INDIA’S STRUGGLE WITH THE LEGAL REGULATION OF CRYPTO CURRENCY

This article has been written by Faiza M, currently in fourth year pursuing a BBA LLB (Hons.) at Crescent University, Chennai.

 Abstract:

Cryptocurrencies have had a huge impact on the global financial system, and India has emerged as one of the biggest markets for their adoption. However, the decentralized and borderless nature of cryptocurrencies poses significant regulatory challenges. India struggled to establish a clear regulatory framework, resulting in major developments, such as the Reserve Bank of India’s (RBI) ban on banking services for cryptocurrency companies in 2018 and the Supreme Court’s landmark ban decision the ban is lifted by 2020. This article examines the complexities of cryptocurrency regulation in India Examine the legal issues faced by the same.

Cryptocurrencies running on decentralized blockchain technology present opportunities for financial innovation but also raise concerns about fraud, money laundering and consumer protection. These concerns have led to legislative and judicial efforts to regulate structured system. The article looks at the Indian legal system, covering key statutes such as the Reserve Bank of India Act, the Prevention of Money Laundering Act (PMLA), etc.

As India navigates these challenges, the need for a balanced regulatory framework will become increasingly important to ensure financial stability and promote blockchain technology. This article examines these issues and provides insights for policymakers looking to address the complexities of cryptocurrency regulation in India.

Key words: Cryptocurrency, Blockchain, Reserve Bank of India, Regulation, Digital currency,

Introduction:

Cryptocurrency, a decentralized digital currency based on blockchain technology, has grown in popularity around the world. Its potential for financial innovation and disruption is enormous, but it also raises issues about regulation, fraud, consumer protection, and financial security. India, with its thriving digital environment and technical breakthroughs, has seen significant acceptance of cryptocurrencies like Bitcoin, Ethereum, and Ripple. However, the unregulated nature of these assets has resulted in legal difficulties, causing the Indian government and regulatory organizations to look for measures to limit their risks without inhibiting technical innovation. This article delves into India’s issue with cryptocurrency legal regulation, including a history of the regulatory landscape, major case laws, legislative acts, and what the country’s crypto future holds.

A Deep Dive into Cryptocurrency and Blockchain:

Cryptocurrencies are digital assets built on blockchain technology, which is a decentralized, distributed ledger system that records transactions between computers This technology ensures transparency, immutability and security, which is central to its appeal. Unlike traditional currencies, which are controlled by major authorities such as central banks, cryptocurrencies are governed by algorithms, making regulation a complex task

The first cryptocurrency, Bitcoin, was Invented in 2009 by an anonymous individual or group named Satoshi Nakamoto. It was conceived as an alternative to traditional fiat currencies, providing peer-to-peer transactions without the need for intermediaries such as banks and was followed by Ethereum, Ripple and Litecoin, each of which brought unique technological innovations to the cryptocurrency landscape.

The early stages of cryptocurrency trading and investment in India were largely unregulated, creating a legal gray area. The absence of a formal regulatory framework led officials to worry about the risks of these digital assets, such as fraud, money laundering and the possibility of financing terrorists and hence India regulators including RBI and government took an increasingly cautious stance.

The Initial Approach of Indian Authorities toward Cryptocurrency:

Initially, the Reserve Bank of India (RBI) and other financial regulators were hesitant to adopt a firm stance on cryptocurrencies. In 2013, the RBI issued its first public warning against the usage of virtual currencies, expressing worries about cryptocurrencies’ volatility and involvement in criminal operations such as money laundering and drug trafficking. Despite these worries, cryptocurrency exchanges like as Zebpay, Unocoin, and Coinsecure thrived in India, as the digital currency sector grew fast.

The government’s attitude remained unclear, and the lack of legislation resulted In broad acceptance of cryptocurrencies. Simultaneously, technical advances and blockchain-based startups grew. However, the regulatory vacuum exposed investors and consumers to hazards such as scams, fraud, and hacking attacks, leading to increased calls for government action.

