528 and Writ
Petition (Civil) No.373 of 2018). held that the RBI's circular violated the rights of virtual
currency exchanges and traders guaranteed under Article 19(1)(g) of the Constitution. The
Apex Court did not deny the powers of the RBI to take such a measure, but concluded that
the action had failed the test of proportionality, since the RBI has been unable to show how
interaction with cryptocurrency trade harms the entities regulated by it. The Hon’ble Apex
Court also observed that the contention of RBI that virtual currency is not a currency runs
counter to the definition of Financial Action Task Force, stating that it has all the attributes
except legal tender status. Considering this classification, the power of RBI to regulate virtual
currencies is still available. Nothing prevents the RBI from classifying it as “Other similar
instruments” like promissory notes, cheques, etc., which are not exactly currencies but
operate as valid exchange.
 
The RBI, being the Central Bank, to discharge its solemn obligations is empowered to:

 To operate the currency and credit system

 To regulate the financial system and
 To regulate the payments and settlements system

(As a natural extension of these powers, The RBI has the mandate to address all issues that
are perceived as potential risks to the monetary, currency, financial, and payments systems
of the country)

If institutions accept cryptocurrencies as a valid payment for purchase of goods and

services, such transactions will fall within the purview of RBI.
 

Road Ahead for Cryptocurrency Regime in India

As noted by the Hon’ble Supreme Court in its judgment, a draft legislation- Banning of

Cryptocurrency & Regulation of Official Digital Currency Bill, 2019, is under
consideration by the Government (The governmental committee previously mentioned had
proposed a complete ban and drafted the legislation.) The proposed draft intends to ban
mining, trading, holding, issuance, or disposal of cryptocurrencies in India and to impose
monetary as well as penal consequences (imprisonment up to 10 (ten) years) for their
violation. Therefore, it can be expected that the RBI will not pursue a similar reactive

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prohibition while Parliament is seized on the matter. Until further
notification/policy/regulation/guidance there seem to be no restrictions for crypto assets
industries to do business, transactions, or investments in India. The Apex Court Judgement
revived hopes of trade and investment in virtual currencies, along with plans for expansion.

However, some banks are reportedly still refusing to open accounts for crypto exchanges,
claiming that they are waiting for further instructions from the RBI. In response to a Right to
Information query filed on April 25, 2020 by a major Indian cryptocurrency exchange, The
RBI has confirmed that there is no banking ban on the crypto industry in status quo. With
such lack of cooperation, cryptocurrency traders have had to explore other options for
financing.

Further, even as a ban on virtual currencies is being proposed by the governmental

committee, it noted with approval the potential beneficial uses of Distributed Ledger
Technologies, both in financial and non-financial areas. In finance, Digital Ledger
Technologies can be beneficial in the areas of trade financing and improving access to
credit. The committee suggested that the technology can be explored for enabling faster and
more secure payment infrastructure, especially for cross-border payments. It noted that
Distributed Ledger-based systems can be used by financial sector regulators to increase
efficiency and security of transactions.

Fresh investments that lifting of the ban has attracted are likely to have various income tax
implications as well. The Apex Indian Direct Tax Administration Body, The Central Board of
Direct Taxes (CBDT) should soon come up with a comprehensive set of regulations
regarding the tax treatment of various transactions involving Crypto
Assets/Cryptocurrencies, which, till now, has been based only on plain elements of taxation
and some assumptions.
 
Cryptocurrencies amid COVID-19 Crisis

Cryptocurrencies are likely to witness a sharp rise during crises currently faced by
economies worldwide. Banks around the world shall undergo an extended period of pain as
an aftermath of the impact of COVID-19. In these unprecedented times, as the corporate
sector struggles for durability, not to forget the local and small businesses, the need for the
trade finance is immense.
 
A new digital society might emerge due to the pandemic induced crisis which can be
considered as an advantage for speeding up under-process technologies. By design, digital
ledger technologies and cryptocurrencies serve the twin benefits of security of transactions
as well as elimination of the need for physical presence. Thus, it can be reasonably be
expected that both these technologies are likely to see growth in this awkward period.
 
In the Indian context, crypto exchanges and traders had already resumed operations after
the Supreme Court Verdict. As per reports, the sector is expected to see substantial growth,
especially with respect to crypto-financing opportunities. During the pandemic,
cryptocurrencies here saw transactions nearly triple and new users double. The trading
volume increased by approximately 275%. Global crypto exchange platforms like WazirX
operating in India stated “The pandemic has caused many people to hedge their
investments by buying into crypto. Since it is online, there is much lesser risk of the
pandemic affecting this. Further people have time now and they are finding newer ways of
investing and learning about this as an alternate asset class.”

ASC Legal Comments

Finally, the Apex Court has opened the door for trade in cryptocurrencies by lifting the de

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facto ban imposed by the RBI. The judgment has the potential to be a game-changer for
India’s crypto industry. Based on global trends, investors predict that peer-to-peer
companies will see inflow of capital. Lastly, in a statement, Internet and Mobile Association
of India said that they are looking forward to working jointly with the RBI and the government
on a constructive policy framework for cryptocurrencies in India. Now is the time watch how
cryptocurrencies can transform the economic and digital landscape of the nation in the
upcoming years.

However, a word of caution is necessary at this stage. It remains to be seen if the Indian
crypto industry can convince the Indian establishment, since the draft bill which seeks to
impose a complete prohibition on mining, holding, selling, trade, issuance, disposal or use of
cryptocurrency, has the potential to undo the positive developments that have taken place
since the landmark Verdict.

On June 12, 2020, The Economic Times reported that the Ministry of Finance has circulated
a Cabinet Note for consultations on the draft legislation, after which the bill may be
presented to Parliament. The Government, as the report suggests, wants to create a strong
legal framework to avoid another situation where the Courts interfere with executive attempts
to ban cryptocurrencies. 

Industry experts have always been critical of the Government’s plans to impose a ban. They
contend that a blanket ban will prove difficult to implement since cryptocurrencies are, by
design, difficult to monitor. They say it is most likely to result in a shadow/underground
market for the same. When it comes to controlling money laundering and other illegal
activities, it is believed that regulation is a more potent weapon than banning. The Internet
and Mobile Association of India has even come up with a Code of Conduct for the crypto
industry, incorporating Know Your Customer and Prevention of Money Laundering
Act requirements.

One will have to see whether the Government of the day decides to pursue the draft
legislation or alters course to adopt a more conciliatory approach due to potential benefits of
cryptocurrencies in light of the challenges thrown up by the pandemic.

Cryptocurrencies in the meanwhile, may just have to bear with the Indian inertia!!

Hope the above is useful.

In case of any assistance/ further clarification required, please do let us know.

 
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Wishing Good Health

With kind regards,

 
Aseem & Team
 
FOR PRIVATE CIRCULATION ONLY

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