Cryptocurrency - An opportunity or a challenge!

Introduction:

Digitalisation as we hear it today, started few decades back. In recent years with growth of technology, almost all sectors be it media, manufacturing, banking, healthcare, etc have experienced digitalisation. It has also been welcomed in the area of currencies and it because of this that now all money related activities have become faster due to the introduction of digital payment methods. Apart from this, in recent times we have also come across the word “digital currency” “virtual currency” or “cryptocurrency” quite often. These terms are being used in several parts of the world today and have been in the minds of researchers for quite some time. Trading and usage of cryptocurrencies call for highly strict laws and regulatory framework mainly because of its decentralized nature. In a country like India, where traditional currencies are being used which are centralized throughout, the term “virtual currency” or “cryptocurrency” is finding it difficult to find a space in the country at the hands of investors. The question of legality of virtual currency or cryptocurrency and its introduction in India has led to various issues that are required to be dealt with efficaciously as on hand it has come forth with a great amount of opportunity for the investors but at the same time has raised a number of regulatory concerns as far as the question of its misuse is concerned. The decentralized and versatile nature of cryptocurrency has put the countries including India in dilemma as to how to make use of cryptocurrency, which is unregulated, legal and acceptable while preventing frauds in transactions.

Cryptocurrency & its origin:

We need to first understand what virtual currency is. Virtual currency, or virtual money, is a type of unregulated digital currency, which is issued and controlled by its developers and used and accepted among the members of a specific virtual community. It is a digital representation of value that is neither issued by a central bank or a public authority but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically. Cryptocurrency is a type of virtual currency that is created and managed through the use of advanced encryption techniques known as cryptography. Since all virtual currencies do not use cryptography, not all virtual currencies are cryptocurrencies. Now the question which arises is what we mean by cryptography. Cryptography is a method of protecting information and communications through the use of codes, so that only those for whom the information is intended can read and process it meaning thereby whatever transactions/investments/payments are made using cryptocurrencies are fully coded and secured.

Bitcoin was the first decentralized cryptocurrency that was developed by an unknown person or group of people using the name Satoshi Nakamoto in the year 2009. Bitcoin is a peer-to-peer currency which means that no central authority issues new money or tracks transactions. These tasks are managed collectively by the network. Apart from bitcoins there are other cryptocurrencies as well.

Paperless currency: Cryptocurrencies are paperless and are not regulated by any central authority. They work with the help of block chain technology and are transferred directly from person to person via the net without going through a bank or clearing house.

Block chain technology-how it works: Block chain, as its name suggests, consists of multiple blocks strung together. In order for a block to be added to the block chain, four things must happen (i) transaction must occur (ii) transaction must be verified (iii) transaction must be stored in a block (iv) verified transaction must be given a code i.e. hash. Once the code is given, the block containing the transaction is added to the block. Similarly when another transaction takes place, this process of adding block is followed and the chain of transaction that forms is called a block chain. When that new block is added to the block chain, it becomes publicly available for view and we can see that we have access to transaction data, along with information about when, where, and by who the block was added to the block chain.

Is Blockchain secure?

In blockchains, new blocks are always stored in a straight line and chronologically and once a block has been added to the end of the blockchain, it is very difficult to go back and alter the information of the block. That’s because each block contains its own hash. If that information is edited in any way, the hash code changes as well. Let us say if a hacker attempts to change the contents of one block, its hash i.e. code changes. However, the next block still contains the old hash and the hacker will have to change that code as well in order to gain access to the information and so on and so forth. In other words, once a block is added to the blockchain it becomes very difficult to edit and impossible to delete any information or contents of the block.

Even though the editing and deleting of information and contents of a block in a blockchain is a back-breaking and gruelling task which makes such transactions and blockchains highly secure, its security and reliability has always been in question in India and in few other countries as well.

Status of Cryptocurrency in other countries:

Trading in cryptocurrency is a debatable topic across various countries. Most of the countries have not clearly determined the legitimacy of cryptocurrencies whereas few countries have accepted it with certain regulatory framework. However, none of the countries have accepted cryptocurrency as a legal tender. The United States of America which is the most powerful country of the world has welcomed the use of bitcoins. Canada, Australia, Belgium is among the few countries who have given a thumbs up to bitcoins but their use is limited for exchange purposes, capital gain purposes, etc. Imposition of taxes in consonance to Tax laws also depends upon the usage of cryptocurrency in these countries.