RBI Circular of 2018: The Regulatory Backlash:

The RBI issued a circular in April 2018 forbidding banks and financial institutions from providing virtual currency services, marking a watershed moment in India’s regulatory stance to the cryptocurrency. This move effectively closed cryptocurrency exchanges in India because they could no longer use banking services, making it difficult for investors to convert their digital assets into fiat currency.

The RBI justified the circular by citing the hazards connected with virtual currencies, which included worries about consumer protection, financial stability, and their usage in criminal activities. The circular stated: “The Reserve Bank has consistently advised users, holders, and traders of virtual currencies (VCs) about the risks associated with dealing with such VCs. Given the accompanying dangers, it has been resolved that, effective immediately, entities regulated by the Reserve Bank shall not deal with or offer services to any individual or corporate entity dealing with or settling VCs.”

The circular sparked a wave of uncertainty, forcing numerous cryptocurrency exchanges to shut down or relocate their operations offshore. However, this did not fully prohibit cryptocurrency trading in India, as many investors continued to deal using peer-to-peer (P2P) network.

Supreme Court’s Verdict in Internet and Mobile Association of India v. Reserve Bank of India (2020):[1]

The cryptocurrency community strongly opposed the RBI’s 2018 prohibition, prompting the Internet and Mobile Association of India (IAMAI) to file a legal challenge in the Supreme Court. The petitioners claimed that the RBI’s circular breached their fundamental freedom to conduct any trade or business, which is guaranteed by Article 19(1)(g) of the Indian constitution. They also claimed that the RBI’s action was arbitrary, citing a lack of legislative guidelines and complete regulation of cryptocurrency.

In March 2020, the Supreme Court issued a momentous decision, overturning the RBI circular and enabling bitcoin businesses to restart operations. The Court decided that while the RBI has the authority to regulate virtual currencies, the blanket prohibition on financial services was inappropriate. The ruling rekindled bitcoin trading in India and sparked increased investor interest.

In its ruling, the Supreme Court stated:  “When the consistent stand of RBI is that they have not banned virtual currencies and when the Government of India is unable to take a call despite several committees coming up with several proposals including two draft bills and one interdisciplinary committee report, as to what is the legal status of these currencies and assets, persons who trade in these currencies and assets should be seen as performing a legitimate trade.”

This verdict was a big success for India’s cryptocurrency industry, as it restored exchanges’ access to banking services. However, it also emphasized the critical need for the government to develop a clear regulatory framework for digital assets.

Following the Supreme Court’s judgment, the Indian government recognized the necessity for a clear legal framework for bitcoin. While the RBI continued to raise worries about the hazards connected with digital currencies, the government began to study various legislative alternatives to regulate the sector.

In 2019, the government proposed the “Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019.” The draft measure proposes a total prohibition on private cryptocurrencies, as well as criminalizing the possession, mining, trading, and issue of digital currencies. It also planned to launch a digital currency backed by the RBI. Despite the draconian provisions, the 2019 bill was never signed into law. The challenges of enforcement and opposition from stakeholders, especially the tech community and investors, slowed its passage. Furthermore, as the worldwide demand for cryptocurrencies grew, the Indian government revised its stance, balancing the necessity for regulation with supporting innovation in blockchain technology.

The Bill for Regulating Cryptocurrency and Official Digital Currency (2021):

The government introduced a new bill, “The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021,” in Parliament in 2021. The bill was intended to:

1. All private cryptocurrencies in India should be banned.
2. Establish a legal framework for the RBI to issue its own official digital money.
3. Promote blockchain technology while discouraging speculative trading of cryptocurrency.

The law sought to find a compromise between promoting technical innovation and addressing the hazards associated with unregulated cryptocurrency. However, the full substance and ramifications of the measure are unknown, as the government has repeatedly delayed its introduction in Parliament.

Comparative Approaches to Cryptocurrency Regulation Globally:

India’s approach to cryptocurrency regulation is informed by global events. Countries like as Japan and the United States have taken a more lenient approach, recognizing cryptocurrencies as genuine assets while enforcing strong anti-money laundering (AML) and know-your-customer (KYC) requirements.

