Curbs On Cryptocurrency Trades Lifted


  • In a significant judgment, the Supreme Court on 4th March, 2020, lifted the curbs imposed by the Reserve Bank of India(RBI) on regulated entities such as banks and NBFCs from dealing with virtual currencies (VC) and from providing services to crypto businesses.
  • The court held that the ban did not pass the “proportionality” test.
  • The test of proportionality of any action by the government must pass the test of Article 19(1)(g), which states that all citizens of the country will have the right to practise any profession, or carry on any occupation or trade and business.

Background

  • The circular issued on April 6, 2018 directed the entities regulated by RBI:
  1. Not to deal in virtual currencies nor to provide services for facilitating any person or entity in dealing with or settling virtual currencies.
  2. To exit the relationship with such persons or entities, if they were already providing such services to them.

While striking down the circular, the Court took note of three factors:

  • RBI, in the past 5 years or more, has not found any of the activities of Virtual Currency exchanges to have actually impacted adversely, the way the entities regulated by RBI function.
  • In its reply, dated 04-09-2019, RBI said that it has not prohibited Virtual Currencies in the country.
  • Even the Inter-Ministerial Committee constituted on 02-11-2017 was of the opinion that a ban might be an extreme tool and that the same objectives can be achieved through regulatory measures.

Reasons to Ban Virtual Currencies

  • Owing to the lack of any underlying fiat, episodes of excessive volatility in their value, and their anonymous nature which goes against global money-laundering rules, the RBI initially flagged its concerns on trade and use of the currency.
  • Risks and concerns about data security and consumer protection on the one hand, and far-reaching potential impact on the effectiveness of monetary policy itself on the other hand, forced RBI to impose the ban on trading of virtual currencies.
  • Further, owing to a significant spurt in the valuation of many virtual currencies and rapid growth in initial coin offerings, virtual currencies were not safe for use.

Petitioner’s Argument

  • The petitioner, Internet and Mobile Association of India (IMAI), had argued in the top court that the RBI had banned cryptocurrencies on "moral grounds" as no prior studies were conducted to analyse their effect on the economy.
  • It was also argued that cryptocurrencies were not "currency" in the strict sense, and that they could be termed as a medium of exchange or a store of value.
  • The RBI should have adopted a wait-and-watch approach, as taken by other regulators such as the Directorate of Enforcement or the Securities and Exchange Board of India.

Impact of SC Judgment

  • The order is likely to come as a big relief to VC proponents in the country.
  • It could lead RBI to reconsider its approach to cryptocurrency and come up with a new calibrated framework or regulation that deals with the reality of these technological advancements.

Digital Currencies

  • Digital currency is the blanket term used to describe all electronic money; that includes both virtual currency and cryptocurrency. It can be regulated or unregulated.
  • Digital currencies, which can only be owned and spent using electronic wallets or designated connected networks, are also commonly called digital money, or cyber cash.

Forms of Digital Currencies

Virtual Currencies

  • Virtual currencies are a type of digital currency, typically controlled by its creators and used and accepted among the members of a specific virtual community.
  • Cryptocurrencies such as Bitcoin and Ethereum are considered to be virtual currencies.
  • Satoshi Nakamoto, widely regarded as the founder of the modern virtual currency -Bitcoin

Cryptocurrencies

  • Cryptocurrencies are digital currencies because they exist online, but they are also virtual currencies created with cryptographic algorithms.
  • Most cryptocurrencies now operate on the blockchain or distributed ledger technology, which allows everyone on the network to keep track of the transactions occurring globally.

Risks Associated with Cryptocurrencies

Business Risk

  • Cryptocurrencies are not backed by a central bank, a national or international organization, or assets or other credit, and their value is strictly determined by the value that market participants place on them through their transactions, which means that loss of confidence may bring about a collapse of trading activities and an abrupt drop in value.

Cyber/Fraud Risk

  • Even with encryption to protect cryptocurrency transactions, there have been hacks resulting in substantial losses.
  • Passwords can be stolen or hacked. Hardware can be corrupted or taken.

Regulatory/Compliance Risk

  • Some countries may prevent the use of the currency or may state that transactions break anti-money laundering(AML) regulations, notwithstanding the global implications.
  • Due to the complexity and decentralized nature of the Bitcoin and the significant number of participants — senders, receivers (possibly launderers), processors (mining and trading platforms), currency exchanges, a single AML approach does not exist.

Market Risks

  • The market risks are idiosyncratic as the currency trades only on demand. There is a finite amount of the currency which means that it can suffer from liquidity concerns and limited ownership may make it susceptible to market manipulation.
  • Further more, given its limited acceptance and lack of alternatives, the currency can appear more volatile than other physical currencies, fueled by speculative demand and exacerbated by hoarding.

Source : Civil Services Chronicle Online, March, 2020