On the other hand there are countries like- China, Russia, Vietnam, Bolivia, Columbia and Eucador who have imposed a complete ban on trading in cryptocurrency in any form mainly because it is versatile, decentralized and not regulated. As far as our country is concerned, cryptocurrency exchanges have taken place few years ago however no such framework either favouring it or penalising it have been set up till now.

India and Cryptocurrency:

India is a country which runs on a centralized system. It has a central authority for all kinds of activities including money related matters and its circulation. The Reserve Bank of India is the central authority that regulates entire banking system of the country. The preamble[1] of the Reserve Bank of India describes the basic functions of the reserve bank as:

"to regulate the issue of Banknotes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth."

Therefore, the introduction of cryptocurrency in India and its use has been a controversial topic in recent times and is nothing but a hot potato whose introduction and usage is still being dealt with by the central banking system of the country.  

Legality of Cryptocurrency: A number of cryptocurrency exchanges started in India between 2012-2017. It was due to this the Reserve Bank of India held various press releases on various dates December 24, 2013, February 1, 2017 and December 5, 2017 wherein the RBI issued various advisories to users, investors, traders and similar parties dealing with cryptocurrencies about the potential financial, legal and security related risks associated with the use of virtual currencies. Vide its press release dated December 24, 2013, RBI clarified that creation, trade and usage of virtual currencies is neither recommended nor authorised by the Reserve Bank of India. It is mainly because of the reason that the virtual currencies are neither centralised nor have been given the status of being legal in India.

The RBI fears and apprehends that in the absence of appropriate established laws for the same, the usage of cryptocurrency in India might lead to increase in money laundering in India and it is for this reason that the use of cryptocurrency has constantly been on the radar of law enforcement agencies. We shall be dealing with the challenges ahead of use of cryptocurrency in this article. 

Recently, a circular “Prohibition on dealing with Virtual Currencies (VCs)” was issued by the RBI on April 6, 2018[2] by which RBI banned the dealing in VCs by entities. The circular also banned provision of services by entities regulated by RBI for facilitating any person or entity in dealing with or settling VCs. Such services include 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. Para 3 of the circular also required the entities who were dealing with VCs or providing such services to exit their relationship within 3 months from the date of the circular. However, in 2018, this circular was under challenge before the Apex Court by one Internet and Mobile Association of India (hereinafter called as “IAMAI”). IAMAI is a not-for-profit industry body registered under the Societies Act, 1896. Its mandate is to expand and enhance the online and mobile value added services sectors.  What is strange here is that though the central bank of India i.e. Reserve Bank of India has banned the use and dealing with VCs, the Apex court on one side has lifted the embargo vide the circular of RBI vide its judgment dated March 4, 2020[3].

Apex Court view on banning of cryptocurrency:

In the instant case, the Petitioner i.e. IAMAI challenged the RBI circular dated April 6, 2018 on various grounds namely-

  1. RBI does not have the power to prohibit the use of Virtual currencies as VCs are not legal tenders and they are not regulated by RBI.
  2. Services rendered by VC do not qualify to be a “payment system” as defined under the Payment and Settlement Systems Act, 2007 and therefore they are not regulated by RBI.
  3. RBI while issuing such circular did not apply its mind.
  4. RBI’s circular is violative of Article 19(1)(g) of the Indian Constitution which gives right to citizens to practice any profession or to carry on any occupation, trade or business.

In response to such allegations, RBI put forth various submissions and also argued that whatever steps were being taken were in public interest and interest of the country at large. The Apex Court however turned down the submission of IAMAI w.r.t RBI not having power to prohibit trading in VCs but at the same time lifted the ban imposed by RBI by turning down the circular dated April 6, 2018.  