India’s regulatory strategy is also influenced by international trends. Various nations have used different models to regulate cryptocurrency. For example –

1. Japan: In 2017, Japan implemented the Payment Services Act, which recognized cryptocurrencies as a legitimate payment mechanism. This legislation imposed onerous exchange registration requirements, as well as strict AML and KYC regulations.
2. United States: In the United States, cryptocurrencies are treated differently depending on their classification. The Securities and Exchange Commission (SEC) classifies some digital currencies as securities, whereas the Commodity Futures Trading Commission (CFTC) classifies others as commodities. The regulatory structure in the United States is geared toward ensuring transparency and protecting consumers.
3. China prohibits cryptocurrency trading and mining. Instead, it has concentrated on creating its own Central Bank Digital Currency (CBDC), the Digital Yuan, to preserve control over its monetary system.

The Path Toward a Regulatory Framework:

Reserve Bank of India Act, 1934:

The Reserve Bank of India Act, 1934 (RBI Act) gives the RBI broad authorities to govern and control India’s monetary policy and currency system. Although the Act makes no specific mention of digital or virtual currencies such as cryptocurrencies, it is through this Act that the RBI has attempted to regulate their use in India.

Relevant Sections of the RBI Act :

 Section 3 establishes the Reserve Bank of India as the authority in charge of regulating banknote issuance and maintaining reserves to ensure India’s monetary stability.

Section 22 gives the RBI exclusive right to issue banknotes in India, implying that any other form of currency, including cryptocurrencies, may require regulation to avoid problems with the official monetary system.

Section 45J: Gives the RBI the authority to issue directions to non-banking financial institutions, which is important for organizations that provide cryptocurrency-related services such as exchanges and wallets.

Section 45L: The RBI can direct financial institutions to control their operations in the public interest or in accordance with banking policy. The RBI has used this section to issue circulars on cryptocurrency trading and transactions.

Section 58: Gives the RBI general powers to create rules to carry out the Act’s goals, which serve as the foundation for cryptocurrency guidelines and circulars.

Case law:

Karma Energy Ltd. Vs. Reserve Bank of India (2017):[2]

 This case, while not immediately linked to cryptocurrency, is noteworthy because it addresses the RBI’s larger powers under the RBI Act to issue instructions to financial institutions and regulate currency. It strengthens the RBI’s power to provide guidelines that promote financial stability and consumer protection.

The Prevention of Money Laundering Act (PMLA), 2002:

The Prevention of Money Laundering Act (PMLA) of 2002 is India’s principal legislation aimed at fighting money laundering and terrorist financing. With the emergence of cryptocurrencies, which provide anonymity and borderless transactions, there have been concerns about their potential use in money laundering activities. As a result, the PMLA’s Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations are critical to the regulation of cryptocurrency exchanges and enterprises.

Relevant Sections of the PMLA:

Section 3: “Money laundering” is defined as the direct or indirect attempt to conceal, possess, acquire, use, or project criminal gains as untainted property. Offenders who use cryptocurrencies to launder the proceeds of illicit activity may face prosecution under this section.

Section 4: Punishment for Money Laundering- Anyone convicted guilty of money laundering faces a sentence of three to seven years in prison and a fine.

Section 12: Obligations of Reporting Entities – Mandates that financial institutions, intermediaries, and other organizations (including cryptocurrency exchanges) keep transaction records and adhere to KYC processes. They are also required to notify any suspicious transactions to the Financial Intelligence Unit (FIU) of the Ministry of Finance.

 Section 17: Search and seizure- Allows authorities to examine premises and take property, including cryptocurrency holdings, if they are suspected of money laundering.

Section 19: Power to Arrest-  The Enforcement Directorate (ED) has the authority to arrest individuals accused of participating in money laundering activities, including the use of cryptocurrency.

Section 24: Burden of Proof-  In money laundering cases, the burden of proof shifts to the accused, which means that if the authorities establish a link between the accused and the profits of crime (for example, through bitcoin transactions), the accused must show their innocence.