If we refer to Para 6 sub-para 173 of the judgement dated March 4, 2020 passed by the Apex Court, it is clear that the Apex Court does not doubt on the wide powers which RBI possess not only in view of the statutory scheme of the 3 enactments i.e. Banking Regulation Act 1949, RBI Act 1934 and Payment and Settlement Systems Act 2007 but it also occupies a special place and role in the economy of the country. The Apex Court also opined that these powers can be exercised both in the form of preventive as well as curative measures but RBI failed to provide any data which showed that damage had been caused by the use or trading of cryptocurrency on the entities regulated by RBI.

Recently, on April 25, 2020 an RTI had also been filed by co-founder of Unocoin, Mr. BV Harish questioning whether RBI had prohibited Banks from providing accounts to crypto exchange traders or companies as the Banks continued to impose restrictions despite the above ruling. The response of RBI to this was in positive. Therefore lifting of ban or turning down of the circular of RBI or RBI response to the RTI does not necessarily mean that trading in cryptocurrencies have become legal in India. It is still a controversial topic as no framework has been set up till now to either monitor or regulate it. Further, the draft bill[4] has been revised which bans such trading and also imposes penalties for such trading. The said bill is in the draft form pending to be looked into, vetted and introduced before the legislative body of the country i.e., the Parliament. 

Constitution of Inter-Ministerial Committee and Draft Bill: An initiative, though not favouring virtual currencies, was taken by the Central Government in the year 2017. An Inter-Ministerial Committee[5] was constituted in November 2017 to study the issues relating to virtual currencies and propose actions to be taken in that direction. A report was submitted by the Committee on February 28, 2019 which was made open to public on July 22, 2019. The report submitted threw light on several risks associated with cryptocurrencies. It also recommended that all cryptocurrencies, except those issued by the government, be banned in India.  It also proposed a draft Bill to ban cryptocurrencies in the country and provide for an official digital currency and recommended use of Distributed Ledger Technology (DLT) as it is more secure and helpful in detection of fraud, as compared to trading in cryptocurrencies.

Distributed Ledger Technology is similar to blockchains or we can say blockchain is a type of DLT. The only difference is that in blockchains the information or transactions are stored linearly in blocks whereas in DLT, the information or transactions is distributed across multiple networks which also makes tampering of data difficult. The focus of the Committee was on use of DLT in few sectors such as land markets as it will serve as an effective record keeping technology and also a tool to prevent fraud.  

Draft Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019: The draft Bill defines cryptocurrency as any information, code, number or token, generated through cryptographic means or otherwise, which has a digital representation of value and has utility in a business activity, or acts as a store of value or a unit of account. The draft Bill has been revised however the same is yet to be looked into and vetted by the Law Ministry before it is introduced before the Parliament. The key highlights of the Bill are-

  • It seeks to prohibit mining, holding, selling, trade, issuance, disposal or use of cryptocurrency in the country and has also imposed punishments for any kind of abovementioned dealing in cryptocurrency in the country.
  • Declare and disposal of any cryptocurrency in possession of any person within 90 days from the commencement of the Act.
  • Permits the use of processes or technology underlying any cryptocurrency for experiment, research, or teaching.
  • The central government, in consultation with the RBI, may issue digital rupee as legal tender.

The draft bill has been prepared keeping in mind the interest of consumers and also the damage it may cause to the monetary system of the country. The Bill also lays down certain benefits of the use of cryptocurrency however it seems that the features of the said bill are contradictory to what has been opined by the Apex Court above. The draft bill has raised a question on the verdict passed by the Apex Court or we can say both the draft bill and the judgement are contradictory to each other and have also developed inquisitiveness among the entities and individuals who are dealing or who wish to deal in cryptocurrencies about the decision on legal status of cryptocurrency in India.

Applicability of other laws of India:

There are number of prevailing laws of the country that can be applied to the dealings of cryptocurrencies provided modifications are brought about in the Act. Whatever may be the decision on the legitimacy of trading of cryptocurrencies in the country, a number of acts enacted by the Parliament exists which may be applied to cryptocurrencies. Few of them are-