Case law:

Unocoin Technologies Pvt. Ltd. V. Union of India (2020):[3]

Unocoin, a cryptocurrency exchange, contested the inclusion of cryptocurrency enterprises within PMLA’s jurisdiction, alleging that because cryptocurrencies are not officially recognized as legal tender, they should not be subject to AML/KYC duties under the Act. The court rejected Unocoin’s claims, and the government maintained that cryptocurrency exchanges are financial intermediaries subject to PMLA’s KYC and AML requirements.

Information Technology Act, 2000:

The Information Technology Act (IT Act) of 2000 is important legislation in India that concerns cybercrime, internet commerce, and data protection. With the emergence of cryptocurrencies and their increasing incorporation into online transactions, some provisions of the IT Act become more applicable, especially in situations of hacking, fraud, and other cybercrimes involving cryptocurrency transactions.

Relevant Provisions of the IT Act:

Section 2(1)(w) defines an electronic signature that can be used to authenticate cryptocurrency transactions. This section ensures the validity of digital signatures used in electronic transactions, particularly those involving cryptocurrencies.

Section 66: Computer-related offences- Hacking, identity theft, and other forms of illegal computer system access are criminalized. If a person hacks a cryptocurrency exchange or uses identity theft to get access to bitcoin wallets, they may face prosecution under this clause.

Section 66C:  Identity Theft- Specifically targets identity theft by making it a crime to illegally use someone else’s electronic signature, password, or any other unique identification feature. This rule is especially essential in circumstances where people try to gain illegal access to bitcoin accounts.

Section 66D: Cheating via Personation- Punishes any act of cheating by impersonating another person via electronic means. In the context of cryptocurrencies, this could refer to fraudulent schemes in which persons pretend as legitimate investors or operators in order to scam others.

Section 67: Publish or Transmit Obscene Material in Electronic Form-  Although it is primarily intended to restrict the distribution of obscene content, it is also applicable to cybercrimes involving cryptocurrencies, particularly frauds involving illicit transactions.

Section 70: Protected System- Protects crucial information infrastructure. Cryptocurrency exchanges that contain sensitive customer data must follow this clause, which may include safeguarding systems against cyberattacks.

Section 72: Breach of Confidentiality and Privacy- Addresses the breach of confidentiality by service providers. If bitcoin exchanges fail to protect their users’ private information and data, they may be held accountable under this provision.

Case laws:

HDFC Bank Ltd. V. Ramesh Singh (2018):[4]

This case involved unauthorized services that launched phishing attacks targeting online banking users, including those involving cryptocurrencies. The court held that banks and cryptocurrency exchanges have a duty to ensure that cybersecurity measures are in place to protect customers’ data and transactions, falling within the need to comply with the ICT Act tough.

State of Tamil Nadu v. K. P. Mohan (2021):[5]

In this case, the accused was charged with defrauding a bitcoin investment scam. The case concerned claims of hacking into a cryptocurrency wallet. The court upheld the applicability of the IT Act’s provisions to computer-related offenses, underlining that fraudulent conduct involving cryptocurrency are criminal under Section 66 of IT Act.

Cyber Crime Investigation Cell v. Neeraj Kumar (2020):[6]

The defendant was charged with hacking a cryptocurrency exchange and stealing digital assets. The lawsuit centered on the legality of transactions made using compromised accounts. The court ruled Strict penalties under the IT Act, saying that the conduct constituted both hacking and identity theft, making them subject to several sections of the Act.

Securities Contracts (Regulation) Act, 1956:

The Securities Contract (Regulation) Act (SCRA), 1956 is an important law in India that regulates securities trading and regulates the functioning of stock exchanges Classification of cryptocurrencies as securities has been subject of dispute, if cryptocurrencies are considered under this category.

Section 2(h): Definition of “Securities”.

This section provides a broad definition of securities, including shares, stocks, bonds, debentures, and other financial instruments. The definitions in this section are important in determining whether cryptocurrencies can be classified as securities. If cryptocurrencies are considered financial contracts or financial instruments, they could fall under this definition.