  1. Prevention of Money Laundering Act 2002- The main objective of this Act is to punish those who are involved in money laundering and confiscate properties derived from money laundering. As stated earlier, cryptocurrency transactions provide high security due to the technology that it uses and therefore can be effective in preventing fraudulent transactions. In such transactions the identity of the persons are not revealed which can lead to increase in money laundering cases across the country. It is in this situation that this Act can be brought into action, however specific provisions pertaining to cryptocurrency transactions will have to be incorporated for the purpose. 
  2. Payment and Settlement Systems Act, 2007 – The Act aims at regulating the payment systems in India and are applied to payments/transfers made online. Cryptocurrency can be brought within the purview of this Act since all transactions shall take place online by way of underlying technology and are marketable like securities. However, slight amendments would be required to be made in the Act with respect to imposing penalties in such cases.
  3. Reserve Bank of India Act 1934- Since entire monetary system is governed by the Reserve Bank of India, all cryptocurrency transactions shall automatically come within the realm of RBI Act 1934.
  4. Securities and Exchange Board of India Act 1992- As cryptocurrencies are speculative in nature, it can be brought under the definition of securities as defined u/s 2 (h) of the Securities Contracts (Regulation) Act, 1956. However, though cryptocurrencies are marketable, in order to bring the same under such definition, modification in the definition of securities will have to be brought into.

Challenges and Opportunities ahead:

Everything has two ends- the challenges that it brings along and the benefits that arises of that thing. As stated earlier, trading of cryptocurrencies has been in question throughout mainly because of the challenges that it brings along. Few of them are-

  1. Cryptocurrency is not controlled by any authority. It is decentralised and therefore there is no one point of control over the system.
  2. Since they are not supported by any central authority, they cannot be treated as a legal tender.
  3. Highly unstable because they are subject to market fluctuations.
  4. Transactions are irreversible meaning thereby one cannot go back and correct a wrong transaction.
  5. Increase in risk of terrorist funding activities and money laundering since the identity of the person is not revealed.
  6. Transactions involve high electricity consumption which can affect the energy security of the country.
  7. Difficult to trace the hacker and reduce cyber threat as the identity of the individuals are not revealed.

Though cryptocurrencies have been in limelight in many countries in recent years, one cannot deny the benefits or opportunities that it confers. Few of them are-

  1. Use of cryptocurrency provides cheaper, effective and faster transactions.
  2. Provides transparency.
  3. Since Cryptocurrencies work through the technology of blockchain, the tampering of information/contents/transactions by hackers become difficult which leads to abatement of frauds in the market.
  4. Reduction in cost as there is no involvement of middlemen which in turn makes the transaction less time consuming and less confusing as it cuts out the middlemen.
  5. Under cash/credit systems, our entire transaction history is at the hands of the bank or credit agency involved. But a cryptocurrency transaction takes place on a peer-to-peer basis which protects our financial history and also protects from potential threat of account.
  6. Cryptocurrencies are not subject to exchange rates, interest rates, etc and therefore cross- border transaction and transfers can be conducted without any complications over currency exchange fluctuations etc.
  7. If used in the field of healthcare, insurance, real estate sector, government services etc, cryptocurrency can help maintain and store huge amounts of data, automatic and faster release of payments without involving complex processes and middlemen and can also help in audit purpose.
  8. No identity theft as personal information of users of blockchain is limited to their username.

Conclusion: 

We see that cryptocurrencies have sparked a debate all over the world. Where most of the countries are making use of cryptocurrency as a payment mechanism or as a mode of exchange, few countries have put a blanket bank on virtual currencies. Similarly, the trading of cryptocurrencies has become a controversial topic in our country. Today when the world is moving towards digitalisation and advancements are taking place in all sectors, it has become necessary to adapt oneself to the changes to be at par in the rat race. However, in order to accept and legalise cryptocurrencies in India, the RBI in consultation with the government of the country will have to bring in strict laws and establish a strong regulatory framework to regulate such transactions so as to curb criminal transactions. Such laws and regulatory framework will have to work in a parallel manner so that the already existing monetary system goes unaffected. Until then what will be the future of cryptocurrencies in the country shall remain a mootable question.

  • [1] https://www.rbi.org.in/Scripts/AboutusDisplay.aspx#EP1
  • [2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11243&Mode=0
  • [3] Writ Petition (Civil) No. 528 of 2018
  • [4]https://www.prsindia.org/billtrack/draft-banning-cryptocurrency-regulation-official-digital-currency-bill-2019
  • [5] https://www.prsindia.org/policy/report-summaries/virtual-currencies-india

 

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