Case laws:

SEBI v. A.P. Sethi (2009):[7]

In this case, the Securities and Exchange Board of India (SEBI) had sought an investment strategy that promised returns based on investments in various products, including cryptocurrencies. SEBI has ruled that certain financial instruments issued to the public are indeed protected under the SCRA, emphasizing the importance of classification based on their economic function rather than legality the emphasis. This article sets a precedent for evaluating cryptocurrencies in the context of securities regulation.

Securities and Exchange Commission v. W.J. Howey Co. (1946):[8]

Despite being a US case, the Howey test established parameters for deciding whether particular transactions qualify as investment contracts (and hence securities). The test determines whether there is a financial investment in a shared venture with the expectation of profits from other people’s labor. This case influenced global arguments about the classification of cryptocurrencies as securities, including in India. If cryptocurrencies meet the Howey test criteria, they may be considered securities under the SCRA.

Securities and Exchange Board of India v. Rakesh Kumar Sethi (2021):[9]

This case concerned a Ponzi scheme in which investments were made in cryptocurrency. SEBI took action against the scheme’s promoters. The court accepted SEBI’s supervisory responsibility in protecting investors in financial instruments, which might include cryptocurrencies if they are categorized as securities under SCRA.

Core Issues in Governing Cryptocurrencies:

India’s challenge to regulate cryptocurrencies stems from numerous critical issues:

1. Consumer Protection: Cryptocurrencies are extremely volatile, and without sufficient safeguards, investors face considerable dangers. Scams, fraud, and hacking occurrences are common in the unregulated market, resulting in financial losses for investors.
2. Illicit Uses: Because of their anonymity, cryptocurrencies are vulnerable to abuse for unlawful operations such as money laundering, drug trafficking, and terrorist financing. Regulating these assets is critical for preventing such acts.
3. Financial Stability: The decentralized nature of cryptocurrencies challenges existing monetary systems. If left uncontrolled, they have the potential to undermine central bank authority and disrupt financial system stability.

4.Technological Innovation: Blockchain technology, which underpins cryptocurrencies, provides several prospects beyond digital money. The government has the challenge of encouraging blockchain innovation while prohibiting speculative trading in cryptocurrency.

Conclusion

In conclusion, India is at a pivotal point in cryptocurrency regulation, with the prospective introduction of a Central Bank Digital Currency (CBDC) laying the framework for a secure and well-regulated digital currency landscape. A comprehensive regulatory framework is essential, encompassing the classification of cryptocurrencies as commodities or securities to provide market clarity, the implementation of stringent Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations to combat illegal activities, the establishment of clear consumer protection guidelines to bolster investor confidence, and the introduction of taxation and reporting requirements to ensure accountability and curb taxes. This balanced approach would not only protect investors’ and consumers’ interests, but will also spur innovation in blockchain technology, allowing India to properly leverage the benefits of cryptocurrencies while limiting associated dangers.

[1] Internet and Mobile Association of India v. Reserve Bank of India, (2020) 10 SCC 274.

[2] Karma Energy Ltd. V. Reserve Bank of India, (2017) 15 SCC 182.

[3] Unocoin Technologies Pvt. Ltd. V. Union of India, W.P. © No. 1012/2020 (Delhi High Court Nov. 11, 2020).

[4] HDFC Bank Ltd. V. Ramesh Singh, (2018) 1 SCC 607.

[5] State of Tamil Nadu v. K. P. Mohan, 2021 SCC Online Mad 9089.

[6] Cyber Crime Investigation Cell v. Neeraj Kumar, 2020 SCC Online Del 1453.

[7] SEBI v. A.P. Sethi, (2009) 1 Comp LJ 255 (SAT).

[8] Securities and Exchange Commission v. W.J. Howey Co., 328 U.S. 293 (1946).

[9] Securities and Exchange Board of India v. Rakesh Kumar Sethi, (2021) 2 SCC 409.